corporate spin-offs: international is the harder part · • a 2015 nysba report noted the...

Corporate Spin-Offs: International is the Harder Part

Moderator:

Nicholas J. DeNovio

Latham & Watkins LLP

Lead Presenter:

Rachel Kleinberg

Davis Polk & Wardwell LLP

Panelists:

Debbie Paul

Wachtell, Lipton, Rosen & Katz

Gretchen Sierra

Deloitte Tax LLP

November 8, 2019

Agenda

• Part I: Overview

• Part II: Splitting Up A Global Group – Allocating Attributes Among CFCs

• Failure of Rules Focused on Preservation of Section 1248 Amount

• General Pass-Through Approach to Allocating E&P and Basis

• The Challenges of PTI

• Part III: Mergers and Inversion Issues Following Spins

• Section 367(a) and Device

• Section 367(a) and ATB

• Overbreadth of NOCD rules

• Shortfalls of Foreign-Parented Group Exception

• Spinversion issues

2

Part I: Overview

3

Basic US Spin Structure

4

U.S. Parent

(Distributing)

Public

U.S. Spin Co. Retain Co.

U.S. Parent

(Acquiror)

U.S. Merger Co.

Public

Contribution of assets and

domestic and foreign

subsidiaries to U.S. Spin Co. 1

Distribution of

U.S. Spin Co. 2

Acquisition of U.S. Spin

Co. for Acquiror shares 4

Merger 3

Subs Subs Domestic and

Foreign Subs Subs Subs Domestic and

Foreign Subs Business to be

spun off

Business to be

retained

But Today …

5

U.S. Parent

(Distributing)

Sub 1 US

Sub 3 F

Sub 4 F

Sub 5 US

Sub 9 F

Sub 6 F

Sub 10 F

Sub 14 F

Sub 11 F

Sub 12 F

Sub 13 F

Sub 7 US

Sub 8 F

Sub 2 US

Business to be

spun off

Business to be

retained

But today, U.S. Parent (Distributing) looks like this . . .

(Page 1 of Steps Plan Deck)

Today, many of the Subs conduct both businesses. The goal is to

reshuffle this group and move assets and subs to U.S. Spin Co. . . .

Sub 15 F

Sub 16 F

Reshuffle (Pages 2 – 198 of Deck Do This …)

6

U.S. Parent

(Distributing)

. . . as shown here . . .

Sub 1 US

Sub 3 F

Sub 4 F

Sub 5 US

Sub 9 F

Sub 6 F

Sub 10 F

Sub 14 F

Sub 11 F

Sub 12 F

Asset Transfers

(orange assets)

3

Sub 17

(Newco) F Form

Newco 2

Internal

Spin Sub 16

by Sub 11

4

Internal

Spin Sub 15 and 17

by Sub 7

5

Sub 13 F

Sub 7 US

Sub 8 F

Transfer

Sub 15 and 17

Shares

6

Internal

Spin Sub 8

by Sub 2

7

Sub 2 US

Split up the group, and go through each step dealing with

Subchapter C non-recognition rules, Subpart F, GILTI, PTI, FTC, etc.

U.S. Spin Co.

Business to be

spun off

Business to be

retained

Sub 15 F

Internal

Spin Sub

15 by Sub

12

1

Sub 16 F

8

Asset

Transfers

(orange

assets)

Internal

Spin Sub

16 by Sub

4

9

The Goal …

7

To get to this point . . .

(Page 199 of Deck)

U.S. Parent

(Distributing)

Public


U.S. Parent

(Acquiror)

U.S. Merger Co.

Public




Distribution of

U.S. Spin Co. 2


Co. for Acquiror shares 4

Merger 3

Subs Subs Domestic and

Foreign Subs Subs Subs Domestic and

Foreign Subs

Business to be

spun off

Business to be

retained

Assume Acquiror Is a Foreign Acquiror

8

U.S. Parent

(Distributing)

Public

Foreign Parent

(Acquiror)

U.S. Merger Co.

Public

Shareholders of Distributing must get back more than 50% of Foreign Parent (Acquiror) for Section 355(e)

vs.

Shareholders of Distributing must get back 50% or less of Foreign Parent (Acquiror) for Reg. § 1.367(a)-3(c) to work

Retain Co. U.S. Spin Co. Business to be

spun off

Business to be

retained




Distribution of

U.S. Spin Co. 2

Merger 3


Co. for Foreign Parent

shares 4

Challenges with Foreign Acquiror, cont’d

9

Foreign Parent

(FP)

Say the deal was done but did not qualify as tax-free under Section 367(a)

U.S. Parent

Public Legacy FP

Public

>50% <50%

U.S. Parent

100%

Subs Subs

Legacy

FP Subs

Today: Foreign Parent wants to break up U.S. Spin Co.


Business to be

spun off

Business to be

retained

Another Series of Issues

10

U.K. Parent

U.K. Spin Co.

Public

Incorporated in

1889

Subs Subs

U.S. Subs Subs

Subs EU Subs

Subs Subs

LATAM Subs Subs

Subs APAC Subs


subsidiaries to U.K. Spin Co. 1

Distribution of U.K. Spin Co. 2

Issues Post-Spin

11

Post-spin, perhaps U.K. Spin Co. will issue shares as part of another deal . . .

U.K. Parent U.K. Spin Co.

Public

Spun-Off

Business

Investors $$$

Shareholders

Target

OR

Subs Subs

Retained Subs

Historical Context

12

While the United States was engaged in a nearly two-decade long debate on

tax policy, a statute was enacted to target this . . .

U.S. Parent

Shareholders

U.S. Management

and Operations

Bermuda Ltd.

Reincorporation

Shareholders

U.S. Management

and Operations

Part II: Splitting Up a Global Group

• This Part focuses on how attributes (basis, E&P, PTI) should be

allocated when one CFC distributes another CFC in a Section

355 transaction

• I am not addressing transactions where Distributing or Controlled is a US

corporation – the goal is a more modest one of trying to determine how to

divide up attributes in a single CFC group

• What should the primary goals of the allocation be?

