IRS Modifies Anti Inversion Rules

After complaints of over-reaching in response to the anti inversion provisions of the American Jobs Creation Act of 2004, the IRS has been tweaking its approach to addressing the problem of those corporations that seek to reduce their US tax liability by inverting into a foreign corporation. The Service issued its latest set of rules under IRC Section 7874 on June 9, 2009.

What's an Inversion?

Corporate inversions occur when the US corporation decides to avoid US taxes by shifting the corporate structure to an offshore jurisdiction. First, the US corporation forms an offshore corporation; past favorite locales included Bermuda, for example. Next, the Bermuda corporation forms a domestic merger subsidiary. The domestic merger subsidiary merges with the US corporation, with the US corporation surviving. The Bermuda corporation becomes the parent corporation, and the US corporation becomes the Bermuda corporation's subsidiary. The US corporation's shareholders exchange their shares in the US corporation for shares in the Bermuda corporation. Effectively, the US corporation has swapped its parent corporation status with an offshore shell corporation to avoid US tax consequences.

Why does the Internal Revenue Service care?

The IRS cares because Congress cares. Congress has been concerned about various off shore abusive tax shelter schemes and believes that inversion transactions involving foreign "shell" or "dummy" corporations needed to be addressed. Congress is seeking ways of adjusting the US tax system so that it can keep up with US-based global companies. It's aware of the need to restructure the US tax code so that the IRS can work to overcome internally existing jurisdictional problems, and, hopefully, the path will be cleared to deal with the collection problems inherent in dealing with other countries.

What are the New Rules?

Basically, Section 7874 outlines criteria the Service would use to determine if a foreign corporation should be treated as a "surrogate foreign corporation," meaning the foreign corporation status would be ignored for tax purposes. Among other indicators, if the foreign corporation does not, post-acquisition, conduct substantial business activity in the foreign country, the parent corporation could labeled a surrogate. The Service makes its determination via a facts and circumstance test, and formerly, Section 7874 included a safe harbor to reduce some of the uncertainty surrounding that test. In the latest revision, the Treasury explicitly states that taxpayers can no longer rely on that former safe harbor provision.

Why does KEMY care?

KEMY clients blow the whistle on all types of tax fraud, including inversion schemes. With tax revenue down, the government's interest in fraud detection increases. Anyone who believes he or she has knowledge of an improper inversion scheme should contact KEMY today.