Tax Regs On Inversions Define Business Activity And Inversion Gain

Inversion regs clarify when a corporation has substantial business activities in a foreign country and describe the calculation of inversion gain. These concepts are pivotal in determining whether an inversion has occurred and, if so, the amount of inversion gain.

Reg. section 1.7874-3 defines substantial business activities and reg. section 1.7874-11 provides the calculation of inversion gain. Reg. section 1.7874-12 provides 20 definitions that apply to the inversion regs and regs under sections 367, 956, and 7701.

A tax inversion is a restructuring that replaces a U.S. parent company with a foreign parent so that the original parent becomes a subsidiary, and the tax residence of the target business changes to a foreign country while ownership of the target remains generally the same.

The inversion rules in section 7874 and the relevant regs are intended to discourage inversions by limiting the ability of U.S. corporations to move their operations overseas without unfavorable U.S. tax consequences.

Previous inversion articles addressed:

• surrogate foreign corporation status in reg. section 1.7874-2;
• rules in reg. section 1.7874-1 that clarify the removal of affiliate-owned stock from the ownership percentage calculation in section 7874(c)(2)(A);
• guidance in reg. section 1.7874-4 on treatment of foreign acquiring corporation stock transfers related to U.S. entity acquisitions;
• rules in reg. section 1.7874-7 that disregard stock attributable to passive assets and reg. section 1.7874-8 that disregard stock attributable to multiple U.S. entity acquisitions;
• rules in reg. section 1.7874-9 that disregard stock attributable to third-country transactions and reg. section 1.7874-10 that disregard stock distributions; and
• rules in reg. section 1.7874-5 that describe the effect of foreign acquiring corporation stock transfers after a U.S. entity acquisition, and in reg. section 1.7874-6 that contain requirements for transferred stock to be treated as held by a member of an expanded affiliated group (EAG).

This article covers reg. sections 1.7874-3, -11, and -12. Reg. section 1.7874-3 was added by T.D. 9720 on June 4, 2015, and amended by T.D. 9761 on April 8, 2016, and T.D. 9834 on July 12, 2018. Reg. sections 1.7874-11 and -12 were both added by T.D. 9834 on July 12, 2018.

Section 7874Section 7874 provides rules on expatriated entities and their foreign parents. The guidance was added to the code by the American Jobs Creation Act of 2004 and contains:

• a general rule imposing a tax on inversion gains;
• a rule treating inverted corporations as U.S. corporations;
• an assortment of definitions and special rules (subsections (c)-(e));
• a rule that prohibits an exemption from section 7874 under a U.S. treaty obligation; and
• a grant of authority to issue regs, including antiavoidance regs.

The general rule in paragraphs (a)(1)-(3) imposes a tax on inversion gain when entities expatriate. Paragraph (a)(1) provides that the taxable income of an expatriated entity for a tax year that includes a portion of an applicable period may never be less than the entity’s inversion gain for the year.

Paragraph (a)(2) generally defines an expatriated entity as a U.S. entity that transfers property to a surrogate foreign corporation, which is a foreign corporation that meets an acquisition test, an ownership test, and a substantial business activities test. Subparagraph (a)(2)(A) defines an expatriated entity as:

• a U.S. corporation or partnership described in clause (a)(2)(B)(i) that transfers property to a surrogate foreign corporation; or
• a U.S. person related (within the meaning of section 267(b) or 707(b)(1)) to a U.S. corporation or partnership that transfers property to a surrogate foreign corporation.

Subparagraph (a)(2)(B) provides that a foreign corporation is a surrogate foreign corporation if, as part of a plan (or series of related transactions), three conditions are satisfied:

• the entity completes (after March 4, 2003) the direct or indirect acquisition of substantially all of a U.S. corporation’s properties or the properties constituting a U.S. partnership’s trade or business;
• after the acquisition, at least 60% of the stock (by vote or fair market value) of the acquiring entity is held by former shareholders of the target U.S. corporation by reason of holding stock in the U.S. corporation, or by former partners of the U.S. partnership by reason of holding a capital or profits interest in the U.S. partnership; and
• after the acquisition, the EAG that includes the acquiring entity does not have substantial business activities in the foreign country in which that entity was created or organized relative to the EAG’s total business activities (clarified by reg. section 1.7874-3).