• Should the rules work differently in a D reorganization versus a

straight spin? A pro rata versus non pro rata distribution?

13

The Current Rules’ Focus on Preserving Section 1248 Amounts Never Worked Well

• Preserving the Section 1248 amount for a CFC’s shareholders was all-important so

basis and E&P were used as levers to preserve that amount

• The debate was whether to make adjustments to preserve the shareholders’

relationship to current E&P or unrealized gain

• A 2015 NYSBA report noted the distinction between preserving pre-division E&P and

preserving potential E&P (i.e., preserving shareholder taxation of unrealized built-in

gains)

• Allocating E&P in accordance with FMV focused on pre-division E&P while using a net

basis method preserved the shareholder relationship with unrealized built-in gains

• Proposed Regulations §1.367(b)-8 uses relative net basis (asset tax basis minus

liabilities assumed) rather than the FMV allocation of §1.312-10 because of a

concern that a later recognition of gain on appreciated property could produce

additional E&P

14

The Current Rules’ Focus on Preserving Section 1248 Amounts Never Worked Well (cont.)

• While tracing E&P to the assets generating them has philosophical appeal, it

adds even more complexity and so the rules never adopted that approach

• The current rules have always had problems and distortions:

• Because the rules only adjust E&P of Distributing and Controlled (and not E&P

of their subsidiaries), there is no preservation with respect to lower-tier

subsidiaries

• There are many circumstances where a deemed dividend was recognized

immediately (particularly in a non-D reorganization)

• There are circumstances of disappearing basis and/or E&P

• The rules are not consistent between a D reorganization and a non-D

reorganization

• No one knew what to do with PTI (and therefore the proposed regulations

reserved on the subject)

15

Post-TCJA, Preserving Section 1248 Amounts Is Much Less Important

• There is less untaxed E&P in the system because of GILTI and Section 965

• More earnings will be PTI

• Untaxed E&P generally only includes exempt earnings:

• 10% exempted return on QBAI;

• High taxed income;

• Tested income offset by tested losses;

• Foreign oil and gas extraction income;

• Phantom earnings under Section 965(b)(4)(B)

• Corporate shareholders get a Section 245A DRD for the untaxed E&P

16

Which Attributes Are Most Important to Allocate Now?

• Untaxed E&P?

• Not as important: as noted above, there is less of it and it is often subject to Section

245A

• One exception is the possibility of shifting untaxed E&P from a Section 245A eligible

shareholder to a non-eligible US shareholder (or vice versa) in a non-pro rata

distribution

• PTI?

• Not as important if the shareholders are eligible for Section 245A (because whether a

distribution is PTI or untaxed E&P, the distribution will likely be non-taxable)

• However, PTEP pools are complicated and PTI is linked to basis numbers

• Shifting PTI between a Section 245A eligible shareholder and a non-eligible US

shareholder can cause timing distortions in a non-pro rata distribution

• If PTI is shifted from a corporation to an individual, a subsequent distribution to the

individual that should be taxed as untaxed E&P may avoid taxation

17

Which Attributes Are Most Important to Allocate Now? (cont.)

• Foreign tax pools?

• Other than foreign taxes in respect of PTI distributions, foreign taxes will generally only

include current year taxes

• Section 960 (as amended by the TCJA) only permits credits for current year taxes

for GILTI and Subpart F income

• The Section 902 deemed-paid credit was repealed and no foreign tax credit is

available for dividends subject to Section 245A

• GILTI gains?

• Tested income for the year of the division and tangible asset basis may matter

• However, where the assets go in a separation is very much a business (not tax)

decision, and reallocating asset basis seems excessive

• It might make sense to allocate current year tested income or loss or require the CFC to

close its taxable year; alternatively, given that tested income or loss is only a current-

year attribute, leave it to the taxpayers to split it up in a tax matters agreement

18

What Should the Goals of Allocation Be?

• Is it more important to preserve the shareholder relationship to current E&P or

unrealized built-in gains?

• Preserving unrealized built-in gains has importance under GILTI – gains may be subject

to GILTI and tax basis may reduce tested income. But:

• Gain may never be triggered

• Tested losses may disappear

• The income may be eligible for the high tax exemption

• Does allocating E&P even help preserve the relationship to unrealized built-in gain in the

post-TCJA world? E&P doesn’t impact tested income

• To achieve shareholder parity in terms of built-in gains would require reallocating

tangible asset basis and current year tested income

• Conclusion: preserving unrealized built-in gain is not particularly feasible or desirable

19

What Should the Goals of Allocation Be? (cont.)

• Is there a relationship between E&P and basis that should be preserved?

• Commentators have noted that E&P can be seen as a balancing figure that

reflects the difference between a corporation’s tax basis and its debt and capital

account

• However, many transactions can distort this balance – e.g., the purchase of a

CFC for cash followed by a Section 332 liquidation

• There is a closer relationship between PTI and basis because Section 961

makes basis adjustments to account for PTI – and the PTI basis tiers up, so it is

reflected at the top of a CFC chain

• Conclusion: it would be helpful to preserve the relationship between PTI and

basis but it is not as important for untaxed E&P

20


• Should only attributes of Distributing and Controlled be reallocated or should

we look to attributes of their subsidiaries as well?

• Currently, only E&P of Distributing and Controlled is subject to adjustment

• With the advent of GILTI and Section 245A, the CFC rules have become more

pass-through like and operate most efficiently in cases where a division-related

result exists

• See David Schnabel’s article from last year’s conference

• E&P can generally be distributed within a CFC group prior to a division without tax

consequences, so why should the outcome vary depending on whether the E&P is

distributed before or after the division?

