Corporate Expatriation : A study of the compatibility of section 7874 with the fundamental freedoms

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Corporate Expatriation

A study of the compatibility of section 7874 with the fundamental freedoms

Author: Sanira Hassan

Mastertrack: Internationaal en Europees belastingrecht Supervisor: M. van Dun

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1

Abstract

As a result of the substantial increase in tax avoidance and the public outcry accompanying it, the European Union has decided to implement a Directive that is meant to curb tax avoidance. One of the rules in the Directive is the Controlled Foreign Companies (CFC) legislation. The CFC legislation has a loophole: it is not effective if a company inverts. This loophole has been exploited in the US after the implementation of the U.S. CFC legislation. As a result, the US has enforced anti-inversion legislation. The goal of this thesis is to examine whether the U.S. anti-inversion legislation is applicable in Europe by assessing the compatibility of the legislation with the fundamental freedoms. The method this thesis uses is dogmatic analysis that evaluates the legislation under the European Court of Justice’s (ECJ) case law. The conclusion this thesis arrives at is that the anti-inversion legislation constitutes a breach of the freedom of establishment. However, the legislation does not constitute a breach of the free movement of capital.

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List of Abbreviations

ATA Anti-Tax Avoidance

BEPS Base Erosion and Profit Shifting

CFC Controlled Foreign Company

EA Expatriating entity

ECJ European Court of Justice

EU European Union

G20 Group of 20

IP Intellectual property

IRC Internal Revenue Code

IRS Internal Revenue Service

M&A Mergers and acquisitions

MNE Multi-National Enterprise

No. Number

NOL’s Net operating losses

OECD Organization for Economic Cooperation and Development TFEU Treaty on the Functioning of the European Union

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1. Introduction

1.1

Background

Tax avoidance is a universal problem that occurs in all societies and in all economic systems. Plato wrote about tax avoidance 2,500 years ago, and the aging Ducal Palace of Venice had a stone with a hole where people could inform the state about tax avoidance and evasion within the community. 1_{Even in the modern era, every country has its own legislation intended to curb} tax avoidance. However, with the globalization of the financial market, including the effortless movement of capital flows and international mobility of people, goods and services, tax avoidance has become more difficult to address.

In January 2015, the EU Council adopted the Anti-Tax Avoidance Directive (ATA Directive). 2_{This Directive urges Member States to take a coordinated stance against multinational} companies that avoid taxes and to adopt international standards against ‘Base Erosion and Profit Shifting’ (BEPS). 3_{The main purpose of the ATA Directive is to provide a clear, coherent and} coordinated transposition of the BEPS measures in the EU.4_{According to the European} Commission, the ATA Directive targets situations where taxpayers take advantage of the disparities between tax systems and thereby reduce their overall tax burden. Unless these situations are effectively addressed, they could create an environment of unfair tax competition within the EU. 5_{The ATA Directive constitutes a step towards policy integration in terms of} corporate taxation within the EU. The EU aims to ensure an effective but growth-friendly taxation policy, while increasing transparency and leveling the playing field within the internal market. 6

1_{Tanzi & Shome 1993, p. 807.}

2_{Council of the European Union, FISC 104 ECOFIN 628, outcome of ECOFIN meeting, 10426/16, Brussels, 17 June}

2016, p. 1.

3_{OECD, Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, 2015.}

4_{Directive (EU) 2016/26 (CNS), Proposal for a Council Directive laying down rules against tax avoidance practices}

that directly affect the functioning of the internal market, Com(2016) 26 Final, Brussel 28 January 2016.

5_{Communication from the Commission to the European Parliament and the Council, Anti-Tax Avoidance}

Package: Next steps towards delivering effective taxation and greater tax transparency in the EU, Com(2016) 23 final, Brussel 28 January 2016.

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7 The ATA Directive contains five legally binding measures one of which is the CFC legislation. Although the EU reached a political agreement concerning the ATA Directive, concerns have been raised regarding the consequences of the CFC.7_{According to some experts, the} implementation of the CFC legislation could result in an exodus of headquarter locations of multinational corporations (tax inversions).8_{The OECD has also considered the risk of} inversion in their report and stated that “it is likely that CFC rules will increase the risk of

inversions”, and although other factors also play a role in inversions “countries may want to consider them as a separate matter”.9_{The phenomenon of inversion has already occurred in} the US on a substantial level, and the U.S. government has responded to inversions by implementing the most comprehensive anti-inversion legislation in the world: section 7874.10

1.2

Research Question and Sub-Questions

The aim of this thesis is to analyze whether section 7874 can be used to supplement the CFC legislation in Europe. To answer this question this thesis would have to include substantive research concerning the compatibility of all relevant EU-law facets, including primary and secondary EU law. To limit the scope of this thesis, the analysis mainly focuses on the question of whether the anti-inversion legislation enforced in the US is compatible with the freedom of establishment, as defined in Article 49 of the Treaty on the Functioning of the European Union (TFEU). The question this thesis intends to answer is formulated as follows: “Is the U.S.

anti-inversion legislation compatible with fundamental freedoms?”

This thesis aims to answer this question by addressing the following sub-questions: - What does the CFC legislation in the Directive and the inversion loophole entail? - How does the U.S. anti-inversion legislation work?

- Is the U.S. anti-inversion legislation compatible with the freedom of establishment? - Is the U.S. anti-inversion legislation compatible with the free movement of capital?

2016.

8_{See the commentary sent by the Dutch Tax Advisors Association to the Dutch Finance Committee.}

9_{OECD, Designing Effective Controlled Foreign Company Rules, Action 3 - 2015 Final Report, OECD/G20 Base}

Erosion and Profit Shifting Project, OECD Publishing, Paris, 2015, p. 19.

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1.3

Method and Material

The method used in this thesis is a traditional juridical approach that can be described as a legal dogmatic analysis. This approach corresponds with the purpose of the thesis , as it attempts to evaluate legislation under the legal European framework set by the European Court of Justice (ECJ) when implementing the relevant European treaties. The material used for this thesis consists of primary legislation, doctrinal articles, and literature. Because there is no ECJ case law available on this specific topic, the ECJ’s case law on other relevant subjects are used to provide guidance for answering the research question.

1.4

Delimitations

Due to the limited scope of this thesis, a variety of delimitations have been made in order to properly center the thesis on the formulated question. First, this thesis focuses on the prime anti-inversion legislation in the US, namely section 7874. Other U.S. anti-anti-inversion legislation is only touched upon to provide the necessary historical context concerning section 7874. Second, this provision is scrutinized as it stands. Third, this thesis limits the compatibility evaluation to the fundamental freedoms. In addition to these delimitations, it is important to note that to present the inversion loophole, the CFC legislation in the ATA Directive is discussed. This discussion is based on the final version of the ATA Directive, which authorities reached consensus on in June 2016.11_{Because this version has yet to be officially published, references} are made to literature discussing the relevant legislation.

