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The University of Chicago Law School
66th Annual Federal Tax Conference
Corporate Inversions
Chicago, Illinois
November 8, 2013
Page 2
Panel
► Session Chair: Hal Hicks, Skadden, Arps, Slate, Meagher
& Flom LLP
► Presenting this Topic: Steven M. Surdell, Ernst & Young
LLP
► Commenting on this Presentation: Lewis R. Steinberg,
Credit Suisse (USA) LLC, John J. Merrick, Special
Counsel to the Associate Chief Counsel (International),
Internal Revenue Service
Page 3
Premise
► Inversion (or Expatriation) Transactions are not going away.
The competition to acquire productive business assets around the world will
continue. This competition will likely be waged primarily by large multinational
corporations that are subject to various taxing jurisdictions and thus a myriad of
international tax rules. Regardless of one’s broader view of the merits of different
international tax regimes (e.g., whether you support “capital export neutrality” or
“capital import neutrality”) the application of different international tax regimes to a
single set of productive assets will affect the value of those assets in the hands of
various bidders. This will force bidders to examine (particularly where the subject
assets constitute an important pre-tax strategic opportunity) whether it makes
economic sense to consider reincorporating in a jurisdiction whose international tax
rules allow it to more efficiently hold (and thus bid on) the productive assets.
Although this panel will not comment on the broader issues of the US international
tax system cross border merger and acquisition transactions present an excellent
prism through which to illustrate those issues.
The observation above is supported by decisions taken in at least some of the
recent cross border combination transactions.
Page 4
The phenomenon of locally incorporated entities reincorporating in jurisdictions
deemed more advantageous to a multinational corporation is not unique to the US.
Consider the recent experience of the UK with its multinationals inverting and how
the UK responded to those actions.
Significantly, although the conventional wisdom is that new waves of inversions
occurred because creative tax planning identified ways to circumvent earlier
limitations, in reality the analysis is far more complex. In many circumstances
outside economic and legal considerations (which were external to US international
tax rules) helped to drive the new wave of inversions.
Premise
Page 5
A Brief History of Inversion Transactions
► Illustrative Transactions
► Response
► Tax Policy Implicated by Each Response
Page 6
1. Hook Stock Inversion (1982) – Illustrative Transaction McDermott InternationalInitial Structure and Transaction
Description
► McDermott International made an offer to
exchange shares of its stock and cash for
shares of McDermott Inc. held by the
public.
► Prospectus stated “[t]he principal purpose
of the reorganization is to enable the
McDermott Group to retain, reinvest and
redeploy earnings from operations outside
the United States without subjecting such
earnings to United States income tax. This
will enable the McDermott Group to
compete more effectively with foreign
companies by taking advantage of
additional opportunities for expansion
which require long-term commitments, the
redeployment of assets and the
reinvestment of earnings.”
McDermott
Inc.
(US)
McDermott
International
(Panama)
Public
McDermott
Group
(US)
1
2
McDermottInt’lsharesandcash
McDermottInc. shares
Page 7
1. Hook Stock Inversion (1982) – Illustrative Transaction McDermott InternationalResulting Structure and Response
Response / Policy Implicated
► IRS contention that the transaction was a failed section 355 spin off
because import of transaction was a McDermott Inc. redemption of its
stock in exchange for McDermott International.
► Policy Implicated – Preservation of corporate level tax / prevention
of corporation level bailout.
► IRS contention that the shareholders engaged in a section 304
transaction.
► Policy Implicated – Preclusion of shareholder enrichment.
► Both arguments rejected by the courts in Rohinton K. Bhada, 89 TC
959 (1987), aff'd sub nom. Caamano v. CIR, 879 F2d 156 (5th Cir.
1989), and Bhada v. CIR, 892 F2d 39 (6th Cir. 1989).
► Enactment of section 1248(i) which would cause McDermott Inc. to
incur the section 1248 amount associated with the McDermott
International stock as a dividend.
► Policy Implicated – Neither corporate bailout nor shareholder
enrichment, but rather preservation of the “section 1248 amount”
which was a condition to the 1962 acceptance of international
deferral. Section 1248 recasts capitalizations into dividends but
only from shareholder’s pro rata share of pre existing untaxed
earnings.
McDermott
Inc.
(US)
McDermott
International
(Panama)
Public
McDermott
Group
(US)
HookStock
Page 8
2. Section 368(a)(2)(E) Inversion (1993) – Illustrative Transaction Helen of TroyInitial Structure and Transaction
Description
► Helen of Troy formed New Helen of Troy
(Bermuda).