• For purposes of this discussion, I am assuming that Section 954(c)(6) will be

retained. If it isn’t, I give up

21


• I’m also assuming that PTI in a lower-tier CFC will increase basis in upper-tier CFCs

for all purposes (and Section 961(c) is self-executing)

• Conclusion: going to a group-wide solution (and taking a division approach to

CFC groups) would appear to make sense

• Other goals of allocations:

• Produce the same results for a D reorganization and a non-D spin

• Avoid current dividend inclusions to the extent possible

22

New Proposed Methodology

• An overview of my proposed methodology for a pro rata spin of a CFC by another

CFC:

• Don’t reallocate PTI accounts and associated E&P at all – it is too much mess to move

PTEP groups and adjust inside basis/foreign taxes

• Because PTI has a closer relationship to basis, allocate Section 961 basis in Distributing

stock between Distributing stock and Controlled stock in proportion to PTI in the

Distributing versus Controlled groups

• Allocate any remaining basis in Distributing stock between Distributing and Controlled

stock in proportion to FMV (without adjustments)

• Allocate aggregate untaxed E&P for the entire group (including subsidiaries of

Distributing and Controlled) between the Distributing group and the Controlled group in

proportion to FMV. We are not worried about unrealized built-in gains

• Reallocate the untaxed E&P within a group from the bottom up (i.e., first allocate the

E&P to the lowest tier sub, up to the amount of historic untaxed E&P at that sub, and

continue up the chain, with any residual E&P at the top-tier entity)

23

New Proposed Methodology (cont.)

• This methodology could also work for a non-pro rata distribution if the

shareholders are all eligible for Section 245A (i.e., we are not worried about

shifting a Section 1248 amount from an exempt shareholder to a non-exempt

shareholder or vice versa)

• In the case of a non-pro rata distribution where one or more shareholders are

not eligible for Section 245A, PTI may need to be reallocated pro rata based on

relative fair market values, and associated inside tax basis and foreign tax pools

would need to be adjusted

• The methodology for such an approach is beyond the scope of this paper

• Under this methodology, Treas. Reg. §1.367(b)-5(c) could be eliminated

entirely in the context of a spin of one CFC by another CFC

24

Overview of Current Allocation Rules for Pro Rata Spin by CFC

• E&P is allocated under Treas. Reg. §1.312-10(a) (for D spins):

• For a new Controlled, Distributing’s E&P is allocated based on the relative FMVs of property

retained and transferred to Controlled. Other methods MAY be allowed

• Prop. Reg. §1.367(b)-8 would instead allocate based on net basis of assets

• For a preexisting Controlled, Treas. Reg. §1.312-10(a) would appear to apply only with respect to

the contributed assets. It is unclear what rules would apply for preexisting assets of Controlled

• E&P is allocated under Treas. Reg. §1.312-10(b) (for non-D spins):

• Distributing’s E&P is decreased by the lesser of (i) the amount of E&P that would have been

reduced if Controlled had been transferred to Newco in a D/355 and (ii) the net worth of Controlled

(i.e., basis plus cash minus liabilities).

• If Controlled’s E&P is less than the reduction to Distributing’s E&P, Controlled’s E&P is “topped

up” to the amount of the decrease

• Prop. Reg. §1.367(b)-8: Distributing’s E&P would be decreased by the amount of E&P that would

have been reduced if it had transferred the stock of Controlled to a Newco in a D/355 but

Controlled’s E&P would not be increased or replaced.

25

Overview of Current Allocation Rules for Pro Rata Spin by CFC (cont.)

• Treas. Reg. §1.367(b)-5(c) preserves Section 1248 amounts for pro rata spins by

reducing basis in Distributing or Controlled

• If the adjustment amount exceeds available basis, the Distributee must recognize a

deemed dividend to the extent of the excess (which is deemed paid prior to the spin-off)

• If the Distributee reduces its basis in the stock of Distributing or Controlled or recognizes

a deemed dividend, the Distributee increases its basis in the other corporation by such

amount

• Treas. Reg. §1.367(b)-5(c)(4) does not allow an increase to the extent it diminishes the

Distributee’s post-distribution Section 1248 amount with respect to such corporation

• Even if the aggregate Section 1248 amount is preserved, the rules can require

basis adjustments if amounts shift between Distributing and Controlled

• For a non-D spin, the “pre-distribution” Section 1248 amount is calculated before

the E&P allocation, while the “post-distribution” Section 1248 amount is calculated

after the E&P allocation – this causes huge distortions

26


27

U.S. Parent

(Distributing)


Sub 1 US

Sub 3 F

Sub 4 F

Sub 5 US

Sub 9 F

Sub 6 F

Sub 10 F

Sub 14 F

Sub 11 F

Sub 12 F

Asset Transfers

(orange assets)

3

Sub 17

(Newco) F Form

Newco 2

Internal

Spin Sub 16

by Sub 11

4

Internal

Spin Sub 15 and 17

by Sub 7

5

Sub 13 F

Sub 7 US

Sub 8 F

Transfer

Sub 15 and 17

Shares

6

Internal

Spin Sub 8

by Sub 2

7

Sub 2 US



U.S. Spin Co.

Business to be

spun off

Business to be

retained

Sub 15 F

Internal

Spin Sub

15 by Sub

12

1

Sub 16 F

8

Asset

Transfers

(orange

assets)

Internal

Spin Sub

16 by Sub

4

9

E&P & Basis Allocation – Non-D Spin by CFC (cont.)