1.5

Disposition

Following the introduction in Chapter One, the CFC legislation and the inversion loophole are presented in Chapter Two. Subsequently, Chapter Three contains a comprehensive overview of section 7874. Chapter Four provides an introduction to the compatibility assessment with important general remarks. This section is followed by the essential assessment of the compatibility with the freedom of establishment. Chapter Six continues with a compatibility assessment of the free movement of capital. Finally, the conclusion is presented in Chapter Seven.

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2. CFC Legislation

2.1

Introduction

As previously mentioned, this thesis will discuss the U.S. judicial anti-inversion measures and the possible implementations of these measures in Europe. To properly asses s this anti-abuse measure it is prudent to analyze the CFC legislation in the ATA Directive. The insights resulting from such an assessment should provide a better understanding of the inversion loophole in the CFC legislation. The central question of this chapter is as follows: “What does the CFC

legislation in the Directive and the inversion loophole entail?” To provide an answer, this

chapter begins by presenting some general background with respect to the purpose of the CFC legislations. The general background is followed by a brief presentation of the CFC legislation in the ATA Directive. Next, the inversion loophole is defined and located in the CFC legislation. This is followed by a brief discussion of the different types of inversion transactions.

2.2

BEPS and the ATA Directive

The international tax system is rapidly changing with more and more aggressive tax planning techniques being applied by high profile multinational corporations. Governments are therefore forced to take measures to address concerns over base erosion and profit shifting, as well as perceived tax avoidance techniques in order to counter fiscal deficits. The OECD introduced an action plan on BEPS in July 2013 that specifically addresses perceived flaws in international tax regulations. The 40-page action plan contained 15 separate action points, some of which were further elucidated by their division into more specific actions.12_{In response to the BEPS} action plan the European Commission adopted the ATA Directive, which complements and reinforces the OECD’s BEPS project. The ATA Directive proposes five legally binding measures against aggressive tax planning and tax avoidance practices, which must be implemented by each EU Member State on or before the 1st_{of January 2019. The ATA} Directive aims to create a minimum level of protection against corporate tax avoidance and harsh tax planning throughout the EU.13_{Considering the importance of introducing CFC} legislation or tightening legislation that is already in place, the ATA Directive contains a clear CFC rule, which is further elucidated in below.

12_{OECD, Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, 2015.} 13_{Nouwen 2013, p.1}

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2.3

Purpose of the CFC Legislation

The purpose of the CFC legislation is to deter profit shifting. The opportunity for profit shifting mainly rests on two grounds. The first of these is that most states recognize that a company should be considered a separate entity for tax purposes. As Schmidt notes “the profits of a

foreign company should be isolated from tax in the residence state of the shareholders, at least until the time of repatriation. The postponement of domestic taxation is referred to as deferral or sheltering of income. Subsequently if the shareholder’s state of residence does not tax the dividends received by the shareholder or any capital gains on the shareholding, the end result will be that taxation in the shareholder’s state of residence is not only de ferred, but avoided altogether”.14

Second, the opportunity for profit shifting depends entirely on the fact that jurisdictions with low or no corporate tax exist. In other words, deferral or sheltering of income is only beneficial if the foreign tax is less than the domestic tax.15_{The benefit therefore depends on the difference} between tax rates, the length of the period of deferral, and the interest rates. If CFC rules are not in place it is relatively easy for companies to reduce their overall tax burden by shifting their mobile assets to companies/subsidiaries in countries with low income tax.16_{This practice} is harmful for governments since they have to cope simultaneously with lower revenue and higher costs to ensure compliance. It also harms individual taxpayers, who have to bear a greater share of this burden by paying more in taxes.17

To counter this problem, the EU Member States have agreed to outline CFC legislation in the ATA Directive that combats profit shifting and long-term deferral of taxation18_{. In sum, the} CFC legislation has the effect of re-attributing the income of a low-taxed controlled subsidiary to its parent company. The parent company then becomes taxable for that attributed income in its resident country. This subject can be clearly illustrated in the case of a multinational corporation parent that resides in a high-tax country. There is not much that a parent corporation can do within a high-tax country to reduce its overall tax burden. However, if the parent

14_{Schmidt 2016, p.2.} 15_{De Wilde 2015, p.1.} 16_{Schmidt 2016, p.2.}

17_{OECD, ‘Action Plan on Base Erosion and Profit Shifting’, OECD publishing, Paris, 2013, p.8}

18_{OECD, Designing Effective Controlled Foreign Company Rules, Action 3 - 2015 Final Report, OECD/G20 Base}

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11 corporation establishes a subsidiary in a low-tax country, it can shift all its passive assets towards this subsidiary where the overall tax burden is much lower. It is also possible for sub-subsidiaries in high-tax countries to repatriate dividends towards the subsidiary in a low-tax country.

2.4

CFC Legislation in the ATA Directive

2.4.1 The Implementation of the CFC Legislation

The implementation of the CFC legislation in the ATA Directive entails a measure of taxation in which the income of the CFC is taxed through the shareholder(s) or parent companies by re-attributing the income of low-taxed controlled subsidiaries to the shareholder(s)/companies.19 This also occurs if the CFC has not distributed dividends. Certain taxable income that arises in, or whose source is in, the territory of another state is included in the direct attribution to the shareholder(s)/companies.20_{The CFC legislation will, to a certain extent, ensure that Member} States do not lose tax revenue as a result of profit shifting or tax flight to low-tax countries.21

19_{Van der Lans & Verhoog 2016, p. 1.} 20_{Van der Lans & Verhoog 2016, p. 1-2.} 21_{Van der Lans & Verhoog 2016, p. 1.}

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2.4.2 Definition of a CFC

A foreign subsidiary or Permanent Establishment (PE) of a parent company established in a Member State of which the profits are not subject to tax or are exempt from tax in that Member State, is treated as a CFC if:

a) The taxpayer by itself or together with its associated enterprises holds a direct or indirect participation of more than 50% of the voting right and/or capital or is entitled to receive more than 50% of the profits of the foreign subsidiary/entity (art.7 (1) a).22

The application of a 50% control threshold in the ATA Directive attempts to ensure that the subsidiary is treated as a CFC when the parent company has sufficient influence or control. It would be unjustifiable to tax the parent company for actions it does not have control over.23 The inclusion of indirect participation and participation held by associated enterprises blocks the circumvention of the participation through the spread of shares.24_{Aside from the “sufficient} control test” the subsidiary or PE is treated as a CFC when:

that directly affect the functioning of the internal market, Com(2016) 26 final, Brussel 28 january 2016.

