What post-acquisition restructuring, if any, is typically carried out and why?
It is often desirable for inbound investors to engage in a post-acquisition integration for various reasons, such as to align the various parts of the group’s businesses, to take advantage of any international tax planning opportunities and to minimise any unnecessary tax leakage. For example, the group may wish to remove any non-US subsidiaries of its newly acquired US business ‘out from under’ the US target corporation to avoid various international regimes that could cause tax leakage to the multinational group going forward, for example, current taxation of certain offshore earnings in controlled foreign corporations, ‘global intangible low-taxed income’ or BEAT. In addition, post-acquisition integration may be necessary to consolidate the group’s unitary groups in various jurisdictions to avoid inefficiency.
Such post-acquisition restructuring may be achieved by any of the techniques discussed in this chapter, including taxable and tax-free acquisitive reorganisations, tax-free spin-offs, incorporations and corporate liquidations, intellectual property planning or various intercompany payments.
Certain post-acquisition restructuring, if part of the same plan, may result in the transaction receiving different tax treatment than anticipated. This can occur generally under certain judicial doctrines, such as the substance-over-form doctrine or step-transaction doctrine.Spin-offs
Can tax-neutral spin-offs of businesses be executed and, if so, can the net operating losses of the spun-off business be preserved? Is it possible to achieve a spin-off without triggering transfer taxes?
US tax law generally allows for spin-offs to be structured to defer the recognition of gain on certain business dispositions. The rules for achieving tax-free treatment are detailed and complex. A tax-free spin-off is the only way under US tax law to remove appreciated assets from corporate solution without paying corporate tax on the appreciation.
The legal form of a tax-free spin-off typically involves the distribution by one corporation (the distributing corporation) of stock of another pre-existing or newly formed corporation (the controlled corporation) to the shareholders of the distributing corporation. For a spin-off to be tax-free, multiple technical requirements must be met, including:
- the distributing corporation must distribute at least 80 per cent of the controlled corporation’s stock;
- the distributing corporation and controlled corporation must each engage in the active conduct of a trade or business immediately after the spin-off, including meeting certain five-year requirements regarding the active conduct of a trade or business before the spin-off;
- the spin-off must not be used as a device for the extraction of earnings and profits;
- the spin-off must have a non-tax business purpose; and
- the historic shareholders must meet certain continuity of interest stock ownership requirements with respect to both the distributing corporation and the controlled corporation.
In particular, requirements (3) and (5) may limit the ability to dispose of controlled or distributing stock in connection with the spin-off without potentially impacting the tax-free nature of the spin-off.
If these and other technical requirements are met, generally the distributee shareholder has no income upon its receipt of the controlled corporation’s stock and allocates its historic basis in the distributing corporation’s stock between the stock of the distributing and the controlled in proportion to their relative fair market values, and the distributing corporation recognises no gain or loss on the distribution of the controlled corporation’s stock.
The US tax rules that ‘turn off’ non-recognition in certain inbound, outbound and foreign-to-foreign transfers must be carefully analysed. No US federal transfer taxes apply to a spin-off.Migration of residence
Is it possible to migrate the residence of the acquisition company or target company from your jurisdiction without tax consequences?
Migrating the tax residence of a US corporation to a foreign jurisdiction generally occurs with significant US tax consequences. First, generally, outbound transfers of appreciated stock or assets that ordinarily benefit from certain non-recognition provisions of US tax law (such as corporate liquidations, contributions or tax-free reorganisations) are subject to gain recognition (unless one of a limited number of exceptions applies). If the transferred assets are intangibles, the transferor may incur deemed royalty income, which is generally ordinary in character. Even if an exception applies, certain outbound stock transfers subject to this rule may require the transferor to enter into a gain recognition agreement with the US Internal Revenue Service to benefit from non-recognition (which subjects the transferor to gain recognition upon the occurrence of certain future events).
In addition, US tax law includes detailed rules designed to prevent corporate inversions. Very generally, if a non-US corporation acquires directly or indirectly (eg, via the acquisition of 100 per cent of its stock) substantially all of the assets of a US corporation, at least 60 per cent of the historic US corporate shareholders continue to own the acquiring non-US corporation, and the multinational group does not have substantial business activities in its jurisdiction of tax residence (the 60 per cent test), then the acquired US corporation may be limited in its ability to do certain types of post-acquisition restructuring in a tax-efficient manner. Additionally, certain insiders may be subject to an excise tax on their stock compensation, and any deferred repatriation tax imposed in connection with the 2017 US tax reform is recaptured at a 35 per cent rate. Moreover, if the requirements of the 60 per cent test are met by substituting 80 per cent for 60 per cent, the acquiring non-US corporation is treated as a US corporation subject to worldwide taxation in the United States.Interest and dividend payments
Are interest and dividend payments made out of your jurisdiction subject to withholding taxes and, if so, at what rates? Are there domestic exemptions from these withholdings or are they treaty-dependent?
Non-US tax residents are generally taxed in the United States on their US source income associated with passive investment assets, including dividends and interest. Such income is subject to a 30 per cent gross basis tax that is enforced by withholding at the source.
In the case of interest, the ‘portfolio interest exemption’ generally exempts, from the otherwise applicable withholding tax, interest paid on registered obligations held by non-US persons that own less than 10 per cent of the voting stock of the borrower. The portfolio interest exemption is subject to various requirements and exceptions; for example, it is not available to banks receiving interest on ordinary-course loans.
The withholding tax on both dividends and interest may be reduced or eliminated by an applicable income tax treaty. Most modern US income tax treaties contain a ‘limitation on benefits’ article, which is intended to prevent tax residents of jurisdictions with which the United States does not have an income tax treaty in effect from obtaining benefits under an income tax treaty between the United States and a third country (‘treaty shopping’). Additionally, US tax law may deny any reduced withholding rate otherwise applicable under an income tax treaty to non-US persons if payments are made through a hybrid entity.Tax-efficient extraction of profits
What other tax-efficient means are adopted for extracting profits from your jurisdiction?
US income tax treaties with many jurisdictions have a 0 per cent withholding rate on dividends and interest payments. However, to the extent that the US does not have an existing treaty with the relevant country (or the treaty does not provide for a 0 per cent treaty rate of withholding on dividends or interest), it may be necessary to undertake additional steps to extract earnings out of the US in a tax-efficient manner.
Under US tax law, only distributions out of earnings and profits are subject to US withholding tax. Thus, US tax planning that can reduce or eliminate earnings and profits can provide a repatriation benefit.
Repayment of principal on intercompany debt, even if sourced from earnings, is not subject to withholding tax. However, recent debt-or-equity and anti-hybrid regulations have made it harder to extract profits from the United States through the use of intercompany debt.
US sourced royalties subject to US tax may qualify for a reduced withholding rate under the relevant income tax treaty. Compensation for services performed outside the United States by employees, officers or directors is generally sourced outside the United States and such compensation is generally not subject to US tax. Royalties and compensation for services may present opportunities to extract profits in a tax-efficient manner if structured properly. Cost-sharing agreements, which generally relate to the costs of the development of intangibles, may also be effective if certain requirements are met.