28

$500 FMV*

$200 AB

Distribution Post-Distribution

Ignore PTI for now. Under §1.312-10(b), Sub 12’s E&P is reduced by $200 (the lesser of the amount that would have been allocated based on

FMV and the net worth of Sub 15) and Sub 15’s E&P is topped up to the amount of the increase ($200). $10 of Sub 15’s E&P disappears

because of the top-up mechanism

*Includes the

value of Sub 15

$250 FMV

$100 AB

$250 FMV

$100 AB

Sub 12

Sub 12 Sub 15 Sub 15

Sub 7 Sub 7 US US

F

F F F

$400 (non-PTI) E&P

$0 PTI E&P

Sub 18

F

$40 (non-PTI) E&P

$20 PTI E&P Sub 18 F

$200 E&P

$400 E&P

$200 E&P

$10 E&P

$40 E&P

$250 FMV

$200 AB in

Sub 15 assets

$10 (non-PTI) E&P

$120 PTI E&P

E&P & Basis Allocation – Non-D Spin by CFC

29

$500 FMV*

$200 AB

$250 FMV

$200 AB in

Sub 15 assets


§1.367(b)-5 is then applied. For a non-D spin, the pre-distribution 1248 amount is determined before the E&P allocation, so Sub 7’s pre-

distribution 1248 amount with respect to Sub 12 ($300) is $150 more than its post-distribution 1248 amount ($150). So the basis of Sub 12

is adjusted down $100 and $50 is included as a dividend (reducing Sub 12’s E&P). Sub 15’s basis would be increased to $250 but

§1.367(b)-5(c)(4) does not allow an increase to the extent it diminishes Sub 7’s post-distribution 1248 amount with respect to Sub 15.

Note that the aggregate Section 1248 amount would not have changed if the E&P had only been adjusted pursuant to §1.312-10

$10 (non-PTI) E&P

$120 PTI E&P

*Includes the

value of Sub 15

$250 FMV

$100 AB

$250 FMV

$100 AB $0 AB

Inclusion of $50

(as a deemed dividend)

[$250 AB]? Sub 12


Sub 7 Sub 7 US US

F

F F F

$400 (non-PTI) E&P

$0 PTI E&P

Sub 18

F

$40 (non-PTI) E&P


$40 E&P

$200 E&P

$200 E&P

$10 E&P

$150 E&P


• End result:

• If Sub 7 sold Sub 12 (when Sub 15 was still a subsidiary) before the transaction, it would

have had $300 gain, all of which would be a Section 1248 amount excluded by Section

245A. In fact, it had enough non-PTI E&P to shelter another $150 of gain under Section

1248

• In the spin, Sub 7 recognizes a $50 deemed dividend (subject to Section 245A). If after

the transaction, Sub 7 sells Sub 12 and Sub 15, it would have additional $400 gain, only

$300 of which is a Section 1248 amount excluded by Section 245A. Sub 15 chain has

enough non-PTI E&P to shelter another $90 of gain

• Net, at least $21 extra tax ($100 of lost basis because the pre-distribution 1248 amount

for Sub 12 is determined before the $200 decrease in E&P, $10 of lost E&P due to the

“top up” mechanism of Section 312, $50 of lost E&P due to the deemed dividend without

a basis adjustment and a disproportionate amount of E&P allocated to the Sub 15 chain)

30


• Does requiring the $50 deemed dividend make sense when a distribution is

pro rata and there is no net Section 1248 amount lost? If CFCs can move

earnings around within a group without significant consequence (again,

assuming Section 954(c)(6) makes sense and is continued), why not just

reallocate those earnings?

• Under the current rules, because preserving Section 1248 amounts was all-

important pre-TCJA, basis and E&P are used as levers. But now Section

1248 amounts are less significant and there is not a strong link between E&P

and basis

• If we are trying to minimize distortions cause by the TCJA, would it make

sense to (i) not adjust basis to preserve Section 1248 amounts and (ii)

allocate E&P proportionately to the FMV in the stocks?

31


32

U.S. Parent

(Distributing)


Sub 1 US

Sub 3 F

Sub 4 F

Sub 5 US

Sub 9 F

Sub 6 F

Sub 10 F

Sub 14 F

Sub 11 F

Sub 12 F

Asset Transfers

(orange assets)

3

Sub 17

(Newco) F Form

Newco 2

Internal

Spin Sub 16

by Sub 11

4

Internal

Spin Sub 15 and 17

by Sub 7

5

Sub 13 F

Sub 7 US

Sub 8 F

Transfer

Sub 15 and 17

Shares

6

Internal

Spin Sub 8

by Sub 2

7

Sub 2 US



U.S. Spin Co.

Business to be

spun off

Business to be

retained

Sub 15 F

Internal

Spin Sub

15 by Sub

12

1

Sub 16 F

8

Asset

Transfers

(orange

assets)

Internal

Spin Sub

16 by Sub

4

9

E&P & Basis Allocation – D Spin by CFC (cont.)

33

$100 FMV*

$40 AB


First, E&P is allocated under §1.312-10(a). While unclear, let’s assume §1.312-10(a) looks to all the assets transferred in the D reorg and

stock deemed transferred in allocating E&P to Sub 16 (i.e., $80 x ($60 / ($40 + $10 + $50)) = $48). For a D spin, the pre-distribution 1248

amount is determined after the E&P allocation, so the 1248 amount in Sub 4 decreased from $32 to $24. Basis is reduced by $8. Sub 16’s

basis would be increased to $32, but that would reduce the post-distribution 1248 amount for the Sub 16 chain so there is no adjustment

$30 E&P

$0 PTI

*Includes the

value of Sub 16

$40 FMV

$16 AB

$60 FMV

$24 AB

Sub 4 Sub 16

US Parent

US

F F

Asset A Asset B

$10 FMV $40 FMV

Sub 4

Sub 16

US Parent US

F

F

Sub 19

F

$80 E&P

$10 PTI

$50 FMV

$40 AB

$0 E&P Sub 19

F

$30 E&P

$78 E&P

$80 E&P

$32 E&P

$8 AB [$32 AB]

$0 E&P

$10 PTI

E&P & Basis Allocation – D Spin by CFC (cont.)