23_{Van der Lans & Verhoog 2016, p. 1-2.} 24_{Van der Lans & Verhoog 2016, p. 1-2.}

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b) The actual corporate tax paid by the entity or permanent establishment is lower than the difference between the corporate tax that would have been charged on the entity or permanent establishment under the applicable corporate tax system in the Member State of the taxpayer and the actual corporate tax paid on its profits by the entity or permanent establishment (art. 7 (1) b).25

Article 7b is well illustrated by the example of a multinational corporation, Parent X, which resides in a high-tax country with a tax rate of 40%, while its subsidiary, Y, resides in a country with a low tax rate of 10%. On a profit of €5,000, for example, subsidiary Y must pay €500 in taxes. The parent corporation X would have to pay €2,000 in taxes on the same profit. The actual tax paid by the subsidiary Y (€500) is lower than the difference between the corporate tax paid by parent X and the tax paid by the subsidiary Y (€2,000 - €500 = €1,500). In this case, subsidiary Y is treated as a CFC thus the CFC legislation is enforced.26_{In other words, a} subsidiary/PE can be qualified as a CFC if the actual tax paid by the subsidiary/PE is lower than 50% of the tax paid in the resident state of the parent corporation.

2.4.3 Definition of Income

When the CFC legislation is applicable and a foreign subsidiary is treated as a CFC, a specific list of “tainted income” is attributable to the parent corporation:

a) The non-distributive income of the entity or the income of the permanent establishment, which is derived from the following categories (art 7(2)(a)):27

- Any income or interest generated by financial assets;

- Any income or royalties obtained from intellectual property; - Any income or dividends obtained from the disposal of shares; - Any income obtained from financial leasing;

- Any income obtained from banking, insurance, and other financial activities; - Any income from invoicing companies that earn income from goods and

services purchased sold to associated enterprises, and add no to little economic value (intercompany transactions);

that directly affect the functioning of the internal market. Com(2016) 26 final, Brussel 28 January 2016.

26_{Van der Lans & Verhoog 2016, p. 2.}

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14 b) Non-distributed income from the entity or permanent establishment arising from

non-genuine arrangements that have been put in place for the purpose of obtaining a tax advantage.

Article 7 (2)(a) ATA Directive does not apply when the CFC conducts substantive economic activity supported by staff, equipment, premises, and assets. When defining “non-genuine arrangement” the ATA Directive applies an approach that is in line with transfer pricing regulations. The ATA Directive states that an arrangement or a series thereof is regarded as non-genuine to the extent that the CFC would economically own the asset or perform the risks.28

2.4.4 CFC Exemptions

The ATA Directive provides an option for Member States to exempt subsidiaries or permanent establishments that own less than 33% of tainted income. Member States can also exempt financial undertakings as CFCs if less than 33% of the entity’s income is derived from intercompany transactions. Entities or PEs with relatively small profits (less than €750,000 or less than 10% of the accounting profits of its operating costs) can also be exempted by Member States.29

2.4.5 Computation of Income and Double Taxation

For the computation of income, the legislation in Member States is applied to calculate the CFC income. Loss carried forward is balanced against future profits of the CFC to prevent import of losses. 30_{The CFC does not take into account taxes that are already paid in the CFC resident} state. On the other hand, it does take into account the economic double taxation that can occur when contributing income/profits to the parent corporation or when the parent corporation gains income by way of disposing participation in the entity or business conducted by the permanent establishment.31

2.5

The Inversion Loophole in the CFC Legislation

The CFC legislation offers a solution for EU Member States in combating tax deferral of multinational corporations. However, the implementation of the CFC legislation has a structural weakness, which is that it functions top-down. Figure 3 illustrates this weakness by describing a multinational corporation X, which resides in an EU Member State where the CFC legislation

28_{Van der Lans & Verhoog 2016, p. 2-4.} 29_{Van der Lans & Verhoog 2016, p. 3.} 30_{Van der Lans & Verhoog 2016, p. 2-4.} 31_{Van der Lans & Verhoog 2016, p. 5-7.}

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15 applies but has a subsidiary Y in a low-tax country. The CFC legislation ensures that income generated by Y is re-attributed to the parent corporation X. Parent corporation X cannot relieve this tax burden by staying in the state where the CFC legislation applies. Therefore, parent corporation X might be inspired to establish a new parent in a country where there is no CFC legislation and attach its subsidiaries to this new parent entity. This will ensure that re-attribution of taxes of its subsidiaries is deferred or even completely avoided.

A transaction in which a multinational company changes its place of incorporation from its resident state to a foreign jurisdiction, often without changes in its business operations is known as an inversion transaction.32_{Multinational corporations in countries such as the US, which has} a high tax rate, have inverted in the past in order to reduce taxation of foreign and even domestic income in their resident state. The goal of an inversion is to ensure that the company seat is transferred to another country for tax purposes, and this can be done by either transferring the real seat or changing the incorporation of a company (e.g. through a merger).

Inversions are achieved relatively easily since corporations only have to change where they are legally incorporated, rather than where they conduct business. There are four methods by which inversion can be accomplished.33_{These are briefly discussed in the next section, and include:} stock transaction, assets transactions, drop-down transactions, and spin-offs (partial inversion).

32_{Tootle 2013, p. 354.}

33_{Tootle 2013, p. 355.}

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2.6

Types of Inversion Transactions

2.6.1 Stock Transactions

In a stock transaction, the shareholders of multinational company A in a high-tax country exchange their shares for stock in a foreign corporation (new foreign parent B) in a low-tax country. This results in the former shareholders of company A owning the foreign parent B while the foreign parent B now owns company A. The exchange of stock can be direct or the foreign acquiring company can create a subsidiary in the country of company A and acquire company A in a reverse subsidiary merger.34

2.6.2 Asset Transactions

In an asset transaction, corporation A (which resides in a high-tax country with CFC legislation) merges with foreign parent B (which resides in a low-tax country). After the merge the general idea is that foreign parent B survives.35_{The CFCs of corporation A are transferred to foreign} parent B during the merge.36