Paragraph (a)(3) coordinates subsections (a) and (b) by providing that a corporation treated as a U.S. corporation under subsection (b) is not treated as a surrogate foreign corporation under paragraph (a)(2).

Subsection (b) provides that an inverted corporation is treated as a U.S. corporation, even when it wasn’t created or organized in the United States, when the corporation would be a surrogate foreign corporation if paragraph (a)(2) were applied using an 80% ownership threshold instead of 60%.

Paragraphs (c)(1)-(6) provide definitions and special rules. Paragraph (c)(1) defines an EAG by cross-reference to the definition of affiliated EAG in section 1504(a), with modifications. Section 1504(a) defines an affiliated EAG as one or more chains of corporations connected through stock ownership with a common parent corporation if:

• the common parent directly owns at least 80% of the stock (by vote and FMV) in at least one of the other corporations; and
• the other corporations directly own at least 80% of the stock (by vote and FMV) in each other (except the common parent).

Paragraph (c)(1) modifies section 1504 by reducing the ownership threshold in section 1504(a) to more than 50% of vote and FMV instead of at least 80% and by disregarding the exclusion of foreign corporations from affiliated EAGs in section 1504(b)(3).

Subparagraphs (c)(2)(A)-(B) provide that, in determining whether the 60% ownership threshold in clause (a)(2)(B)(ii) for surrogate foreign corporation status is met, taxpayers should disregard:

• stock held by members of the EAG that includes the acquiring foreign corporation; or
• stock of a foreign corporation sold in a public offering related to the U.S. entity acquisition described in clause (a)(2)(B)(i).

Paragraph (c)(3) assumes a plan is present if a foreign corporation acquires substantially all properties of a U.S. corporation or partnership during the four-year period that begins two years before the 60% ownership requirement is met.

An antiavoidance rule in paragraph (c)(4) disregards transfers of properties or liabilities that are part of a plan to avoid section 7874.

Paragraph (c)(5) applies the 60% test in clause (a)(2)(B)(ii) to the acquisition of a U.S. partnership trade or business by treating partnerships under common control (within the meaning of section 482) as one partnership.

Paragraph (c)(6) grants authority to prescribe regs that help taxpayers determine whether a corporation is a surrogate foreign corporation.

Paragraphs (d)(1)-(3) provide additional definitions. Paragraph (d)(1) defines the applicable period as beginning on the date on which properties are first acquired as part of the U.S. entity acquisition and ending 10 years after the last date on which properties are acquired.

Paragraph (d)(2) defines inversion gain and is clarified by reg. section 1.7874-11. Inversion gain is income or gain received by an expatriated entity because of a stock transfer, non-inventory property transfer, or license during the applicable period.

If the transfer or license occurs after the U.S. entity acquisition, it still generates inversion gain if the recipient is a foreign related person, defined in paragraph (d)(3) as related to the expatriated entity within the meaning of section 267(b) or 707(b)(1), or under the same common control as the expatriated entity within the meaning of section 482.

Paragraphs (e)(1)-(4) provide special rules that address tax credits, expatriated partnerships, coordination with net operating loss provisions, and the statute of limitations.

Paragraph (e)(1) limits the use of tax credits to offset the tax on inversion gain. Credits (other than the foreign tax credit in section 901) are allowed only to the extent the tax exceeds the inversion gain multiplied by the highest tax rate in section 11(b) (or 21%). To determine the FTC allowed by section 901, inversion gain is treated as U.S.-source income.

Paragraph (e)(2) applies when the expatriated entity is a partnership and provides that paragraph (a)(1) applies at the partner rather than the partnership level.

A partner’s inversion gain equals its distributive share of the partnership’s inversion gain plus gain recognized by the partner because of the transfer of a partnership interest to a surrogate foreign corporation during the applicable period. Moreover, the tax is calculated using the highest rate applicable to the partner instead of the rate in section 11(b).