• End result:

• If US Parent sold Sub 4 (along with Sub 16 as a sub) before the transaction, it

would have had $60 of gain, all of which would be a Section 1248 amount

excluded by Section 245A. The chain has enough non-PTI E&P to shelter

another $50 of gain

• If after the transaction, US Parent sells Sub 4 and Sub 16, it would have $68

gain, all of which is a Section 1248 amount excluded by Section 245A. The Sub

16 chain has enough non-PTI E&P to shelter another $42 of gain

• No immediate net tax cost, but $8 of basis is lost (and therefore unavailable to

shield future gain)

34

Potential Distortions in Existing Rules

• Differences in E&P allocation between a D reorg and non-D reorg: lack of value for existing

assets in Controlled in a D reorg with Oldco

• Adjustments can be made to basis even if the aggregate Section 1248 amount is preserved

• For a non-D reorg, the pre-distribution Section 1248 amount is calculated before the E&P

allocation

• The “top up” approach to E&P in a non-D reorg

• The Controlled net worth limitation on the decrease of Distributing’s E&P in a non-D reorg

(particularly if Controlled is leveraged up to the amount of its basis, and therefore has $0 net

worth)

• Treas. Reg. §1.367(b)-5(c)(4) does not allow an increase in basis to the extent it diminishes

the Distributee’s post-distribution Section 1248 amount with respect to such corporation

• Adjustments are only made to the attributes of Distributing and Controlled, not their

respective subsidiaries

35

Alternative to Section 1248 Preservation Approach

• What if instead, we allocated (i) basis in Distributing solely in proportion to

FMV (without adjustment) and (ii) all the E&P in the entities and their

subsidiaries on a group basis in proportion to FMV?

• Preserves overall Section 1248 amount

• It can shift amounts between Controlled and Distributing, but Controlled could

distribute E&P to Distributing anyway

• Consistent with a division approach to CFCs

• Could be distortive if Section 954(c)(6) no longer applied

36

Alternative to Section 1248 Preservation Approach (cont.)

37

$500 FMV*

$200 AB

$250 FMV

$200 AB


$10 (non-PTI) E&P

$120 PTI E&P

*Includes the

value of Sub 15

$250 FMV

$100 AB

$250 FMV

$100 AB

Sub 12


Sub 7 Sub 7 US US

F

F F F

$400 (non-PTI) E&P

$0 PTI E&P

Sub 18

F

$40 (non-PTI) E&P


$225 E&P

$40 E&P

$185 E&P

Sub 12 group

½ of $450 non-PTI E&P = $225

Sub 15 group

½ of $450 non-PTI E&P = $225

What to Do with PTI?

• Some issues with PTI:

• Kept at the shareholder level (though there are successor in interest rules under Treas.

Reg. §1.959-1(d))

• “Annual layer” of PTI for each year of inclusion (regardless of when distributed)

• There are at least 16 different PTEP groups for each FTC limitation and each year

• Distributions of PTI produce foreign currency gain or loss (attributable to FX rate

movements between the income inclusion date and distribution date)

• Distributions of PTI bring up foreign taxes under Section 960(b) and can increase the

Section 904 limitation under Section 960(c)

• We could allocate PTI E&P in accordance with FMV (like non-PTI E&P)

• This separates the PTI E&P from the actual cash, but we are already doing that for non-

PTI E&P

• What happens though to PTEP groups? Foreign taxes? Do they get reallocated too?

• We would also have to make basis adjustments throughout the chain

38

Proposed Alternative to Deal with PTI

• As noted above, for a pro rata spin, what if instead, we:

• Retain PTI accounts and E&P as is (i.e., E&P at the CFC that incurred in)

• Allocate Section 961 basis between Distributing and Controlled stock in proportion to

PTI in each group

• Allocate the rest of basis solely in proportion to FMV (without adjustment)

• Allocate non-PTI E&P (on a whole group level) in proportion to FMV

• Reallocate the non-PTI E&P within a group from the bottom up (i.e., starting at the

lowest tier subsidiary, reallocate E&P up to the amount of the historic E&P with any

residual at the top of the group)?

• Preserves Section 1248 amount – it may shift between subs but at least it is in

proportion to value

• Avoids messing with PTEP groups and PTI-related foreign tax pools

39

E&P & Basis Allocation – Non-D Spin by CFC

40

$500 FMV*

$200 AB

$250 FMV

$200 AB


$10 (non-PTI) E&P

$120 PTI E&P

*Includes the

value of Sub 15

$250 FMV

$30 non-PTI AB $250 FMV

$140 PTI AB + $30 non-PTI AB

Sub 12


Sub 7 Sub 7 US US

F

F F F

$400 (non-PTI) E&P

$0 PTI E&P

Sub 18

F

$40 (non-PTI) E&P

$20 PTI E&P Sub 18

F

$40 non-PTI E&P

$20 PTI E&P Sub 12 group

½ of $450 non-PTI E&P = $225

Sub 15 group

½ of $450 non-PTI E&P = $225

$225 non-PTI E&P

$0 PTI E&P

$185 non-PTI E&P

$120 PTI E&P

E&P & Basis Allocation – D Spin by CFC

41

$100 FMV*

$40 AB


$30 E&P

$0 PTI

*Includes the

value of Sub 16

$40 FMV

$10 PTI AB + $8 non-PTI AB $60 FMV

$10 PTI AB + $12 non-PTI AB

Sub 4 Sub 16

US Parent

US

F F

Asset A Asset B

$10 FMV

$80 E&P

$10 PTI Sub 4

Sub 16

US Parent US

F

F

Sub 19

F

$0 E&P

$10 PTI

$50 FMV

$40 AB

Sub 19

F

$40 FMV

$0 non-PTI E&P

$10 PTI E&P

Sub 4 group

4/10 of $110 non-PTI E&P = $44

Sub 16 group

6/10 of $110 non-PTI E&P = $66

$66 non-PTI E&P

$44 non-PTI E&P

$10 PTI E&P

E&P Groupings, Foreign Taxes & Deficits

• Under Prop. Reg. §1.367(b)-8, adjustments generally would be made pro rata

over the various E&P “statutory groupings”

• This general approach could be maintained

• Prop. Reg. §1.367(b)-8 would also reduce foreign Distributing’s pre-transaction

taxes ratably to the reduction or allocation of E&P

• If Controlled is foreign – pre-transaction taxes would carry over to Controlled in

accordance with the rules for foreign-to-foreign Section 381 transactions.