2.6.3 Drop-down Transactions

In a drop-down transaction, corporation A (residing in a high-tax country) transfers its assets to the new foreign parent B through reincorporation.37_{This is followed by the new parent B} immediately contributing some of those assets to newly formed subsidiary C in the same country where corporation A previously resided. Because foreign parent B resides in a country with no CFC legislation, there is no re-attribution of the income to subsidiary C.38

2.6.4 Spin-offs (Partial Inversion)

In a spin-off transaction, corporation A (residing in a high-tax country with CFC legislation) could invert by spinning off part of itself to corporation B (residing in a low-tax country). Corporation B legally becomes the new parent and the CFC under corporation A is shifted to the new parent B.39

34_{Tootle 2013, p. 363.}

35_{Lemein & McDonald 2002, p.8.} 36_{Tootle 2013, p. 363.}

37_{Lemein & McDonald 2002, p.8.} 38_{Lemein & McDonald 2002, p.9.} 39_{Tootle 2013, p. 363.}

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17 The question that arises is whether there are still advantages for companies if these transactions are taxable. The history of inversions in the US has demonstrated that companies still redomiciled despite the transactions being taxed because the advantage of the inversion in the long term can outweigh the disadvantage of the tax paid in respect to the transaction.

2.7

Conclusion

As previously mentioned, the purpose of this chapter was to answer the following question: “What does the CFC legislation in the Directive and the inversion loophole entail?” The CFC legislation in the ATA Directive aims to combat tax deferral or avoidance through CFCs in low-tax countries. The legislation accomplishes this by attributing the income of the CFC to the parent company. However, the legislation works top-down; a multinational can circumvent the CFC legislation by headquartering in a country with no CFC legislation in place.

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3. U.S. Anti-Inversion Legislation

3.1

Introduction

This chapter primarily focuses on U.S. anti-inversion legislation. The first section justifies the choice of the legislation scrutinized. Afterward, anti-inversion legislation is discussed by shedding light on inversion history in the US. This is followed by the discussion of section 7874. The main question addressed in this chapter is: “How does the U.S. anti-inversion

legislation work?”

3.2

Why U.S. Anti-Inversion Legislation?

Before discussing the evolution of the U.S. anti-inversion legislation, it is prudent to elucidate why U.S. anti-inversion legislation is the subject of this thesis. U.S. anti-inversion legislation was chosen because the US has one of the most comprehensive anti-inversion legislations in the world.40_{Corporate inversions have become a popular phenomenon under U.S. multinational} corporations.41_{Since 1982, over 60 formerly U.S. multinationals expatriated their tax} headquarters to foreign shores, forcing U.S. legislators to counteract this effect through the implementation of anti-inversion measures.42_{As a result, the U.S. government introduced the} first anti-inversion legislation to specifically target inversion in 2004. Nevertheless, 47 companies have still redomiciled through inversion in the past decade, causing the issue of corporate inversion to rise to the top of the current tax agenda in the US.43

Considering these facts, the question could be asked as to why this thesis chose to study U.S. anti-inversion legislation to close the CFC loophole when this legislation has itself failed to curb inversion. In answer to this, it is important to review the reason behind corporate inversion in the US, as the U.S. CFC legislation does not constitute the sole driver of expatriation of multinationals. There are other incentives for multinational corporations to expatriate, and economists have emphasized two other aspects of the U.S. tax law as the main reasons for the current exodus of corporations. These include the high U.S. corporate income tax rate and the

40_{Tootle 2015, p. 368.}

41_{Behagg 2016, p.132.}

42_{Bloomberg, ‘Tracking Tax Runaways: Bloomberg Inversions Database’. Online at:}

https://www.bloomberg.com/graphics/infographics/tax-runaways-tracking-inversions.html.

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19 implementation of the worldwide tax system.44_{In the US, both domestic source income and} foreign source income are taxable. The US applies a system in which companies are taxed based on their entity. This is also known as the “worldwide system” of taxation.45_{If a corporation is} incorporated in the jurisdiction of the US, the corporation is deemed domestic regarding taxation affairs, meaning the federal government will tax the corporation regardless of where the income is earned.46/47_{This stands in contrast with the “territorial system” of taxation applied} by the majority of countries worldwide. In the territorial system, foreign sourced income is exempt from taxation in the corporation’s country of residence.48

The worldwide system of taxation is considered to be a disadvantage for U.S. multinationals, and deemed to be even more detrimental in combination with the high U.S. statutory income tax rate. The US has the highest statutory income tax rate of any OECD member. The maximum federal corporate income tax rate is 35%, and taxes on domestic source income are at approximately 39%, almost 15% higher than the OECD average. The combination of the tax system, the tax rate, and the implementation of the U.S. CFC legislation has led to a wave of inversion despite the adoption of comprehensive anti-inversion legislation.49_Economists believe that the U.S. anti-inversion legislation would be more effective if the US applied a territorial taxation system or a lower tax rate.50_{Most Member States either apply a territorial} taxation system or a participation exemption system. In a participation exemption system, most active earning repatriated from subsidiaries resident in foreign countries are exempt. Furthermore, the tax rates are, in average, lower in the Member States. Since most Member States already have these factors in place, the U.S. anti-inversion legislation could prove to be quite effective if adopted in the EU. Thus, the legislation proves to be a solution worthy of evaluation.

3.3

The U.S. Tax Law Hierarchy

In order to understand the following sections on anti-inversion, a basic understanding of the sources of U.S. tax law is imperative. This section provides a brief, general overview of the

44_{Solomon 2012, p. 1206-1207.} 45_{Yang 2016, p. 48.}

46_{Yang 2016, p. 48.}

47_{To avoid double taxation, the U.S extends domestic corporations a credit for taxation paid in foreign countries.} 48_{Capurso 2016, p. 584.}

49_{Behagg 2016, p. 134.} 50_{Solomon 2012, p. 1211}

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20 U.S. federal tax law hierarchy. The relevant sources of the federal tax law with regard to this chapter are delineated below, beginning with the highest authority.

3.3.1 The U.S. Constitution

The Constitution is the supreme law of the US, from which the power of taxation in the US is derived. The Constitution gives Congress the power “to lay and collect taxes, duties, imposts

and excises”.51_{Congress has adopted the Internal Revenue Code (U.S. tax law) by virtue of the} Constitution.