Paragraph (e)(3) coordinates the tax on inversion gain with the alternative minimum tax rules in section 55 and the NOL rules in section 172. It generally limits the use of NOLs and alternative tax NOLs to offset inversion gains.

Paragraph (e)(4) modifies the statute of limitations for deficiencies attributable to inversion gains. The statutory period for the assessment of those deficiencies for a pre-inversion year does not expire before the end of three years from the date on which the taxpayer notifies the Treasury secretary of the U.S. entity acquisition related to the inversion gain. A pre-inversion year is a tax year that includes a portion of the applicable period and that ends before the year in which the acquisition is completed.

Subsection (f) provides that a U.S. treaty obligation does not create an exemption from section 7874, whether the treaty was entered into before or after the section’s enactment.

Paragraphs (g)(1)-(2) grant authority to provide regs necessary to carry out section 7874, including regs that prevent avoidance by using related persons, passthrough or other noncorporate entities, or other intermediaries, as well as transactions designed to have persons cease to be (or not become) members of EAGs or related persons.

Section 7874 imposes tax on the inversion gains of expatriated entities, which are U.S. entities that transfer substantially all their properties to surrogate foreign corporations, which are foreign corporations that satisfy the property acquisition, 60% ownership, and substantial business activities tests in subparagraph (a)(2)(B).

Inversion gain is the income recognized by an expatriated entity from the transfer during the applicable period of stock or other properties, income received during the applicable period under a license of property as part of the acquisition, or income received after the acquisition if the property transfer or license is to a foreign related person.

If the 60% ownership test is met, the new foreign parent will still be treated as a foreign corporation, but the expatriated entity’s taxable income cannot be less than the inversion gain recognized during the 10-year applicable period. Its ability to offset the gain with FTCs or NOLs is limited.

If an 80% ownership test in subsection (b) is met, the new foreign parent is treated as a U.S. corporation (not a surrogate foreign corporation), and the inversion is not respected under U.S. tax law. Moreover, section 367(a) does not apply to the expatriated entity’s shareholders because no outbound property transfer has occurred.

Reg. Sections 1.7874-1 to -12Regs accompanying section 7874 are provided in reg. sections 1.7874-1 to -12. The guidance provides:

• rules addressing the disregard of affiliate-owned stock in determining ownership;
• clarification of the definition of surrogate foreign corporation;
• a description of substantial business activities;
• rules addressing the disregard of foreign acquiring corporation stock related to a U.S. entity acquisition;
• a description of the effect of stock transfers related to a U.S. entity acquisition;
• rules addressing stock transferred by EAG members;
• rules addressing the disregard of stock attributable to passive assets;
• rules addressing the disregard of stock attributable to multiple U.S. entity acquisitions;
• rules addressing the disregard of stock attributable to third-country transactions;
• rules addressing the disregard of stock distributions;
• a description of inversion gain; and
• definitions.

Reg. sections 1.7874-3 and -11 contain descriptions of business activities and inversion gain. Reg. section 1.7874-12 provides definitions.

Reg. Section 1.7874-3Reg. section 1.7874-3(a) describes when an EAG will be considered to have substantial business activities in the relevant foreign country compared with the EAG’s total business activities under section 7874(a)(2)(B)(iii). The guidance includes:

• a general rule for determining whether an EAG has substantial business activities in the relevant foreign country compared with its total business activities;
• a description of items that are not taken into account as located or derived in the relevant foreign country;
• definitions and operating rules;
• rules for the treatment of partnerships; and
• applicability dates.

The general rule in reg. section 1.7874-3(b) is that an EAG will be considered to have substantial business activities in the relevant foreign country on the completion date compared with the EAG’s total business activities only if each of the requirements in subparagraphs (b)(1)-(4) are satisfied.