• With no foreign tax credits for amounts distributed under Section 245A and a credit

only for current year taxes for GILTI and Subpart F, this would appear to be a

smaller issue. I would leave foreign taxes with the associated PTI

• While the current rules do not generally allocate an E&P deficit, the

methodology described above could be implemented for both positive and

negative E&P

42

Part III: Mergers and Inversion Issues Following Spins • The far-reaching aspects of both the Helen of Troy regulations and the

Section 7874 rules interact with spin-offs in ways that are not always justified

by the policy concerns

• Helen of Troy regulations’ requirement of shareholder-level gain as a means

of protecting against corporate base erosion has not been particularly

effective

• In addition, the Section 7874 rules are not as necessary in light of various

TCJA changes – there are other incentives (lower rate, etc.) not to invert

• The Section 7874 rules also treat certain transactions that do not have much

U.S. tax nexus as inversions

43

How Relevant Are Sections 7874 and 367(a) Today? • Pamela Olson, testifying to Congress in 2002:

“The policy response to the recent corporate inversion activity should be broad enough to

address the underlying differences in the U.S. tax treatment of U.S.-based companies and

foreign-based companies, without regard to how foreign-based status is achieved. Measures

designed simply to halt inversion activity may address these transactions in the short run, but

there is a serious risk that measures targeted too narrowly would have the unintended effect of

encouraging a shift to other forms of transactions and structures to the detriment of the U.S.

economy in the long run.”

• Cites areas of change needed:

• Interest deductions on related-party debt

• Income shifting and transfers of intangibles

• Income tax treaties

• Reporting requirements

44

How Relevant Are Sections 7874 and 367(a) Today? (cont.)

• The issues cited in 2002 are significantly reduced today

• In light of Section 163(j), BEAT, the lowered corporate tax rate

and a quasi-territorial system, there is much less incentive to

invert

• The only real reason to invert is for the “option premium” of

having a non-US corporation in case a new Congress undoes

the changes of the TCJA

• Accordingly, the overbreadth of Sections 7874 and 367(a) are

particularly notable and should be re-examined

45

Diligence When Foreign Parent Acquires US Spin Co

46

U.S. Parent

(Distributing)

Public

Foreign Parent

(Acquiror)

U.S. Merger Co.

Public

If Section 367(a) applies, is there a device issue?

Must consider any calibrations of the size of U.S. Parent or U.S. Spin Co (debt allocation, cash extraction, value

fluctuations between steps 2 and 3) and distributions by U.S. Spin Co in Section 7874 dieting rules

Acquiror will want to understand how tax sharing agreements allocate liability for U.S. Spin Co (including CFC subs)

Retain Co. U.S. Spin Co.




Distribution of

U.S. Spin Co. 2

Merger 3


Co. for Foreign Parent

shares

4

Diligence When Foreign Spin Co Acquires US Parent

47

Foreign Parent

(Distributing)

Public

U.S. Parent

(Acquiror) U.S. Merger Co.

Public

Issues: Was Foreign Spin Co artificially “stuffed”; Did it issue shares for non-qualified property? Did it acquire a U.S.

affiliate before spin?

Foreign Spin Co has a history: very relevant to U.S. Parent.

Foreign Retain

Co. Foreign Spin Co.



subsidiaries to Foreign Spin

Co.

1

Distribution of

Foreign Spin Co. 2

Merger 3

Acquisition of U.S Parent

shares. for Foreign Spin

Co shares 4

Thesis – Sections 367(a) & 355

• If Helen of Troy regulations are not completely overhauled (see

Debbie Paul’s article), the government should at least:

• Provide that a stock-for-stock transaction that is subject to Section 367(a)

gain is not evidence of a device for bailout of earnings and profits

• Provide that a transaction that is subject to Section 367(a) gain is not a

taxable acquisition of an active trade or business

• Transactions under Section 367(a) should not be treated any

differently than tax-free stock acquisitions for purposes of the

spin-off rules

48

Section 367/Section 355 at Odds

49

Legacy

US Spinco

SHs

Foreign Parent

U.S. Spin Co.

Legacy

Foreign

Co SHs

If Legacy U.S. Spin Co Shareholders own >50%:

1) Good for Section 355(e)

2) Bad for Section 367(a)

3) Section 355 Device?

* Note: 367(a)/7874 adjustments always at issue.

If Legacy Foreign Parent Shareholders own >50%:

1) Bad for Section 355(e)

2) Good for Section 367(a) but that may not

matter.

Can a Section 367(a) Acquisition Cause a Device Problem for a Prior Spin?

• Under Section 355(a)(1)(B) “device” test, the distribution cannot

be a transaction that facilitates the avoidance of a dividend by

sale of stock of one corporation and retention of the other

• A disposition does not contravene device test if no gain or loss is

recognized

• Should 367(a) gain make a difference? No cash out

• See PLR 201232014

50

Should a Section 367(a) Acquisition Be Treated as a New Business under the ATB Rules?

51

Foreign Parent

(FP)

Say the deal was done less than 5 years ago but did not qualify as tax-free

under Section 367(a)

U.S. Parent

Public Legacy FP

Public

>50% <50%

U.S. Parent

100%

Subs Subs

Legacy

FP Subs

Today: Foreign Parent wants to break up U.S. Spin Co.


Should a Section 367(a) Acquisition Be Treated as a New Business under the ATB Rules? (cont.)