► New Helen of Troy (Bermuda) formed Helen of
Troy MergerCo (US).
► Helen of Troy MergerCo merged with and into
Helen of Troy (US) in a transaction intended to
qualify as a reorganization under section
368(a)(2)(E). In the merger the shares of
Helen of Troy MergerCo were converted into
shares of stock of Helen of Troy (US) and the
shares of Helen of Troy (US) held by the public
were converted into shares of New Helen of
Troy (Bermuda).
► Prospectus suggests that CFC assets would
be sold to New Helen of Troy (Bermuda) for
fair market value consideration in transaction
that would not be taxable in the US.
Helen of Troy
(US)
New
Helen of Troy
(Bermuda)
Public
Helen of Troy
Group
(US)
1
2
Helen of Troy
MergerCo
(US)
Helen of Troy
CFCs
3
Merger of Helen of Troy and Helen of Troy MergerCo
Page 9
2. Section 368(a)(2)(E) Inversion (1993) – Prototype Transaction Helen of Troy Resulting Structure and Response
Response / Policy Implicated
► Notice 94-46. Make transaction taxable to shareholders if shareholders
of US public have 50% or more of resulting corporations.
► Policy Implicated – Avoidance of US tax (seemingly subpart F, etc.
but possibly future income that could be earned outside the US and
that was never earned by a CFC). Political implications?
► Treas. Reg. §1.367(a)-3(c). Make transaction taxable to US shareholders
unless: (i) shareholders of US public receive 50% or less of acquiring
corporation; (ii) resulting non-US corporation has a 3 year active business
and has no plan or intent to dispose of that business; (iii) transferee
foreign corporation greater than or equal to the value of the US target;
and (iv) GRA in 5% circumstances.
► Policy Implicated – Preclude avoidance of US tax (presumably
subpart F, etc.) similar to the policy of Notice 94-46 outlined above.
Allow “real” third party transactions, but forestall non-third party
inversions. Mechanic chosen to enforce the policy very different
than section 1248(i) in McDermott. Section 1248(i) imposes a
corporate level tax (which makes sense in light of the policy) while
Treas. Reg. §1.367(a)-3(c) imposes a tax on shareholders. Does
taxing the shareholders make sense when the policy concern
involves the corporation avoiding tax?
Helen of Troy
(US)
New Helen of
Troy
(Bermuda)
Public
Helen of Troy
Group
(US)
Helen of Troy
CFCs
Page 10
3. Third Party Transactions Undertaken After Treas. Reg. §1.367(a)-3(c) – Illustrative Transaction Vodafone / AirTouch (PLR 199929039)Initial Structure and Transaction
Vodafone
(UK)
V Public
AirTouch
(US)
A Public
AirTouch
MergerCo
(US)
1
2
Merger
Description
► Vodafone formed AirTouch MergerCo (US).
► AirTouch MergerCo merged with and into
AirTouch US in a transaction intended to
qualify as a reorganization under section
368(a)(2)(E). In the merger the shares of
AirTouch MergerCo were converted in shares
of AirTouch and shares of AirTouch were
converted into shares of Vodafone and some
cash. Total combined market cap $110 Billion
(in 1999).
Page 11
3. Third Party Transactions Undertaken After Treas. Reg. §1.367(a)-3(c) – Illustrative Transaction Vodafone / AirTouch (PLR 199929039)
Vodafone
(UK)
Legacy
V Public
Legacy
A Public
AirTouch
(US)
Response / Policy Implicated
► PLR 199929039. Vodafone had traded at a higher market
capitalization than AirTouch for all but 3 days of the six
month period before announcement. However because
Vodafone had agreed to pay a premium for AirTouch (in
part because of bid competition) the market capitalization
of AirTouch at the time of the merger closing date would in
all likelihood exceed that of Vodafone.
► IRS exercised its discretion under Treas. Reg. §1.367(a)-
3(c)(9) to issue a PLR that the transaction was in
substantial compliance with the active trade or business
test.
► Policy Implicated – Allow third party transactions to
occur even if in a “merger of equals” (or a merger
where the US corporation was actually larger) the
parties chose a foreign jurisdiction as the resulting
corporation.
Page 12
4. Section 368(a)(2)(E) Inversions Redux (2001) –Illustrative Transaction Cooper IndustriesInitial Structure and Transaction
Description
► Cooper formed Cooper (Bermuda).
► Cooper (Bermuda) formed Cooper MergerCo.