The requirement in subparagraph (b)(1) relates to the quantity and compensation of EAG employees. The number of EAG employees based in the relevant foreign country must be at least 25% of the total number of EAG employees on the applicable date; and the compensation paid to EAG employees based in the relevant foreign country must be at least 25% of the total employee compensation for all EAG employees during the testing period.

The requirement in subparagraph (b)(2) relates to the FMV of EAG assets. The FMV of the EAG assets in the relevant foreign country must be at least 25% of the total FMV of all EAG assets on the applicable date.

The requirement in subparagraph (b)(3) relates to EAG income. The EAG income derived in the relevant foreign country must be at least 25% of the total EAG income during the testing period.

The requirement in subparagraph (b)(4) relates to the tax residence of the foreign acquiring corporation. That corporation must be a tax resident of the relevant foreign country. However, this requirement does not apply if the relevant foreign country does not impose corporate income tax.

Reg. section 1.7874-3(c) describes items that are not considered in applying the 25% employee, income, and asset tests in subparagraphs (b)(1)-(3). The general rule in subparagraph (c)(1) is that the following items are included in the denominator but not the numerator for each of the 25% tests in subparagraphs (b)(1)-(3):

• EAG assets, employees, or income attributable to business activities associated with properties or liabilities the transfer of which is disregarded under the antiavoidance rule in section 7874(c)(4);
• EAG assets or employees located in, or income derived in, the relevant foreign country as part of a plan with a principal purpose of avoiding section 7874; and
• EAG assets or employees located in, or income derived in, the relevant foreign country if the EAG assets, employees, or business activities to which the income is attributable are subsequently transferred to another country in connection with a plan that existed at the time of the U.S. entity acquisition.

Subparagraph (c)(2) modifies the rules in subparagraph (c)(1) for transfers of properties to the EAG. EAG assets, employees, or income attributable to business activities associated with property that is transferred to the EAG in a transfer that is disregarded under section 7874(c)(4) are not included in the numerator or the denominator for each of the 25% tests in subparagraphs (b)(1)-(3).

Reg. section 1.7874-3(d)(1)–(12) provides several definitions and special rules that apply in addition to the definitions in reg. section 1.7874-12.

Subparagraph (d)(1) defines applicable date as either of the following dates applied consistently:

• the completion date; or
• the last day of the month that ends before the month that includes the completion date.

Subparagraph (d)(2) defines employee compensation as all amounts incurred by EAG members that directly relate to services they perform, including wages, salaries, deferred compensation, employee benefits, and employer payroll taxes. Compensation for a particular EAG employee is treated as incurred when it would be deductible by the employer as compensation, and the amount of employee compensation equals the amount that would be deductible.

Both the timing and the amount of the deduction for employee compensation must be determined for all EAG employees under U.S. tax law or based on relevant non-U.S. tax law. Employee compensation is determined in U.S. dollars and translated using the weighted average exchange rate (as defined in reg. section 1.989(b)-1) for the testing period.

Subparagraph (d)(3) defines EAG assets as tangible personal or real property used or held for use in the active conduct of a trade or business by EAG members, provided the property is either owned or rented by EAG members at the close of the completion date.

A EAG asset is in the relevant foreign country only if the asset was physically present in that country:

• at the close of the completion date; and
• for more time than in any other country during the one-year testing period defined in subparagraph (d)(12).

However, an EAG asset that is mobile in nature and used in a transportation activity (like a vessel, aircraft, or motor vehicle) is considered to be located in the relevant foreign country if the asset was physically present in that country for more time than in any other country during the testing period, regardless of whether the asset was physically present in that country at the close of the completion date.

EAG assets must be valued on a gross basis (not reduced by liabilities) and by consistently using for all EAG assets either the adjusted tax basis or FMV determined in U.S. dollars and translated at the spot rate determined under reg. section 1.988-1(d)(1), (2), and (4).

Tangible personal or real property that is rented by EAG members from a person other than an EAG member is treated as an EAG asset provided the property is used in the active conduct of a trade or business and is being rented by EAG members at the close of the completion date. An EAG asset that is rented is valued at eight times the net annual rent paid or accrued for the asset by EAG members.