• The transaction would appear to violate the active trade or business test of Section

355(b) – the business was acquired in a taxable deal

• On an internal distribution by U.S. Spin Co – Section 355(b)(2)(D) had a purpose of

preventing the avoidance of GU repeal. The concern was parent buying target

stock, allocating high outside basis between Distributing and Controlled, and then

selling Distributing or Controlled

• Here, the acquiror is foreign and not seeking to sell one of the companies in a taxable

transaction

• On an external distribution – Section 355(b)(2)(C) was intended to backstop the

device test (i.e., the acquiror uses liquid assets to purchase an active business and

spins it off)

• Here, the acquiror is using its own stock as a currency – device is not implicated, and

there is no bailout of acquiror’s earnings

52

Thesis – Overbreadth of NOCD Rules

• The non-ordinary course distribution (“NOCD”) rules are intended to prevent

“skinny down” transactions by disregarding NOCDs during the 36-month (or

other applicable) period before the inversion. Section 355 transactions can

be treated as NOCDs

• Because Section 355 transactions tend to be so sizeable, the NOCD rules

have an outsized impact on a division of businesses relative to other types of

distributions, and the elements of the NOCD rules that are overbroad are

particularly treacherous for spins

• In addition, given the many Section 355 requirements, it is much less likely

that the spin-off of a business (as opposed to, for instance, the distribution of

cash) is being used for the purpose of reducing the size of a US company in

anticipation of an inversion

53

Thesis – Overbreadth of NOCD Rules (cont.)

• While NOCD rules are necessary to prevent abuse, additional rules should

be implemented to ensure that they do not interfere with innocuous spin

transactions

• NOCD rules should not apply to a prior spin if the subsequent acquisition was

not part of a plan

• Similar rules to Section 355(e) in determining a plan?

• Calculation of NOCDs (i.e., “add-back”) should be based on the actual mix of

stock and cash or other non-stock consideration used in the foreign acquisition

of the U.S. target

• Consider using “lesser of” formula for valuation at distribution versus acquisition

54

NOCDs: Overview of Issues

• Controlled is treated as having distributed the stock of Distributing for

purposes of the NOCD rule if the FMV of Controlled is more than 50% of the

FMV of Distributing (ex Controlled), e.g., a “reverse spin”

• Note that allocations of debt between Distributing and Controlled may affect whether this

50% threshold is hit, and the value of the NOCD

• The amount of the distribution is determined based on the value of the

property at the time of the distribution

• The NOCD rule is automatic (applied without regard to purpose)

• The calculation of the NOCD is not based on the actual mix of stock and

cash used in the foreign acquisition of the U.S. target

55

No Plan to Do a Subsequent Acquisition

56

Spin Co

stock

FA Stock Section 355 Spin-Off

U.S. Parent

(Distributing)

Public

Assets &

Stock

U.S. Spin

Co.

U.S. Spin

Co. Foreign

Acquiror

U.S. Spin

Co. Shs

Foreign

Acquiror

Shs

FMV = $500 FMV = $600

FMV = $430

Despite the fact that there is no plan to do the subsequent acquisition at the time of the spin, and the shareholders of U.S.

Spin Co are only receiving 58.25% of the total Foreign Acquiror stock, the NOCD rules add back $500 to U.S. Spin Co’s

value. The ownership fraction is 1100/1530 = 72% and the transaction is subject to Section 7874

2.5 years later:

Greater Discrepancy between Actual Percentage and Inversion Fraction for Stock & Cash Acquisitions

57

Spin Co

stock

60% FA Stock ($360)

40% Cash ($240) Section 355 Spin-Off

U.S. Parent

(Distributing)

Public

Assets &

Stock

U.S. Spin

Co.

U.S. Spin

Co. Foreign

Acquiror

U.S. Spin

Co. Shs

Foreign

Acquiror

Shs

FMV = $500 FMV = $600

FMV = $430 (before cash payment)

U.S. Spin Co shareholders receive 45.6% of FA stock

The NOCD rules add back the full $500 to US Spin Co’s value even though only 60% of the consideration is stock. Assuming

the cash consideration is sourced from Foreign Acquiror, the ownership fraction = 860/1290 = 67%, and the transaction is

subject to 7874. If the cash consideration were sourced from U.S. Spin Co, that amount would itself be a NOCD

Beware of Value Fluctuations

• Beware of fluctuations in value:

58

Spin Co

stock

FA Stock

2.5 Years Later Section 355 Spin-Off

Assume due to decrease in value, U.S. Parent is now worth $15 and U.S. Spin Co is now worth $25.

U.S. Spin Co is treated as having made a $45 distribution to U.S. Parent 2.5 years prior and therefore the ownership percentage of the

U.S. Spin Co shareholders is 70/82 = 85.4%

U.S. Parent

(Distributing)

Public

Assets &

Stock

U.S. Spin

Co.

$45 FMV $55 FMV

U.S. Spin

Co. Foreign

Acquiror

$25 FMV

U.S. Spin

Co. Shs

$12 FMV

Foreign

Acquiror

Shs

U.S. Spin Co shareholders receive 67.57% of FA stock

Thesis – Foreign-Parented Group Exception Should Always Apply to Spins from a Foreign Group

• A transfer of a US sub to a foreign spinco by a foreign parent should be

subject to the foreign-parented group exception, even if a later, related,

transaction would break the expanded affiliated group

• The US sub is already inverted – the splitting up or reshuffling of a foreign

group should not impact the analysis

• If the US sub had already existed under foreign spinco, the foreign-parented

group exception would not even be implicated

59

Can Foreign Parent Contribute US Sub to Foreign Spinco under Section 7874?