3.3.2 Federal Tax Statutes

The Internal Revenue Code (IRC), which is enacted by U.S. Congress, provides the basis of the federal tax authority in the US and is also the authority when conducting federal tax research. The interpretation of the IRC is given in Treasury Regulations and judicial decisions.52

3.3.3 Treasury Regulations

Treasury Regulations are the official interpretation of the Treasury Department on how certain IRC sections should be administered and applied. The Treasury Department derives their authority to issue regulations from laws enacted by Congress. When Congress creates an agency, the agency is given the authority to regulate certain activities within the jurisdiction of that agency. Agencies do not enact or create law, however, they are empowered in creating rules which must be adhered to in order to advance a particular enacted legal provision and for the enforcement of the law. Tax regulations exist in three types: final Treasury Regulations, temporary Treasury Regulations, and proposed Treasury Regulations. In addition, there are also three types of tax regulations: legislative, procedural, and interpretive. Final regulations are the highest authority used by the Treasury Department and are above Internal Revenue Service (IRS) rulings. Final regulations must be followed by IRS and provide guidance to tax professionals. Temporary regulations provide guidance until final regulations are issued; temporary regulations have the same authority as final regulations. Proposed regulations are non-binding and serve simply as guidance, however, proposed regulations are useful in indicating the IRS position on certain matters. Notices are proposed regulations and are

51_{U.S. Const. art. I, § 8.}

52_{Wolters Kluwer CCH tax law tutorial,’ Tax Research: Understanding Sources of Tax Law}

(Why my IRC beats your Rev Proc!)’ pp.2-3. Online at:

https://www.cchgroup.com/media/wk/taa/pdfs/accounting-firms/tax/understanding-sources-tax-law-fact-sheet.pdf and IRS, ‘Tax Code, Regulations and Official Guidance’. Online at:

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21 therefore non-binding. Legislative regulations are issued when the IRS provides operational rules for specific IRC provision on the authority of the IRC. Legislative regulations generally carry the same authority as the law. Procedural regulations address procedural matters and are binding. Interpretive regulations explain the position of the IRS on different IRC sections; these regulations are not specifically authorized by the law. However, interpretive regulations can carry a substantial amount of authority. The regulations issued in regard to section 7874 and discussed in these sections are interpretive regulations because they can be challenged.53

3.4

The Evolution of the Anti-Inversion Legislation

3.4.1 The First Inversion and the Enactment of Section 1248 (i)

The first inversion occurred in the early 1980s when McDermott redomiciled its headquarters to Panama. McDermott is a construction, procurement, and engineering company that distributed equipment to offshore oil and gas operations. Because McDermott funneled all of its international profit through a Panamanian subsidiary, the U.S. CFC regime became a substantial burden.54_{As a result, McDermott announced its inversion in 1982. The Panamanian} subsidiary, McDermott International, bought shares from the public shareholders of the parent corporation, McDermott Inc., in exchange for newly issued shares in McDermott International. After the completion of this deal, McDermott International became the parent corporation, and McDermott Inc. became the U.S. subsidiary of McDermott International.55

The reorganization of McDermott did not lead to any substantial change in control. As Behagg notes, “the shareholders held almost the entirety of the voting stock in McDermott

International, effectively allowing control of the newly arranged company to continue as before”.56_{With this new technique, McDermott managed to circumvent the U.S. CFC regime} (known as subpart F). Through inversion, McDermott avoided up to $220 million of U.S. subpart F tax over a time span of five years, and to make matters worse, McDermott brazenly

53_{Wolters Kluwer CCH tax law tutorial,’ Tax Research: Understanding Sources of Tax Law}

(Why my IRC beats your Rev Proc!)’ pp.2-3. Online at:

https://www.cchgroup.com/media/wk/taa/pdfs/accounting-firms/tax/understanding-sources-tax-law-fact-sheet.pdf and IRS, ‘Tax Code, Regulations and Official Guidance’. Online at:

https://www.irs.gov/tax-professionals/tax-code-regulations-and-official-guidance.

54_{Kimmel 1990, p. 265.} 55_{Chiu 2015, p. 726.} 56_{Behagg 2016, p. 132.}

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22 proclaimed that the transaction was solely entered into for tax purposes.57_{In its disclosure,} McDermott explained that “the 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”.58

The U.S. tax administration tried to challenge the transaction under existing regulations but failed.59_{Fearing the new technique would become a trend with other U.S. corporations, the} government responded by enacting section 1248(i).60_{In general, section 1248 serves as a} complementary provision to subject accumulated capital gains by a CFC not included under the U.S. CFC regime.61_{Where there is a lower rate on capital gain compared to dividend income,} section 1248 was designed to prevent the conversion of a foreign corporation into capital gain through the sale or liquidation of a controlled foreign corporation. Section 1248 accomplished this by taxing the capital gain as a dividend. The added section 1248(i) extended this tax treatment to transactions similar to the McDermott transaction.62_{At the time, section 1248(i)} was perceived as a successful response to inversions, since it brought a halt to inversions for nearly a decade. Tax authorities did not foresee the mass exodus that would follow the next inversion.

3.4.2 The Second Inversion and the Amendment to Section 367 (a)

By introducing section 1248(i) the capital gain advantage was eliminated, and CFCs profits were taxed as if they were dividends to the parent company. This resulted in the elimination of tax benefits of the transaction. However, if a company inverted using a CFC with no earnings or profits of any kind, Section 1248(i) would have no effect. Like the Trojan War, the next battle was instigated by a “Helen of Troy”, and this is exactly how the company executed the second inversion.63_{Helen of Troy established a brand-new company in Bermuda so that the} shareholders could exchange their shares for those of the Bermudan CFC. Thus, just like McDermott, Helen of Troy became a U.S. CFC to her Bermudan subsidiary.64_{With this}

57_{Behagg 2016, p. 132.} 58_{Kimmel 1990, p. 266.} 59_{Tootle 2013, p. 365.} 60_{1248(i) IRC.} 61_{Tootle 2013, p. 365.} 62_{Tootle 2013, p. 365.} 63_{Yang 2015, p. 679.} 64_{Yang 2015, p. 679.}

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23 inversion, Helen of Troy realized the circumvention of the first anti-inversion regulation, and like McDermott, Helen of Troy explicitly stated that their reorganization was meant to minimize non-U.S. income taxes.65

