On June 7, 2012, Treasury and the Internal Revenue Service (the IRS) issued much-anticipated final, temporary, and proposed regulations under section 7874, which provides rules governing so-called “inversion transactions.” In an effort to provide certainty with respect to the determination of “substantial business activities” in a foreign country for purposes of the statutory exception of section 7874(a)(2)(B)(iii), the temporary and proposed regulations have effectively nullified that exception to the application of the inversion rules. In this regard, the new regulations adopt a bright-line rule for purposes of the substantial business activities determination that few multinational companies could be expected to satisfy. Moreover, the final regulations have made several changes with respect to the rules concerning the treatment of options and “downstream transactions” for purposes of the ownership and acquisition tests of the statute.

Background

Section 7874 provides rules for two types of inversion transactions. First, if a foreign corporation acquires substantially all of the properties held by a domestic corporation, and the shareholders of the domestic corporation receive at least 80% of the vote or value of the stock of the acquiring foreign corporation, the acquiring foreign corporation generally will be treated as a domestic corporation for federal tax purposes. Second, if the shareholders of the domestic corporation receive at least 60%, but less than 80%, of the vote or value of the acquiring foreign corporation’s stock, then, among other consequences, the use of the acquired domestic corporation’s tax attributes (if any) generally will be limited for a 10-year period.