Subparagraph (d)(4) defines EAG employees as all individuals who are employees of EAG members.

Whether individuals are employees must be determined for all EAG members under U.S. tax law or relevant non-U.S. tax law. An EAG employee is based in the relevant foreign country only if the employee spent more time providing services in that country than in any other single country during the testing period.

Subparagraph (d)(5) defines EAG income as the gross income of EAG members from transactions occurring in the ordinary course of business with customers that are not related persons.

EAG income must be determined consistently for all EAG members either under U.S. tax law or as reflected in relevant financial statements. EAG income is translated into U.S. dollars using the weighted average exchange rate (as defined in reg. section 1.989(b)-1) for the testing period. EAG income is considered derived in the relevant foreign country only if it is derived from a transaction with a customer in that country.

Subparagraph (d)(6) defines net annual rent as the annual rent paid or accrued for property minus any payments received or accrued from subleasing the property or a similar arrangement.

Subparagraph (d)(7) defines related person by cross-reference to the more than 50% ownership vote or FMV threshold in section 954(d)(3), but applied by reference to EAG members rather than controlled foreign corporations.

Subparagraph (d)(8) defines relevant financial statements as financial statements prepared consistently for all EAG members in accordance with either U.S. generally accepted accounting principles or the international financial reporting standards used for the EAG’s consolidated financial statements.

However, if after the U.S. entity acquisition, financial statements will not be prepared consistently for all EAG members in accordance with either GAAP or IFRS, the relevant financial statements are those prepared in accordance with either GAAP or IFRS for each member. The relevant financial statements must take into account income items generated by EAG members over the entire testing period.

Subparagraph (d)(9) defines relevant foreign country as the country in which, or under the laws of which, the foreign acquiring corporation was created or organized.

Subparagraph (d)(10) defines relevant tax law as the tax law to which the EAG member is subject. This definition applies to determine whether an individual who performs services for an EAG member is an employee, and to determine the timing and amount of employee compensation. However, if the tax law to which an EAG member is subject does not distinguish between an employee and an independent contractor, then the relevant tax law is U.S. federal tax law.

Subparagraph (d)(11) defines a tax resident of a country as a body corporate liable to tax under the laws of the country as a resident.

Subparagraph (d)(12) defines testing period as the one-year period ending on the applicable date defined in subparagraph (d)(1).

Reg. section 1.7874-3(e)(1)-(2) describes treatment of partnerships in determining EAG members and business activities. Under subparagraph (e)(1), in determining the EAG members, each partner in a partnership (determined without regard to subparagraph (e)(2)) is treated as holding its proportionate share of stock held by the partnership as calculated under sections 701–777.

Under subparagraph (e)(2), if one or more EAG members (determined after applying subparagraph (e)(1)) own an aggregate of more than 50% (by FMV) of the interests in a partnership, the partnership is treated as a corporation that is an EAG member. Therefore, all items of the partnership are taken into account in applying the business activities tests. However, no partnership items are considered unless the partnership is treated as an EAG member under subparagraph (e)(2).

Reg. section 1.7874-3(f)(1) provides that reg. section 1.7874-3 generally applies to U.S. entity acquisitions that are completed on or after June 3, 2015. For acquisitions completed before that date, taxpayers are directed to reg. section 1.7874-3T as revised April 1, 2016.

However, reg. section 1.7874-3(f)(2) modifies the applicability dates of subparagraphs (b)(4) (tax residence of the foreign acquiring corporation), (d)(8) (definition of relevant financial statements), and (d)(11) (definition of tax resident). The first sentence of paragraph (b)(4) applies to U.S. entity acquisitions completed on or after November 19, 2015, and the second sentence applies to U.S. entity acquisitions completed on or after July 12, 2018.

Subparagraph (d)(8) applies to U.S. entity acquisitions completed on or after April 4, 2016. Subparagraph (d)(11) applies to U.S. entity acquisitions completed on or after July 12, 2018.