► Cooper MergerCo merged with and into Cooper
(US) in a transaction intended to qualify as a
reorganization under section 368(a)(2)(E). In the
merger the shares of Cooper MergerCo were
converted into shares of stock of Cooper (US) and
the shares of Cooper (US) held by the public were
converted into shares of Cooper (Bermuda).
Intercompany leverage inserted as part of the
transaction.
► Section 367(a) and Treas. Reg. §1.367(a)-3(c)
“worked” to impose a shareholder level tax. Belief
however was that due to large number of
institutional shareholders the shareholder level tax
did not act as a sufficient impediment to the
transaction occurring. In other words external
economic factors rendered the Treas. Reg.
§1.367(a)-3(c) toll change ineffective in certain
cases.
Cooper
Industries
(US)
New
Cooper
(Bermuda)
Public
Cooper
Group
(US)
1
2
Cooper
MergerCo
(US)
Cooper
CFCs
3
Merger of CooperIndustries andCooper MergerCo
Page 13
4. Section 368(a)(2)(E) Inversions Redux (2001) –Illustrative Transaction Cooper IndustriesResulting Structure and Response
Response / Policy Implicated
► Section 7874 enacted imposed two sets of rules
► 7874(a). If (i) foreign corporation acquires
substantial all of US corporations assets, and (ii)
resulting foreign entity does not have substantial
business operations in the place of its
reincorporation, and (iii) shareholders receive 60%
or more (but less than 80%) of resulting foreign
corporation by reason of holding US stock then
certain attributes limited and excise tax imposed.
► 7874(b). All of the above but shareholders receive
80% or more then resulting foreign corporation is a
US corp (regardless of place of incorporation).
► Policy Implicated – Concern that corporations
continue to conduct business in the same
manner as before the inversion but with the
result that the inverted entity avoids US tax on
foreign operations.
Cooper
Industries
(US)
Cooper
Industries
(Bermuda)
Public
Cooper
Group
(US)
Cooper
CFCs
(US)
Intercompany
debt
Page 14
5. Section 368(a)(2)(E) Inversions Redux 2.0 (2009-2011) – Illustrative Transaction Ensco InternationalInitial Structure and Transaction
Description
► Transactional structure similar to other section
368(a)(2)(E) transactions.
► In response to major FTSE members migrating to
Ireland (e.g., WPP PLC, Shirer Pharmaceuticals)
UK announced it would move to a modified
territorial system.
► UK change caused the following four things to
occur: (i) WPP to return (see comments of Sir
Martin Sorrell regarding reasons for leaving and
why WPP would consider a return to UK); (ii)
reportedly other UK multinationals to refrain from
leaving; and (iii) caused US corporations like
Ensco to consider expatriating to the UK.
► Ensco is a provider of offshore drill rigs for oil
companies that have rights to the underlying
hydrocarbons. It had provided drill rigs in the UK
portion of the North Sea for well over 20 years. It
had significant assets, operations, cash flows,
employees in the UK. Ensco believe (correctly)
that it met the then applicable substantial business
activity test of section 7874(a)(2)(B)(iii).
Ensco
International
(US)
New
Ensco
(Bermuda)
Public
Ensco
Group
(US)
1
2
Ensco
MergerCo
(US)
Ensco
CFCs
3
Merger of EnscInternationaland Esco MergerCo
Page 15
► Speaking at the CEO Summit, organized by The Times, [Chancellor of the Exchequer
George] Osborne singled out WPP as an example of a UK business that had moved the
location of its headquarters from London to Dublin due to stringent tax laws, which mean UK
companies are charged corporate taxes for all overseas interests.
► Almost 90% of WPP Group revenue is earned outside the UK.
► Osborne said: "I want to reform the corporate tax system so that international
companies locate in Britain rather than leave Britain.“
► In April, Sir Martin Sorrell stated that he would be open to returning WPP's interests to the
UK if a new government changed the overseas tax law.
► And following the Chancellor's comments, Sorrell said he was, "delighted to hear the
Chancellor’s comment" and to hear the Chancellor and the prime minister "stress that Britain
must be open for business.“
► The move reduced the network's effective tax rate from 31.2% in 2008 to 23.5% in 2009.
► [Sir Martin Sorrell] "We made the move because it makes the tax planning process much
easier. You don't have to deal with the British Treasury trying to tax any of your foreign
profits."
5. Section 368(a)(2)(E) Inversions Redux 2.0 (2009-2011) – Illustrative Transaction Ensco InternationalInitial Structure and Transaction
Page 16
5. Section 368(a)(2)(E) Inversions Redux 2.0 (2009-2011) – Illustrative Transaction Ensco InternationalInitial Structure and Transaction
Response / Policy Implicated
► Revise substantial business activity rules within Treas. Reg.
