The recent wave of U.S. companies exploring corporate inversions, which has involved mega-billion dollar deals and household brands such as Pfizer and Burger King, has attracted significant attention and fierce criticism. Some people have gone so far as to characterize these U.S. companies as “unpatriotic” or even worse. The combination of inversion activity reaching new heights and the Congressional deadlock has caused the Obama Administration to act unilaterally in an effort to make inversions less attractive.

On September 22, 2014, the IRS released Notice 2014-52 describing regulations to be issued in order to limit the tax benefits of certain inversion transactions. The notice, focusing on certain post-inversion planning techniques, already led to the termination of AbbVie’s $54 billion merger with Shire Plc (triggering $1.64 billion in break-up fees) and impacted other pending deals.

Further developments in this area are to be expected but they would likely depend, on the one hand, on the appetite of dealmakers to pursue additional inversions using tax-enhancing techniques given the current uncertain environment and, on the other hand, on the impact such activity may have on prompting further action by Treasury or breaking the Congressional deadlock.


Inversions and Section 7874

Inversions have been around since the 1980s and they typically come in waves, generating strong public and political reactions that lead to Congressional or regulatory actions. These actions, in turn, require dealmakers to adjust their techniques and the companies they are targeting.

In a typical inversion, a U.S.-based multinational group transforms itself into a foreign-based group. There are many ways to achieve this, but the end result is that the U.S. shareholders of the U.S. inverted company become shareholders of a foreign parent. The relevant foreign country would typically offer a more favorable tax regime as compared to the U.S. tax regime and hence the new address gives the combined enterprise an opportunity to reduce its overall tax bill. The controversy centers around post-inversion strategies that can reduce the U.S. tax burden of the operations conducted in the U.S. and can also facilitate access to earnings that are trapped in foreign subsidiaries of the U.S. inverted company without triggering U.S. tax. The notice attacks a subset of those techniques.

In 2004, in reaction to a wave of “naked” inversions in which the foreign parent was usually a pure shell entity incorporated in countries that impose low or no tax, Congress enacted the anti-inversion provisions of Section 7874. Very generally, unless the group has “substantial” business activity in the foreign country, Section 7874 applies two anti-inversion rules depending on the percentage ownership fraction of the new foreign parent shares held by the former shareholders of the U.S. inverted company. If the percentage ownership fraction equals at least 60% but less than 80%, Section 7874 limits the ability of the U.S. inverted company to shelter gain from certain inversion-related transactions. If the percentage ownership fraction equals at least 80%, the new foreign parent is treated as a domestic company for U.S. tax purposes, thereby largely eliminating any U.S. tax benefits from such transaction.