U.S. Inbound Pre- and Post- Acquisition Planning: Issues and Considerations

1
U.S. Inbound Pre- and Post- Acquisition Planning
Issues and Considerations
May 2008
Ronald Bordeaux PricewaterhouseCoopers Washington,
DC
James R. Barry Mayer Brown LLP Chicago, IL
This document was not intended or written to be
used, and it cannot be used, for the purpose of
avoiding U.S. federal, state or local tax
penalties.
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Introduction and Overview

• Pre-Acquisition Planning
• Stock vs. Asset Acquisition
• Financing the Acquisition
• Repatriation Strategies
• U.S. Grouping
• Post-Acquisition Planning
• Post-Deal Integration
• CFC Restructuring
• Post-Acquisition Planning for Intangibles

3
Stock v. Asset AcquisitionsSelected Topics

• Section 338 Elections
• Section 338 Consistency Rules
• Section 7874
• What is substantial activity under IRC Sec.
  7874?
• Can Assets or Shares of the U.S. subsidiary be
  acquired separately from the foreign target?
• Decontrol Transactions

4
Stock v. Asset Acquisitions Section 338
Elections

• Section 338 permits corporate purchasers of 80
  or more of the stock of a target corporation (a
  qualified stock purchase) to elect to treat the
  transaction as if assets were purchased instead
  of stock.
• Benefits of election.
• Other means to get basis increase check the box
  election.
• Special International Issues.
• Seller of foreign target treated as shareholder
  at end of acquisition date. Thus, shareholders
  of foreign target must take into account the
  consequences of deemed sale.
• Increased EP for section 1248 purposes,
  Potential subpart F income, Income under PFIC
  rules.
• Treatment of deemed sale for foreign tax credit
  purposes. Generally do not determine source and
  character by virtue of deemed sale.

5
Stock v. Asset Acquisitions Section 338
Consistency Rules

• Affects benefits of purchasing subsidiaries or
  assets separately.
• Application of consistency rules.
• If apply, get carryover basis in asset purchased.
• If target affiliate of domestic corporation
  seller is a CFC and buy asset where gain would be
  reflected in CFC stock basis, then purchaser gets
  carryover basis in purchased asset.

6
Stock v. Asset Acquisitions Section 7874

• Section 7874. Rules Relating to Expatriated
  Entities and Their Foreign Parents.
• Section 7874 was intended to negate the effect of
  certain "inversion" transactions also results in
  encompassing many unintended non-inversion
  transactions, such as
• internal restructuring transactions entered into
  by publicly traded foreign multinational
  corporations, or
• joint ventures entered into by publicly traded
  foreign multinational corporations.
• In both instances, there exists absolutely no
  U.S. nexus except that a U.S. target corporation
  is being acquired in a tax-free exchange.

7
Stock v. Asset Acquisitions Section 7874,
continued

• Key Issues
• Acquisitions of larger U.S. companies by foreign
  companies.
• Can inadvertently trigger section 7874.
• Definitions
• Substantially All The Properties.
• Substantial Business Activities.

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Assets Acquired Separately

• Potential Benefits
• Increased basis.
• Avoid post acquisition restructuring.
• Issues
• Section 338 Consistency rules.
• Staged Acquisitions.
• US day one, foreign parent day two.
• Section 304?
• Respect Steps?

9
Decontrol Transactions

• Interest Expense Allocation breaks affiliated
  group.
• Section 904(j).
• Applies if two or more domestic corporations
  would be members of the same affiliated group if
  (1) 1504(b) were applied without exceptions
  (e.g., foreign corporations and 936 corporations
  and (2) the section 1563 attribution rules
  applied.
• Avoid by setting up on day one because not
  deconsolidating?

Foreign Person
Domestic Corp
79
21
Domestic Corp
10
Decontrol Transactions, continued

• Preferred Stock Freezes (see diagram)
• Redemptions

Foreign Person
Domestic Corp
Preferred Stock 79
Common Stock 21
Domestic Corp
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Financing the Acquisition

• Tax efficient financing structures.
• Considerations include
• Debt-Equity,
• Treaty qualification,
• Anti-conduit rules,
• Section 163(j) Issues,
• Integration of public borrowing into the overall
  financing structure.
• Multiple country financing structures.
• IRS audit activity.

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Financing the AcquisitionTax Efficient Financing
Structures

• Third-Party Borrowing
• DGP Structure (e.g., Australia, Germany,
  Luxembourg), or Canadian Tower Structure
  (subject to impact of pending protocol to the
  U.S.-Canada Treaty, to take effect no earlier
  than 1/1/2010, and Canadian restricted interest
  proposal).
• Consider U.S. earnings stripping and foreign thin
  capitalization requirements.
• Consider domestic reverse hybrid rules.
• Consider foreign exchange implications.
• Swiss structure.

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Financing the AcquisitionTax Efficient Financing
Structures

• Related-Party Borrowing.
• Sale and repurchase (repo) transactions (e.g.,
  Germany, Luxembourg, France, Australia).
• Disregarded loan structures (e.g., Germany, UK).
• Consider UK anti-arbitrage rules, and U.S. DCL
  rules.
• Notional interest deduction structures (e.g.,
  Belgium, Switzerland).
• Ruling may be needed in foreign jurisdiction.