§1.7874-3T.
► 2006 temporary regulations contained a facts and circumstances
test and 10% safe harbor (10% of assets, sales and employees).
► 2009 draft of temporary regulations removed 10% safe harbor and
retained facts and circumstances test.
► 2012 draft of temporary regulations removed facts and
circumstances test and established a 25% floor.
► Policy Implicated – 10% was too low so 25% was required?
How many companies could possibly meet the 25% test? TD
9592 states “[t]he IRS and the Treasury Department believe the
facts and circumstances test of the 2009 temporary regulations
should be replaced with a bright-line rule describing [the
requisite activity needed to meet the substantial business
activity test]. The IRS and the Treasury Department believe
that such a rule will provide more certainty in applying section
7874 to particular transactions than the 2009 temporary
regulations and will improve the administrability of this
provision.”
Ensco
International
(US)
Ensco
International
(UK)
Public
Ensco
Group
(US)
Ensco
CFCs
(US)
Page 17
6. Third Party Acquisition Inversion (2011-?) –Illustrative Transaction Biovail-ValeantInitial Structure
Description
► Biovail (BVF), a Canadian corporation,
and Valeant Pharmaceuticals Int’l (VRX),
a US corporation, entered into a series of
transactions in an effort to effect a
merger that would achieve numerous US
and foreign tax benefits
► Prior to these transactions, the equity
value of BVF was approximately $2.5B
and the equity value of VRX was
approximately $3.7B
BVF
(Canada)
BAC
(US)
VRX
(US)
V Public
B Public
Foreign
Subs
US
SubsForeign
Subs
US
Subs
Page 18
Transaction Steps
► VRX obtains a $3B loan from Lenders
(the “VRX Debt”).
► VRX distributes $1.3B cash to VRX
shareholders. This shrinks the value of
VRX from $3.7B to $2.4B (thus making
its market cap less than that of BVF).
► Newly formed Merger Sub merges into
VRX with VRX surviving the merger.
Each VRX share is converted into 1.78
shares of BVF stock.
► BVF guarantees the VRX Debt.
BVF
(Canada)
BAC
(US)
Merger
Sub
VRX
(US)
Lenders
(4) Guarantee
(3b) BVF Stock
(3a) Merger
(1) $3B Loan
(2) $1.3B
Distribution
VRX
S/hs
6. Third Party Acquisition Inversion (2011-?) –Illustrative Transaction Biovail-ValeantTransaction Overview
Page 19
Intended US Tax Treatment
► Pre- distribution intended to be treated
as a Section 301 distribution, not Section
356 “boot” (See Reg. §1.368-1(e)(7), ex.
9).
► Merger intended to qualify as a B
Reorganization (Rev. Rul. 74-565).
► VRX shareholders avoid Treas. Reg.
§1.368(a)-3(c) shareholder level tax.
► Retention and utilization of BVF’s
existing corporate tax structure, which is
highly advantageous.
► Insertion of debt in the US.
BVF
(Canada)
BAC
(US)
VRX
(US)Lenders$3B Loan
VRX
S/hs
BVF
historic
ops
BVF
S/hs
~50.5% ~49.5%
Sources of Deal Consideration (Per Share)
Value %
Cash $16.77 53.5%
Shares $14.60 46.5%
Total $31.37 100%
6. Third Party Acquisition Inversion (2011-?) –Illustrative Transaction Biovail-ValeantResulting Structure
Page 20
Biovail-Valeant InversionSelect Key US Tax Issues
► Independence of the special distribution from the share-for-share exchange
► Qualification of the transaction as a B Reorganization
► Relevant to the Section 301 versus Section 356 treatment of the cash received
by VRX’s shareholders via the pre-merger distribution?
► Should the BVF guarantee affect the analysis? If so, how?
► Establishing the value of VRX on the closing date
► For the share exchange to remain tax-free, Section 367 requires that the FMV
of BVF’s equity equal or exceed the FMV of VRX’s equity at closing
► How do you establish value in the case of a pure share-for-share exchange –
fixed exchange ratio?
► Treatment of prior acquisitions by BVF in the 36-month pre-closing period?
Comparison of anti-inversion rules
Section 7874 Reg. §1.367(a)-3(c)
Consequence
if applicable
BVF will be taxed as a US corporation if 80% owned by
former VRX shareholders. Alternatively, if former VRX
shareholders own between 60% and 80% of BVF,
certain limitations apply to the use of VRX’s attributes to
offset “inversion gain”.