• Under Section 7874(c)(2)(A), foreign acquiror (“FA”) stock owned by

members of the “Expanded Affiliated Group” (EAG) of which foreign acquiror

is a member is not included in the numerator or (sometimes) the

denominator of the ownership fraction

• But stock of FA that is:

• Received by a former owner of the U.S. target company and

• Later transferred in a transaction related to the inversion (including a spin) will be

included in both the numerator and the denominator of the fraction (making an inversion

more likely)

• This subsequent transfer rule is subject to two exceptions involving U.S.-

parented groups and foreign-parented groups

60

Foreign-Parented Group Exception

• A transfer of US sub to Foreign Spinco is not a Section 7874 transaction if

the “foreign-parented group” (“FPG) exception applies:

• Transferred stock is treated as held by a member of the EAG for purposes of

the EAG rules if:

• Before the acquisition, the transferring corporation and the domestic entity are

members of the same FPG; and

• After the acquisition, the transferring corporation is a member of the EAG or would

be a member of the EAG absent the subsequent transfer of any stock of the foreign

acquiring corporation by a member of the FPG in a transaction related to the

acquisition (but taking into account all other transactions related to the acquisition)

61

FPG Exception Applies to Basic Spin Patterns

62

U.K. Parent

U.K. Spin Co.

Public

Incorporated in

1889

Subs Subs

U.S. Subs Subs

Subs EU Subs

Subs Subs

LATAM Subs Subs

Subs APAC Subs


subsidiaries . (including U.S.

subs) to new U.K. Spin Co 1

Distribution of U.K. Spin Co. 2

This is ok under the foreign-parented group exception

But…What if There’s a Post-Spin Transaction?


Public

Spun-Off

Business

IPO:

Issue $510 of U.K. Spin

Co shares for cash

Investors $$$

Subs Subs

Retained Subs

If after the spin, U.K. Spin Co issues more than 50% of its stock in a related transaction, U.K. Spin Co and U.K. Parent will not be

treated as part of the same EAG under the foreign-parented group exception. In this example, U.K. Spin Co issues $510 of its shares

in a related IPO after the spin, and the EAG is broken. Furthermore, the cash is non-qualified property, and therefore excluded from the

denominator. Therefore the ownership fraction is 400/490 = 81.63%.

Suppose new U.K. Spin Co has FMV = $490 after a contribution of a $400 U.S. sub and a $90 U.K. sub

Post-Spin Transactions – Acquisition of US Target

64


Public

Spun-Off

Business

Shareholders

U.S. Target

Subs Subs

Retained Subs

Assume the same facts as the last example, except that instead of issuing the shares in an IPO, they are issued in exchange for

shares of a U.S. Target. Again, the foreign-parented group exception does not apply because EAG is broken. Here, however, the

shares of U.S. Target are qualified property, so are included in the denominator. However, the U.S. target is treated as the same

domestic entity as the U.S. sub that was contributed to U.K. Spin Co under §1.7874-2(e) because the acquisition of the two domestic

entities is pursuant to a plan or series of related transactions. The ownership fraction is 910/1000 = 91%. The serial acquisition rules

of §1.7874-8 can also apply.

FMV = $490

Suppose new U.K. Spin Co has FMV = $490 after a contribution of a $400 U.S. sub and a $90 U.K. sub

Issue $510 shares of

U.K. Spin Co Shares for

US Target

Post-Spin Transactions – Acquisition of Foreign Target

65

Assume the same facts as the last example, except that instead of issuing the shares for a U.S. Target, they are issued in exchange

for shares of a Foreign Target. Again, the foreign-parented group exception does not apply. The shares of Foreign Target are qualified

property, so are included in the denominator. The ownership fraction is 400/1000 = 40%.

Suppose new U.K. Spin Co has FMV = $490 after a contribution of a $400 US sub and a $90 UK sub


Public

Spun-Off

Business



Foreign Target

Shareholders

Foreign

Target

Subs Subs

Retained Subs

FMV = $490

Post-Spin Transactions – Additional Complications

66

• But what if there had also been a $600 distribution by USS to U.K. Parent prior to the contribution of USS to U.K. Spin Co that counts as a NOCD under

§1.7874-10? That number gets added back to the numerator and denominator – now the ownership fraction is 1000 (400 + 600 NOCD)/1600 = 62.5%

• What if instead, Foreign Target has acquired a US Co for $300 for FT stock prior to its acquisition as part of a plan? Under §1.7874-(2)(c)(4), those shares

are included in the numerator and denominator of the subsequent ownership fraction. So the ownership fraction is 700 (400 + 300)/1000 = 70%

• Finally, what if instead, 35 months after the acquisition of Foreign Target (when the value of Foreign Target has doubled and equals $2000), UK Spin Co

acquires a US company worth $7000 in exchange for 77.78% of its equity in an unrelated transaction? Under §1.7874-8 (the serial acquisition rule), with

respect to that transaction, a portion of the UK Spin Co stock attributable to USS gets excluded from the denominator. The ownership fraction is 7000/

(9000 – (800 ($400 of shares from USS which have doubled in value))) = 85.37%

New U.K. Spin Co has FMV = $490 after a contribution of a

$400 US sub (USS) and a $90 UK sub


Public

Spun-Off

Business



Foreign Target

Shareholders

Foreign

Target

Subs Subs

Retained Subs

FMV = $490

Post-spin Foreign Merger Variations

US Co Distributes CFC to Public (“Spinversions”)

67

U.S. Distribution of CFC to Public Post-Spin

Treas. Reg §1.7874-6 - USPG exception unavailable if US Sub is contributed to Foreign Sub

If Section 7874 does not apply because no “substantially all” transfer to Foreign Sub:

• Gain recognized to US Parent on distribution to foreign persons (Section 367(e)) or US individuals (Section 367(b))

• Previously a huge impediment – but does TCJA make this more viable? Rate is now 21% and basis

increases attributable to Section 965 and possible DRD for Section 1248 amounts may mitigate gain

• Treatment of US corporate distributees governed by Section 1248(f)

• Additional provisions may apply (e.g., Section 367(a)) if the spin-off is preceded by a D reorganization

US Parent

Foreign

Sub

Public Public

US Parent Foreign Co

corporate spin-offs: international is the harder part · • a 2015 nysba report noted the...

Documents