In June, the IRS and U.S. Treasury released final regulations under the anti-inversion provisions of Section 7874 (T.D. 9720). The final rules, effective for acquisitions completed on or after June 3, 2015, include a few changes from the regulations proposed in 2012. Most notably, the final rules retain the 25 percent bright-line tests for whether an expanded affiliated group (EAG) has “substantial business activities” in a foreign country for the purpose of determining whether the foreign parent of an inverted corporation will be treated as a “surrogate foreign corporation.” The controversial bright-line tests first appeared in the 2012 proposed regulations, and many stakeholders found the tests—especially the 25 percent threshold—unnecessarily tough to achieve Section 7874’s policy objectives. Multinationals with operations in many countries, for example, could have trouble meeting the 25 percent thresholds in any single foreign country where an acquiring foreign corporation is organized. The 2015 regulations include some helpful, simplifying rules in applying the substantial business activities tests, but the retention of the strict bright-line threshold reflects the government’s and the general public’s unsympathetic view of inverting companies and ongoing efforts to rein in the trend.


Section 7874 was added to the Code to combat the perceived abuse of U.S. entities inverting into foreign corporations to move their tax residency outside the U.S. The statute’s provisions operate to prevent these transactions by fully taxing gain on the inversion transaction or, in some cases, by treating the foreign acquiring corporation as a domestic corporation for U.S. tax purposes. Section 7874 applies if, pursuant to a plan or a series of related transactions, (1) a foreign corporation acquires substantially all the assets of a U.S. entity, (2) after the acquisition, the former owners of the U.S. entity hold at least 60 percent (by vote or value) of the stock of the foreign corporation by reason of holding interests in the U.S. entity, and (3) the EAG (connected by more than 50 percent ownership) that includes the acquiring foreign corporation does not have substantial business activities in the foreign country in which the foreign corporation is incorporated.

2015 Regulations

The final regulations maintain the 25 percent tests for substantial business activities. The rules incorporate several “operational” rules for applying the 25 percent bright-line tests:

  • Items disregarded under Section 7874(c)(4) (relating to avoidance transfers) are excluded from both the numerator and denominator of the relevant fractions.
  • The timing and amount of employee compensation for purposes of the 25 percent test must be determined under U.S. income tax principles.
  • Whether an individual is an employee of an EAG member can be resolved under U.S. income tax law or applicable foreign law—provided the same standard applies to all EAG members.
  • Group income may be determined using U.S. income tax principles, U.S. generally accepted accounting principles (GAAP), or International Financial Reporting Standards (IFRS)—provided that income is determined consistently for all EAG members.

The 2015 regulations also “clarify” certain rules for determining the members of an EAG:

  • An entity that is not a member of an EAG on the acquisition date will not be a member of the EAG even though it was a member earlier in the testing period (i.e., the one-year period ending on the date the acquisition is completed or the last day of month preceding the acquisition month).
  • The members of an EAG are determined by taking into account all transactions related to an acquisition, even those that occur after the acquisition.
  • Coordination for the “deemed corporation” rule and “partnership look-through” rule: The deemed corporation rule allows more than 50 percent owned partnerships to be treated as EAG members, while the partnership look-through rule treats each partner in a partnership as holding its proportionate share of stock held by the partnership. Under the final regulations, the look-through rule will apply first to identify the actual corporations included in an EAG. Next, the deemed corporation rule applies to treat partnerships in which those corporations own more than 50 percent interests as corporations and, therefore, EAG members.