As a response, the U.S. government attempted to make inversion less attractive by taxing the shareholders. This was achieved by modifying section 367(a) of the U.S. tax code, also known as the Notice 94-46 amendment.66_{During the inversion of Helen of Troy, the transaction was} tax-free for shareholders. The U.S. tax code contained general “non-recognition” rules that allowed certain transactions to be exempt from taxation. Section 367(a) nullified these non-recognition rules in cases were a foreign corporation was involved.67_{The amendment through} Notice 94-46 brought the transaction of Helen of Troy under the scope of section 367(a).68_In the modified section 367(a), avoiding shareholder-level taxation became more challenging since several new requirements had to be met. With the new section 367(a) ownership as a group was targeted. The new regulations stated that all U.S. persons transferring stock to a foreign company were not allowed to own more than 50% of the resulting foreign company’s stock as a group.69_{This contrasted the previous regulation where the tax liability was based on} U.S. transferor’s individual ownership. Furthermore, the regulation also accounted for economic control by applying a threshold on preferential shares that contained special voting power.70_{Shareholders with economic motives were spared from the section through “an active} trade or business test” provision added in the amendment. This provision contained a requirement stating that foreign companies (or qualified subsidiaries/partnerships) were not allowed to have plans of discontinuing the business for at least 36 months prior to the transaction.71_{The shareholder would furthermore only be exempt from the disposal profit} concerning the shares if the U.S. shareholders owned less than 5% of the foreign company acquiring the shares.72_{Another requirement was that the transaction had to pass the} “substantiality test”. This test required that the foreign company had to be at least as big as the

65_{Hwang 2015, p. 824.}

66_{367(a) IRC.}

67_{Hwang 2015, p. 824.}

68_{Lipeles, McDonald & Levy 2012, p.2.} 69_{Hwang 2015, p. 824.}

70_{Hwang 2015, p. 825.} 71_{Rao 2015, p. 8.} 72_{Hwang 2015, p. 825}

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24 U.S. target company.73_{The reason for this was because the US believed that the acquisition of} large domestic companies by smaller foreign companies would only occur for tax purposes.74 These new requirements were meant to actively halt inversions. The shareholder-level tax was meant to make inversion of public companies undesirable and burdensome for shareholders.

3.4.3 The Wave of Inversion in the 1990s and Early 2000s

Despite the effort of the U.S. government, the inversion transaction completed by Helen of Troy was followed by a wave of inversion in the late 1990s to the early 2000s. Over a short period of time, around 20 big corporations expatriated from U.S. soil by means of an inversion.75_Until the mid-1990s, inverting a U.S. company was considered unbeneficial, due to section 367(a) an unfavorably high tax would have to be paid in share value for reincorporating outside the US. However, the economic decline and crash of the stock market in the late 1990s diminished the effect of section 367 (a), and as the value of shares in U.S. corporations hit rock bottom, inversion suddenly gained popularity.76_{Lower stock prices inevitable resulted in lower} shareholder-level tax (or even zero tax for shareholders who had sustained losses). Lower stock prices and heightened pressure on managers to increase profit made companies turn to inversion to increase stock prices. Once inversion gained media attention and entered the public eye it began to attract criticism, which only intensified after 11 September 2001 when contributing one’s fair share was deemed a patriotic act. The public scrutiny and backlash against inverting companies prompted the U.S. government to take new measures to prevent inversion.77

3.5

Section 7874

3.5.1 The American Jobs Creation Act

To counter inversions the American Jobs Creation Act of 2004 was enacted, which contained broad anti-inversion legislation defined under a new code, section 7874.78_{Section 7874} sanctions inverting businesses with taxation if, pursuant to a plan or series of related

transactions, the following requirements are met:

73_{Hwang 2015, p. 825.} 74_{Rao 2015, p. 8.} 75_{Avi-Yonah 2002, p. 1794.} 76_{Tootle 2013, p. 366.} 77_{Avi-Yonah 2002, p. 1794.} 78_{Wong 2015, p. 456.}

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25 1. The new foreign parent corporation directly or indirectly substantially acquires all

properties from the domestic corporation;

2. At least 60% of the stock of the new foreign parent corporation is owned by the former shareholders of the inverted company/domestic corporation;

3. After the acquisition the expanded affiliated group of the inverting entity does not have substantial business activities in the foreign country in which the parent company is relocated.79

The three requirements also known as the “Acquisition Test”,80_{the “Stock Ownership test”,}81 and the “Business Activities Test”82_{are applied, taking into account any series of related} transactions.83_{In the following paragraphs, the three tests are further elucidated. If a transaction} fails all three tests, the section will recognize the new foreign parent as a “surrogate foreign corporation”. Section 7874 applies different tax treatments to surrogate foreign corporations in cases of 80% inversions or 60% inversions, with the percentages measuring the continuity of shareholder interest.84_{Between the enactments of section 7874 in 2004 until 2009 only three} companies inverted, and these companies have had significant business operations in the countries they relocated to. Section 7874 proved to be useful against inversion until the commencement of the second inversion wave in 2009, which like its predecessor was sparked by a new economic crisis.85

3.5.2 The Acquisition Test

The acquisition test is based on the foreign company directly or indirectly substantially acquiring all the properties held directly or indirectly by the domestic corporation.86_{By “direct”} the test means an acquisition of either the stock or assets of a domestic company. The “indirect” phrasing is applied for triangular reorganizations in which a domestic corporation A acquires the stock or assets of a domestic target corporation B in exchange for the stock of a foreign corporation that controls domestic corporation A.87

79_{Wong 2015, p. 456.}

80_{7874(a)(2)(B)(i) IRC.} 81_{7874(a)(2)(B)(ii) IRC.} 82_{7874(a)(2)(B)(iii) IRC.}

83_{Dolan, Jackman, Tretriak & Dabrowski 2005, p. 1.} 84_{Wong 2015, p. 457.}

85_{Tootle 2014, p. 368.}

86_{Dolan, Jackman, Tretiak & Dabrowski 2005, p. 2} 87_{Dolan, Jackman, Tretiak & Dabrowski 2005, p. 2}

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26 The acquisition test has its own criteria for determining if an acquisition is pursuant to a plan. Under section 7874(c)(3), “if a foreign corporation acquires directly or indirectly all the

properties of a domestic corporation or partnership during the 4-year period beginning on the date which is 2 years before the ownership requirements are met, the acquisition will be treated as pursuant to a plan”.88_{Thus, the acquisition of the assets will be disregarded if this} acquisition is not followed by a stock transaction between the new foreign corporation and the former shareholders for the shares in the expatriating entity.89_{When considering stock} acquisition inversion, there is no clear definition in the IRC of how much stock represents “substantially all” of the underlying assets. Through judicial decisions, IRS rulings and practice “substantially all the assets of a target” has been defined as assets having a fair market value of at least 90% of all the target’s assets with liabilities.90

3.5.3 Stock Ownership Test

After the acquisition of the foreign corporation, former shareholders of the domestic corporation must hold at least 60% of the stock (by vote or value) of the transferee foreign corporation. 91_{“Former shareholders” in this context is emphasized, and simply means that the} shareholders of a domestic corporation must exchange their shares for shares in the new parent company. Stock that is sold in a public offering related to an acquisition of a domestic corporation’s assets is disregarded by section 7874. However, an expatriating corporation may not use a public offering to dilute the ownership of the “former shareholders”. Shares in the transferee foreign corporation acquired by direct investment or by means of private placement fall under section 7874.92

3.5.4 Business Activity Test

Under section 7874, a corporation is not deemed to be a surrogate foreign corporation if its expanded affiliate group has substantial business activities in the foreign country (determined in comparison to the total business activities of the corporation). After the enactment of section 7874 the business activity test led to a great deal of confusion, as there were no clear guidelines regarding what activities constituted “substantial business activities”. In response, Treasury

88_{Dolan, Jackman, Tretriak & Dabrowski 2005, p. 2}

89_{In the case of an asset reorganization in which the domestic corporation transfers its assets to the transferee}

foreign corporation section 7874 will not apply.

