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Corporate Inversion Rules Contain Bright-Line Substantial Presence Test

By Alison Bennett
Publication Date: 06/08/2012

Companies will have more certainty as to when they would be considered to have a substantial presence in a foreign country under a bright-line test in new proposed and temporary rules (REG-107889-12, T.D. 9592) on corporate inversions unveiled by the Internal Revenue Service June 7.

IRS restored a tougher version of the safe harbor it yanked under proposed and temporary rules (REG-112994-06, T.D. 9453) the agency issued in 2009.

The June 7 rules are the agency's latest effort to implement tax code Section 7874, intended to stop abusive corporate inversions. IRS put in place a new bright-line rule for determining whether expanded affiliated groups have a substantial foreign presence based on a 25 percent test rather than the 10 percent test in the 2009 rules.

IRS also unveiled, as a separate project, final rules (T.D. 9591) addressing when a foreign corporation is treated as a surrogate foreign corporation. Those rules finalize the 2009 proposed regulations with changes, the agency said.

Rules Outline 25 Percent Test

The 2012 temporary regulations provide that an expanded affiliated group will have substantial business activities in the relevant foreign country only if at least 25 percent of the group employees, group assets, and group income are located and derived in the relevant foreign country, IRS said in the preamble to T.D. 9592.

“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,” the agency said.

To determine whether 25 percent of a group's employees are in the foreign jurisdiction, the rules set out two tests that both must be satisfied, IRS said.

The first test is calculated as the number of group employees based in the foreign country divided by the total number of group employees on an applicable date.

The second, IRS said, is calculated as compensation for employees based in the foreign jurisdiction divided by the total compensation paid to all group employees during a one-year testing period.

According to the preamble to T.D. 9592, groups also must calculate whether they meet the 25 percent group asset test through a formula involving division.

Group Asset Test Spelled Out

The test is calculated as the value of all the group assets located in the relevant foreign country divided by the total value of all group assets determined on the applicable date, IRS said.

The agency clarified that the term “group assets” generally means tangible personal property or real property used or held for use in the active conduct of a trade or business by members of the expanded affiliated group.

IRS said the definition includes certain property rented by group members. The value of that property will be deemed to be eight times the net annual rent paid or accrued for that property, the agency said.

“The IRS and the Treasury Department believe that using an eight-times multiple for this purpose is administrable and consistent with the treatment of rented property for other purposes,” IRS noted.

Finally, IRS said, the group income test is calculated as the group income derived in the relevant foreign country divided by the total group income determined during the one-year testing period.

The term “group income” means gross income of members of the expanded affiliated group from transactions occurring in the ordinary course of business with customers that are not related persons, the agency said.

Applicable Date Explained

The 2012 temporary regulations provide that the number of group employees and the value of group assets can be measured as an applicable date, IRS said.

That date is either the date on which an acquisition is completed or the last day of the month immediately preceding the month in which the acquisition is completed, according to the preamble.

The temporary and final rules are effective June 12, when they will be published in the Federal Register.

The complete text of this article can be found in the BNA Daily Tax Report, June 8, 2012. For comprehensive coverage of taxation, pension, budget, and accounting issues, sign up for a free trial or subscribe to the BNA Daily Tax Report today. Learn more »

© 2012, The Bureau of National Affairs, Inc.