Gain or loss recognized by US shareholders of VRX. All
shareholders of VRX are presumed to be US persons
(subject to rebuttal).
Rule applies if: (i) BVF acquires substantially all the assets of VRX (the
“Acquisition Test”);
(ii) More than 60% (or 80%) of the BVF stock (by vote
OR value) is held by the former shareholders of VRX
(not just US shareholders) (the “Ownership Test”);
AND
(iii) BVF does not have substantial business activities in
its country of incorporation compared to the activities of
the “expanded affiliated group” (EAG) (the “Substantial
Business Activities Test”)
(i) More than 50% (by vote or value) of the stock of BVF is
received in the transfer by US transferors (presumed to be
all VRX shareholders);
(ii) More than 50% (by vote and value) of the stock of the
BVF is owned immediately after the transfer by US persons
that are either officers or directors of VRX or that are 5%
VRX shareholders;
OR
(iii) BVF fails the active trade or business test.
(Also a GRA requirement for 5% shareholders of VRX).
Internal group
restructurings
Reg. §1.7874-1(c) provides an “internal group
restructuring” exception to the ownership test in which
stock held by members of the EAG is included in the
denominator for purposes of the Ownership Test
Effectively permits certain internal restructurings to
avoid application of §7874.
Section 367(a) applies to internal restructuring transactions
without any special exceptions for internal transactions.
Internal transactions remain subject to all of the rules of
§367(a) and must satisfy the usual exceptions to
qualify for nonrecognition treatment.
Page 21
Comparison of anti-inversion rules
Section 7874 Reg. §1.367(a)-3(c)
Business test Based on facts and circumstances, including: (1)
conduct of continued business activities in Canada by
the EAG; (2) amount of (i) EAG property located in
Canada , (ii) services performed by employees of the
EAG in Canada and (iii) sales by EAG members to
customers in Canada ; (3) performance of substantial
managerial activities by EAG members, officers and
employees based in Canada ; (4) substantial degree of
ownership of the EAG by investors resident in Canada ;
(5) existence of business activities in Canada that are
material to the achievement of the EAG’s overall
business objectives.
• Business must be performed in BVF’s country of
incorporation
(1) BVF or its “qualified subsidiaries” (80%-owned
subsidiaries not affiliated with VRX before the transaction
and not acquired with the principal purpose of satisfying
the active trade or business test) must engage in the
active conduct of a trade or business outside the US for
the entire 36-month period immediately before the
transaction; (2) at the time of the transaction, there can be
no intention to substantially dispose of or discontinue such
trade or business; and (3) the entire value of BVF
(including BVF) must be at least equal to the entire value
of VRX.
• Active business may be performed outside BVF’s
country of incorporation
Effect of
acquisition of
BVF
-- Might be able to take into account business activities
of BVF and its subs to satisfy the Substantial Business
Activities Test, if necessary (but only if BVF and subs
are organized in same jurisdiction as BVF).
-- Activities of BVF may be relied on to satisfy the active
business test.
-- Cannot rely on business of its CFCs in this case.
Page 22
Comparison of anti-inversion rules
Section 7874 Reg. §1.367(a)-3(c)
Application of
rule
Taxpayers must “fail” one (but not all) of the
requirements (the Acquisition Test, the Ownership Test
or the Substantial Business Activities Test) to avoid the
application of §7874.
Taxpayers must meet all of the enumerated requirements
in order to qualify for nonrecognition treatment.
Page 23
Page 24
Policy Issues
► How do the recent inversion transactions (involving cross border combinations) differ
from historic inversion transactions?
► What underlying international tax policies were furthered by the responses to the
various historic inversion transactions?
► When reviewed collectively did the responses to the various historic inversion
transactions constitute a cohesive set of policies?
► Given the differences between the various historic inversion transactions and the recent
cross border combination transactions what international tax policy implications (if any)
are raised by the latter transactions?
► Given that many of the cross border acquisition provisions were enacted or
promulgated in response to transactions that occurred in arguably very different
economic circumstances is it time to rethink the applicability of all of those provisions?
► If we are rethinking these issues should broader macroeconomic issues inform the
international tax policy analysis of cross border transactions in general?
Should we encourage/discourage US multinationals to be the acquirers in these transactions?
Should we encourage/discourage non-US multinationals from being the acquirers in these
transactions?
Should this examination include the consideration of other international tax policy/economic
issues such as locations of headquarters, encouragement of employment in particular
jurisdictions, etc.
Recommended