90_{‘Substantially all assets’ is also defined as a fair market value of at least 70% of all targets assets without}

considering the liabilities.

91_{Dolan, Jackman, Tretriak & Dabrowski 2005, p. 2.} 92_{VanderWolk 2010, p. 701.}

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27 enacted guidelines to clarify the substantial business activity test.93_{Treasury derives its} authority to issue regulations based on section 7874(c)(6), which states that the Secretary of Treasury can prescribe regulations “as may be appropriate to determine whether a corporation is a surrogate foreign corporation”.94

Treasury and the IRS enacted their first temporary regulations in 2006 by elaborating the substantial business activity test. According to the 2006 Treasury Regulations , an activity qualifies as “substantial business activity” if it either passes the facts and circumstances test or the safe harbor test.95_{The facts and circumstances test determines whether an expatriated entity} has substantial business activity in a country by evaluating the facts and circumstances in each case. As guidance, Treasury and the IRS provided a non-exhaustive list of factors to be considered. Treasury also presented examples of activities that pass the test. Treasury and the IRS further introduced the safe harbor test. In accordance with this test, corporations with at least 10% of their employees, assets, and sales located in the new foreign headquarters would be deemed to have substantial business activity in the foreign country.96

In 2009 Treasury revoked the safe harbor test and the examples that followed the facts and circumstances test. According to the IRS, the safe harbor test exempted “certain transactions that are inconsistent with the purpose of section 7874”. The implementation of the 2006 regulations and the enactment of 7874 proved to be quite successful. Only four companies inverted between 2004 and 2009, and it can even be questioned whether these transactions should be considered inversions, since all four companies had substantial business activities in the country they relocated to.97_{The author questions why the 2006 regulations were amended} in 2009. Perhaps the realization that a company with 90% of its business activity located in the US and 10% of its activity in a foreign country could invert without being sanctioned by section 7874 created an incentive to amend the 2006 regulations.98_{Whatever the reason, it did not stem} the tide of inversions following the 2009 regulations. This new wave of inversions arose partly because of the financial crisis. Stock prices had been depressed, making shareholders inclined to avoid the gain recognition of section 367(a). Another cause for the inversions is the

93_{Tootle 2013, p.371.} 94_{26 U.SC § 7874(c)(6).} 95_{Wong 2015. P. 458.} 96_{Tootle 2013, pp. 378-379} 97_{Tootle 2013, pp. 378-380} 98_{Tootle 2013, p. 380}

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28 amendment of the 2006 regulations. The number of inversions depending on “the business activity test” increased only after the 2009 regulations were enacted.

As a response to the increase in inversions, the Treasury Department issued new temporary regulation in 2012. These regulations amended the 2009 regulations by presenting a new safe harbor test and rescinding the facts and circumstances test. The new safe harbor test is more stringent than its predecessor. Under the new test, a foreign corporation only has substantial business activity in a nation if at least 25% of its group employees group, assets and group sales are located in that nation.99

3.6

Sanctions under Section 7874

3.6.1 Sanctions on a 60% Inversion

Section 7874 divides the inversion transaction into two different categories,7874(a) and 7874(b), each with a different set of rules. Section 7874(a) applies in cases of a transaction that satisfies the 60% inversion threshold. If after the acquisition, the shareholders or partners of a domestic corporation hold at least 60% but less than 80% of the stock of the foreign acquiring corporation, the expatriating entity (i.e. domestic corporation) is taxed for the inversion gain for 10 years subsequent to the final acquisition of properties.100_{Inversion gain is defined in} section 7874 as:

1. Income or gain obtained by reason of transfer of stock or other properties by an expatriated entity.

2. Income received or accumulated by reason of license of any property, but only if the income or gain arises:

(A) In a transfer taking into account the acquisition described in the acquisition test subsection;

(B) If the transfer or license is to a foreign related person.

To provide an example, if an expatriating entity inverts and relocates their intellectual property (IP) to the surrogate foreign corporation, the expatriating entity would still be taxed for the profits generated by the IP for a period of 10 years. The entity is also restricted in using any tax

99_{Wong 2015, p. 459.}

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29 attributes (such as net operating losses (NOLs), deduction or credits) for offsetting gain from the inversion transaction.101

3.6.2 Sanctions on an 80% Inversion

Section 7874(b) applies in cases of an 80% inversion, where a foreign corporation acquires 80% or more of the domestic corporation’s stock.102_{In cases where this requirement is met, the} foreign corporation is treated as a domestic corporation for all purposes of the IRC.103_Foreign subsidiaries of the surrogate foreign corporation will become a CFC under subpart F provision of the code, diminishing the opportunity for future U.S. tax reduction. The fact that there is no time period linked to the extent of the application of this sanction makes it one of the most drastic measures in U.S. tax legislation.104

3.7

Changes to Section 7874

Since 2004, the Treasury Department issued regulations concerning the interpretation of section 7874. As mentioned previously, Treasury gains its authority to enact regulations based on section 7874(c)(6). Treasury further draws its authority from section 7874(g). This article gives Treasury the power to provide regulations that are “necessary to carry out this section, including regulations providing for such adjustments to the application of this section as are necessary to prevent the avoidance of the purposes of this section”.105_{Under this authorization, Treasury has} issued numerous regulations that further elaborated the section. These regulations are outlined below.