14
Financing the AcquisitionConduit Issues

• Intermediate party withholding,
• Public debt,
• Portfolio Interest Exception,
• Bank syndicate loans.
• Treasury Center / Cash Pooling.

15
US Groupings Section 163(j) Proposed Regulations

• Cherry picking with respect to Section 163(j)
  proposed regulations.
• The Service is not permitted to take positions
  inconsistent with proposed regulations if there
  are no final or temporary regulations that are
  currently applicable to the particular matter.
• Guidance indicates taxpayers need not follow
  positions in the proposed regulations.
• Issues related to multiple affiliated groups.

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Financing the AcquisitionThird Party Debt

• Potential issue under Section 956 by reason of
  the CFCs serving indirectly as security for U.S.
  borrowing.
• Concept of remoteness implicit in Section 956.
• Little direct guidance.
• Difference between general financial guarantee
  and handing over stock.

Foreign Parent
Third Party Loan with Guarantee by Foreign Parent
US Sub
CFCs
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Financing the AcquisitionIRS Audit Issues

• Continued focus on hybrid securities.
• Sale and Repurchase (Repo) transactions.
• Currently a Tier 1 issue.
• We are not aware of any adverse adjustments.
• Purchase price allocation.
• Company purchased a company with U.S. and foreign
  assets.
• IRS is disputing the purchase price allocation,
  asserting that the taxpayer allocated too much to
  the U.S. group.
• Calls into question third party agreed-upon
  purchase price allocations.

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Repatriation Strategies

• Modeling cash repatriation for alternative
  structures.
• U.S. and foreign withholding taxes.
• Distribution of a note or cash.
• Respected as valid debt.
• Withholding taxes.
• EP analysis.
• Potential codification of economic substance.

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Repatriation StrategiesReverse Hybrid Structure
Parent Co

• Considerations
• HCo is a flow through entity for foreign tax
  purposes and a corporation for U.S. tax purposes.
• OpCo Sub loans cash to HCo.
• OpCo Sub can claim an interest deduction on the
  interest payments on the Loan. There may be U.S.
  withholding tax on the payments.
• Potentially no Subpart F inclusion under the
  same-country exception.

USCo
OpCo Sub (non-U.S.)
SPV (U.S.)
Loan

HCo (non-US)
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U.S. GroupingsSelected Topics

• Consideration of whether it is more advantageous
  to have multiple U.S. consolidated return groups.
  Consider impact on
• foreign tax credit,
• Section 163(j) calculations,
• debt-equity implications.

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Post-Acquisition Planning

• Material tax issues to consider after the
  completion of the acquisition of a U.S. target
  group by a non-U.S. based acquirer.
• Post-deal integration,
• CFC restructuring,
• Post-acquisition planning for location and
  ownership of intangibles.
• Financing.

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Post-Acquisition Planning Post-Deal Integration

• Integration of the U.S. target operations with
  the operations of the non-U.S. acquirer,
  including
• New non-U.S. holding companies and mergers.
• Simplify and integrate the organizational
  structure, facilitate cash repatriation.
• Whether U.S. target might receive a preferred
  interest in a new holding company.
• Foreign tax credit implications, potential
  check-the-box planning.

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Post-Deal IntegrationCash D Reorganization

• Considerations
• Merges U.S. target with existing U.S. group.
• Business purpose.
• Other reorganization requirements.
• Basis implications.
• Treaty implications.

Step 1 - US OpCo1 shares and cash for all of US
OpCo2 assets
Foreign Parent
Cash
US OpCo1
US OpCo2
US OpCo2
Step 2 Deemed or actual liquidation of US OpCo2
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CFC RestructuringPreferred Share Structure

• Steps
• US transfers CFC to FC in exchange for preferred
  stock of FC.
• Disregarded entity election made for CFC.
• Considerations
• Preferred stock cannot be non-qualified preferred
  stock
• Annual dividend based on FMV of CFC at the time
  of the transfer
• CFC status may remain based on value.
• If not, US must include Sec. 1248 amount in
  income.
• US must own at least 10 of FC for foreign tax
  credit purposes
• Other possibilities hyped foreign tax credits,
  selectively bring up dividends, financing
  (high-low planning).

Foreign Parent
Preferred stock
FC (non-U.S.)
US
1
CFC (non-U.S.)
2
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CFC RestructuringSection 304(a)(1) Version 1

• Steps
• (A) Foreign Parent transfers non-CFC foreign
  assets, and USS transfers CFC assets to a new
  foreign holding company (New FHC), which might or
  might not be a CFC. (B) CFC and non-CFC elect to
  be treated as disregarded for U.S. federal tax
  purposes.

Foreign Parent
A
FSub
USS
A
CFC
New FHC
B
B
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CFC RestructuringSection 304(a)(1) Version 1,
continued

• Steps
• Foreign Parent sells its interest in New FHC to a
  foreign affiliate (FA) for cash or a note.
• Considerations
• Business purpose.
• Long-term tax efficiency.
• U.S. withholding tax.
• Foreign tax.
• Subpart F.
• Fast pay regulations.