For U.S. entity acquisitions between June 3, 2015, and April 4, 2016, taxpayers may elect to apply subparagraph (d)(8). For U.S. entity acquisitions completed between November 19, 2015, and July 12, 2018, taxpayers may elect to apply the second sentence of subparagraph (b)(4) and subparagraph (d)(11).

Reg. Section 1.7874-11Reg. section 1.7874-11(a) describes its scope as providing rules for determining the inversion gain of an expatriated entity under section 7874. The guidance provides:

• general rules for determining the inversion gain of an expatriated entity;
• special rules for foreign partnerships in which an expatriated entity owns an interest;
• definitions;
• one example; and
• applicability dates.

The general rule in reg. section 1.7874-11(b)(1) provides that inversion gain includes income (including amounts treated as dividends under section 78) or gain recognized by an expatriated entity for any tax year that includes any portion of the applicable period because of a direct or indirect transfer of stock or other properties or a license of any property either as part of the U.S. entity acquisition, or after the acquisition if the transfer or license is to a specified related person (as defined in reg. section 1.7874-12(a)(18)).

Subparagraph (b)(2) provides an exception for property described as inventory in section 1221(a)(1). Inversion gain does not include income or gain recognized by reason of the transfer or licensing, after the U.S. entity acquisition, of property described in section 1221(a)(1) in the hands of the transferer or licenser.

Subparagraph (b)(3) modifies the general rule as applied to partnerships. Except as provided in paragraph (c) and section 7874(e)(2), inversion gain does not include income or gain recognized because of the transfer or license of property by a partnership.

Reg. section 1.7874-11(c) further clarifies the treatment of transfers and licenses by partnerships. If a partnership that is a foreign related person transfers or licenses property, a partner is treated as having transferred or licensed its proportionate share of that property, as determined under sections 701–777, for calculating the inversion gain of an expatriated entity.

Taxpayers are directed to section 7874(e)(2) for rules regarding the treatment of transfers and licenses by U.S. partnerships and transfers of interests in U.S. partnerships.

Reg. section 1.7874-11(d) incorporates by cross-reference the definitions in reg. section 1.7874-12.

Reg. section 1.7874-11(e) provides one example that illustrates the inversion gain rules in reg. section 1.7874-11. On July 1, 2016, foreign acquiring corporation FA acquires all stock of domestic target corporation DT in an inversion transaction. When the inversion transaction occurred, DT wholly owned foreign subsidiary (and CFC) FS.

During the applicable period, FS sells to FA property that, in the hands of FS, is not described in section 1221(a)(1). Under section 951(a)(1)(A), DT has a $80 subpart F income inclusion that is attributable to the FS gain from the sale of the property.

Under section 960(a)(1), DT is deemed to have paid $20 of the post-1986 foreign income taxes of FS by reason of this income inclusion and includes $20 in gross income as a deemed dividend under section 78. DT therefore recognizes $100 of gross income because of the FS sale of property to FA ($100 = $80 subpart F inclusion + $20 deemed dividend).

Under section 7874(a)(2)(A), DT is an expatriated entity. Under reg. section 1.7874-11(b)(1), DT’s $100 gross income recognized under sections 951(a)(1)(A) and 78 is inversion gain, because it is income recognized by an expatriated entity during the applicable period by reason of an indirect transfer of property by DT (through FS) after the inversion transaction to a specified related person (FA).

Sections 7874(a)(1) and (e) therefore prevent the use of some tax attributes (like NOLs) to reduce the U.S. tax owed on DT’s $100 gross income recognized under sections 951(a)(1)(A) and 78.

Reg. section 1.7874-11(f) provides that reg. section 1.7874-11 applies to transfers and licenses of property completed on or after November 19, 2015, but only if the inversion transaction was completed on or after September 22, 2014.

For inversion transactions completed on or after that date, however, taxpayers may elect to apply paragraph (b) by excluding the reference to dividends under section 78 for transfers and licenses of property completed between November 19, 2015, and April 4, 2016.