3.7.1 The 2016 Regulations and Notice 2014-52 and 2015-79

The enactment of section 7874 and the regulations issued by the Treasury had a significant impact on the inversion landscape. Many corporations were unable to use the classic inversion transactions of their predecessors due to the substantial business activity test. Inversions executed after the implementation of section 7874 no longer involved tropical islands that functioned as tax havens, such as Bermuda. The post-2004 inversions involve countries with significant business operations such as Ireland and Canada.106_{Whereas previously corporations} used existing subsidiaries or established new subsidiaries, modern inversion transactions entail

101_{VanderWolk 2010, p. 704.} 102_{VanderWolk 2010, p. 707.} 103_{VanderWolk 2010, p. 710.} 104_{Tootle 2013, p.371.} 105_{26 U.SC § 7874(c)(6).} 106_{Wong 2015, p. 457.}

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30 U.S. corporations purchasing or merging with a foreign corporation that has substantial business activity in the destination country.107_{Dozens of companies have used this modern inversion} technique to expatriate. Examples of inverted companies include Civea Corp, Energy Fuels Inc., Coca-Cola Enterprise, CF Industries, Endo International Plc, Horizon Pharma PLC, Omnicon and Aon.108

The fact that a modern inversion is structured as part of a mergers and acquisitions (M&A) transaction brings new challenges to legislators. While previous inversions were openly characterized as tax driven deals, corporations now hide inversion behind strategic business justifications. For instance, on August 26, 2014, Burger King Worldwide Inc. conveyed its plans to purchase Tim Hortons Inc.109_{The acquisition of the Canadian donut company would} result in the two companies merging to become the Canadian company, Restaurant Brands International.110_{The CEO of Burger King announced that the deal was “not a tax-driven deal”.} 111_{Burger King explained that Canada forms the biggest share of revenue for the new} corporation, and the inversion formed part of strategic model allowing Burger King to expand its market share. Despite these claims, the public backlash and skepticism Burger King received was not completely unfounded. The merger did not explain why the Canadian shareholders would only get 22% of the new corporation while the bulk share of the revenue came from Canada.112

In response to the modern inversion, the Obama administration proposed new anti-inversion rules. In April 2016, Treasury and the IRS issued temporary regulations regarding inversion legislation. The regulations were the most comprehensive regulations issued yet, and the temporary regulations exceeded 200 pages and focused on different sections of the IRC. 113 Prior to the release of the temporary regulations, the IRS released two notices; Notice 2014-52 and Notice 2015-79, which addressed most of the issues in the temporary regulations. The temporary regulations consisted of the guidance provided in previous notices including new

107_{Wong 2015, p. 457.} 108_{Yang 2016, p. 51.} 109_{Capurso 2016, p. 581.} 110_{Yang 2016, p. 54.} 111_{Capurso 2016, p. 604.} 112_{Capurso 2016, p. 605.}

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31 rules that targeted specific inversion techniques. Through the enactment of the temporary regulations the Notices became obsolete as of April 2016.114_{The new temporary regulations} are very comprehensive, and this thesis does not attempt to address every aspect and detail of those regulations (such as addressing how specific terms should be interpreted). Instead, this thesis addresses the broader concepts of the issued regulations in regard to Section 7874. This is done by first providing a summary of the superseded Notices, after which provisions of the April 2016 temporary regulations are discussed separately.

The Treasury Department and the IRS issued Notice 2014-52 115_{followed by Notice} 2015-79.116_{The reason given for the enactment of Notice 2014-52 derived from the concern that} recent inversion transactions “were inconsistent with the purposes of section 7874”.117_Notice 2014-52, which warned that temporary regulations were to be expected, mainly addressed two broad concepts:

1. Techniques aimed at manipulating the ownership threshold for application of the inversion rules;

2. Techniques aimed at achieving post-inversion benefits, specifically repatriation of foreign earnings without triggering repatriation taxes and thus without incurring U.S. taxation118_.

Notice 2014-52 provided rules for the limitation of the ability to inflate the value of the foreign target by means of using passive assets (i.e. assets that are not part of the entity’s daily business functions such as cash, marketable securities, etc.)119_{Inflating the value of the foreign target} was executed in the attempt to make the U.S. acquiring company fall below the 80% or 60% ownership threshold. In Notice 2015-79, this concept is further clarified by excluding certain active banking financing and/or insurance property from these passive assets. Under Notice 2015-52, passive assets are not taken into account in applying the 80% or 60% threshold if 50% or more of the foreign merger partner’s assets are passive assets. In addition, distributions made by the U.S. inverting company within three years preceding the inversion to dilute the domestic

114_{Schmidt & Thompson 2016, p. 11.} 115_{2014-2 CB 712.}

116_{2015-49 IRB 775.}

117_{Schmidt & Thompson 2016, p. 12.} 118_{Wong 2015, p. 460.}

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32 ownership, thereby making the percentage of ownership smaller in order to pass the 80% or 60% ownership threshold, would not be taken into account in determining the inverted company’s value.120_{Previously, companies would attempt to dilute domestic ownership by} paying out non-ordinary dividends, or extraordinary dividends (i.e. a dividend is considered non-ordinary if its 110% greater than the average from the year before). In sum, if a domestic corporation dividend payout is within three years of the inversion transaction, they are disregarded as a mere attempt to dilute the corporation’s size and value.121_{Notice 2015-79} excludes dividends from this rule if shareholders of the U.S. acquired company hold a minimum amount of stock in the foreign acquiring company after the acquisition. This exception applies when the ownership continuity percentage is less than 5%, and after the inversion, former shareholders of the domestic corporation own, in aggregate, directly and indirectly less than 5%.122

Notice 2014-52 also prevents access to foreign profits without incurring U.S. tax. This post-inversion benefit is gained by accessing trapped cash/assets accumulated offshore by a CFC through loans or investments. This is seen when, for example, a CFC loans its trapped cash to the foreign parent, thus “skipping/hopscotching” the domestic corporation. The domestic corporation then receives access to the money through a capital injection by the foreign parent.123 _{Notice 2014-52 halts the circumvention of repatriation taxes by treating a} “hopscotch” loan as U.S. property for a period of 10 years after the inversion.124

The 2014 Treasury Regulations also attempted to close the loophole of “decontrolling transactions”. Essentially, the decontrolling transaction loophole begins after an inversion, when there is a stock-asset swap between the new foreign parent and the CFC of the domestic corporation. If the multinational group ends up owning 50% or more of the CFC after the transaction, the CFC automatically becomes the foreign subsidiary of the new foreign parent. This ultimately means that the domestic corporation no longer has a controlled foreign subsidiary and therefore it cannot be subjected to U.S. CFC legislation. The 2014 Treasury Notice addresses this issue by treating the foreign subsidiary in a decontrolled transaction as a

122_{Wong 2015, p. 461.}

Corporate Expatriation : A study of the compatibility of section 7874 with the fundamental freedoms