Foreign Parent
FA
USS
New FHC
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CFC RestructuringSection 304(a)(1) Version 2

• Steps
• Foreign Sub2 purchases US NewCo from an unrelated
  party. A valid Section 338 election is made with
  respect to US NewCo.
• CFC elects to be treated as disregarded for U.S.
  federal income tax purposes.
• Foreign Sub1 transfers CFC to Foreign Sub2 in
  exchange for US NewCo.

Foreign Parent
USCo
Foreign Sub2
3
3
Foreign Sub1
US NewCo
1
US NewCo
2
3
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CFC RestructuringSection 304(a)(1), Version 2 -
continued

• Considerations
• Steps 2 and 3 (check the box election and sale of
  CFC to Foreign Sub2) are expected to be a sale of
  assets. See Dover v. Comm., 122 T.C. 324 (2004).
• No subpart F income expected if assets are
  business assets for Sec. 954(c).
• Section 304(a)(1) applies to the Step 3 transfer.
  The transfer of CFC to Foreign Sub2 is treated as
  a dividend to Foreign Sub2, first from Foreign
  Sub1 to the extent of its EP, and then from US
  NewCo to the extent of its EP.
• Business purpose, fast-pay regulations, subpart
  F, U.S. withholding tax, foreign tax, long-term
  tax efficiency.

Foreign Parent
USCo
Foreign Sub2
Foreign Sub1
US NewCo
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CFC RestructuringSection 304(a)(2)

• Steps
• USCo forms Foreign Sub. Foreign Sub issues common
  stock to USCo.
• USCo transfers common shares of CFC to Foreign
  Sub in exchange for common shares of Foreign Sub.
• CFC elects to be disregarded.
• Foreign Sub transfers all of the common shares of
  CFC to Foreign Parent in exchange for common
  shares of USCo.

Foreign Parent
4
USCo
4
CFC
Foreign Sub
1
2
3
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CFC RestructuringSection 304(a)(2), continued

• Considerations
• The transfer in Step 4 is recharacterized under
  Sec. 304 as a distribution by Foreign Sub to
  Foreign Parent in redemption of USCos stock.
• Foreign Sub recognizes gain / realizes loss, if
  any.
• Foreign Parent is treated as receiving a Sec. 301
  distribution (FMV of CFC).
• Business purpose is required.
• Foreign tax consequences.
• Long-term implications.
• Subpart F considerations.
• OFL recapture rules.
• Fast-pay regulations.
• Withholding tax considerations.

Foreign Parent
USCo
Foreign Sub
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CFC RestructuringShare Contribution with
Redemption
Foreign Parent

• Steps
• Foreign Parent transfers Foreign Sub shares to
  CFC in exchange for CFC common shares.
• Foreign Sub liquidates / elects to be treated as
  disregarded for U.S. federal income tax purposes
  (a deemed liquidation).
• CFC redeems its shares held by US Sub.
• Considerations
• Business purpose required.
• May be able to freeze the value of the CFC stock
  held by US Sub.
• Fast pay, FTCs, Sec. 861 allocations, EP.

Foreign Sub
US Sub (U.S.)
Step 3 Share Redemption
Step 1 Foreign Sub shares for CFC shares
CFC
Step 2 Deemed Liquidation
32
CFC Restructuring

• Steps
• Foreign Parent and CFC form a Foreign
  Partnership, and each contributes business in
  exchange for a common (FP) and preferred
  partnership interest (CFC).
• Considerations
• Special allocations - allocate higher taxed EP
  to CFC to facilitate FTC recovery.
• Consider special allocation of Subpart F income
  to Foreign Parent.
• Consider allocation of RD deductions to CFC.
• No special constraints under Sec. 367 or the
  partnership rules because under Sec. 704(c) the
  pre-contribution gain is taxed back to the
  contributor.

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Post-Acquisition Planning for Intangibles

• Integration with non-U.S. entrepreneur
  structures.
• Transfer of IP out of the United States.
• Use of foreign partnerships for holding IP.

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Offshore IP
Foreign Parent
2

• Steps
• 1. Foreign Parent and USCo form a Foreign
  Partnership (FP).
• 2. Foreign Parent contributes 5M cash and a
  promise to contribute another 50M at a future
  time in exchange for a 55 interest in the FP.
• 3. U.S. transfers worldwide IP rights to FP in
  exchange for a 45 interest in FP valued at 45M.
  
• 4. FP funds the development of IP rights.

USCo
3
45
55
CFC
Foreign Partnership
1
35
Offshore IP
Foreign Parent

• Considerations, continued
• Business purpose required.
• Consider whether contribution would qualify for
  Section 721 tax-free treatment.
• Section 367 not expected to apply.
• Section 482 likely applies to the valuation of
  initial contributions to FP and to the ongoing
  allocations.
• Consider how Section 704(c) special allocation
  rules would apply.
• Consider whether RD costs would qualify for
  Section 174 treatment.

USCo
45
55
CFC
Foreign Partnership