In a suit against the IRS challenging the new anti-inversion regulations, the United States Chamber of Commerce and the Texas Association of Business are attacking the validity of the “multiple domestic entity acquisition rule,” also known as the anti-“serial inverter” rule. Inversions and Related Transactions, 81 Fed. Reg. at 20,865–66; see 26 C.F.R. § 1.7874-8T. The suit alleges, among other things, that the new regulation is unlawful under the Administrative Procedures Act, 5 U.S.C. § 706. The new rules—an effort by the Treasury to curb what it perceives to be abusive inversion transactions—are, like the transactions that they target, controversial. The plaintiff duo, in its complaint, alleges that:
(Complaint, p. 1.) The “inversion” debate has been at the center of a broader debate about international tax reform in recent years—and it is a charged topic. In fact, since just 2005, there have been almost 50 legislative bills introduced seeking to deter inversions. See, e.g., S. 2667, 114th Cong. (2d Sess. 2016); H.R. 3959, 109th Cong. (1st Sess. 2005). None of them, however, have been enacted into law.
The Complaint does a good job of putting the inversion debate into perspective, emphasizing the competitive disadvantage that U.S. corporations often face in the global marketplace:
Compl., p. 2) As the Complaint further explains, the rise of inversions is an outgrowth of the U.S. tax system itself:
(Compl., p. 6.) The blame, in other words, lies squarely with the U.S. tax system, according to the plaintiffs.
So, for those initiated to the topic, what exactly is an “inversion?” In a typical corporate inversion, “a U.S. corporation with foreign subsidiaries engages in a transaction with a foreign corporation whereby the U.S. corporation becomes a subsidiary of a new foreign parent, which is typically incorporated in a lower-tax jurisdiction.” (Compl., p. 2); See also, Staff of the Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 108th Congress (JCS-5-05) (May 31, 2005), at 342. That’s the idea in a nutshell; and it has proven to be a popular tax planning device for multinational corporations.
As a little statutory background, Congress enacted Section 7874 of the Internal Revenue Code as part of the American Jobs Creation Act of 2004 in an effort to combat what it deemed to be improper inversions. The provision sets out a comprehensive scheme that governs inversions. Under Section 7874, a foreign corporation that acquires substantially all of the property of a U.S. corporation “pursuant to a plan” will fall into one of three categories for federal tax purposes:
(Compl., p. 7)
That is a pretty good high-level summary of how section 7874 works. And it was against this statutory backdrop that Treasury enacted the new corporate inversion regulations—and the rules being challenged in the lawsuit—in an effort to further curb transactions that allow U.S. corporations to invert into foreign entities.
According to the preamble to those regulations, the Treasury Department and the IRS, in enacting the rule being challenged in the litigation, were concerned that a single foreign acquiring corporation might avoid the application of section 7874 by completing multiple domestic entity acquisitions over a relatively short period of time in circumstances where section 7874 would otherwise have applied if the acquisitions had been made at the same time or pursuant to a plan. In such situations, according to Treasury, the value of the foreign acquiring corporation increases to the extent it issues stock in connection with each successive domestic entity acquisition, thereby enabling the foreign acquiring corporation to complete another, potentially larger, domestic entity acquisition to which section 7874 would not apply. The Treasury Department and the IRS concluded, according to the preamble, that it is not consistent with the purpose of section 7874 to permit a foreign acquiring corporation to reduce the ownership fraction for a domestic entity acquisition by including stock issued in connection with other recent domestic entity acquisitions. Therefore, the new regulations provide that stock of a foreign acquiring corporation that was issued in connection with certain prior domestic entity acquisitions occurring within a 36-month look-back period should be excluded from the denominator of the ownership fraction. (Preamble, pp. 31-32.)
The litigation will be interesting to watch as it plays out. While it certainly raises an interesting challenge to important policy decisions, the challenge is likely to face a number of procedural hurdles. For one thing, the Anti-Injunction Act generally prohibits a challenge of such a nature until the tax is actually assessed (and then a party with standing (i.e., against whom it is assessed) may challenge the regulation). It is not clear that the Chamber or TAB will be able to overcome these hurdles.