Reg. Section 1.7874-12Reg. section 1.7874-12(a)(1)–(20) provides definitions that apply to reg. sections 1.7874-1 through -11, and reg. sections 1.367(b)-4 (acquisition of foreign corporate stock or assets by foreign corporations in nonrecognition transactions), 1.956-2 (definition of U.S. property), and 1.7701(l)-4 (definitions and rules for inversion transactions).

Subparagraph (a)(1) defines an affiliated group by reference to section 1504(a), but with modifications that disregard the foreign corporation exclusion in section 1504(b)(3), and reduce the ownership threshold in section 1504(a) to more than 50% from at least 80%. A member of the affiliated group is an entity included in the affiliated group.

Subparagraph (a)(2) defines the applicable period as the 10-year period described in section 7874(d)(1). However, special rules in reg. section 1.7874-2(b)(13) apply when a subsequent acquisition (or a similar acquisition under reg. section 1.7874-2(c)(4)(i)) occurs that is also an inversion transaction. In that case, the applicable period begins on the first date that properties are acquired as part of the initial acquisition.

Subparagraph (a)(3) defines the completion date as the date on which the U.S. entity acquisition and all transactions related to the U.S. entity acquisition are complete.

Subparagraph (a)(4) defines a CFC by cross-reference to section 957.

Subparagraph (a)(5) defines a domestic entity acquisition as an acquisition described in section 7874(a)(2)(B)(i), or the acquisition of substantially all properties held by a U.S. corporation or constituting a trade or business of a U.S. partnership.

Subparagraph (a)(6) defines a domestic entity as a U.S. corporation or partnership described in section 7874(a)(2)(B)(i). A reference to a U.S. entity includes a successor, including a corporation that succeeds to and takes into account amounts of the U.S. entity under section 381 (requiring an acquiring corporation to succeed to 26 tax items listed in section 381(c) of the transferer corporation in the case of an asset acquisition that is a liquidation or reorganization).

Subparagraph (a)(7) defines an EAG as an affiliated group that includes the foreign acquiring corporation (determined as of the completion date). A member of the EAG is an entity included in the EAG. A reference to an EAG member includes the member’s predecessor.

Subparagraph (a)(8) defines an expatriated entity as the acquired U.S. entity and a U.S. person that, on any date on or after the completion date, is or was related to the U.S. entity (within the meaning of section 267(b) or 707(b)(1)).

Subparagraph (a)(9) defines an expatriated foreign subsidiary (EFS), which is relevant to the treatment of post-inversion transactions under reg. sections 1.956-2(a)(4), 1.7701(l)-4(c)–(d), and 1.367(b)-4(e)-(f).

The definition disregards any application of the constructive ownership rules in section 318(a)(3)(A)–(C) that would treat a U.S. person as owning stock actually owned by a non-U.S. person in determining whether the tested foreign corporation is a CFC; a person is a U.S. shareholder of the CFC; or the tested foreign corporation is an EAG member.

Section 318(a)(3)(A)–(C) attributes stock ownership from partners, beneficiaries, grantors, and shareholders to partnerships, estates, trusts, and corporations.

The general rule in subdivision (a)(9)(i) defines an EFS as a foreign corporation:

• that is a CFC (determined without applying section 318(a)(3)(A)–(C) so that a U.S. person is considered to own stock owned by a non-U.S. person); and
• in which an expatriated entity is a U.S. shareholder (determined without applying section 318(a)(3)(A)–(C) so that a U.S. person is considered to own stock owned by a non-U.S. person).

Subdivision (a)(9)(ii) provides an exception to the general definition of an EFS in subdivision (a)(9)(i). A foreign corporation is not an EFS if, because of an inversion transaction that would otherwise cause the foreign corporation to be an EFS:

• on the completion date, the foreign corporation was both a CFC (determined without applying section 318(a)(3)(A)–(C) so as to consider a U.S. person as owning stock owned by a non-U.S. person) and a member of the EAG; and
• on or before the completion date the U.S. entity was not a U.S. shareholder (determined without applying section 318(a)(3)(A)–(C) so as to consider a U.S. person as owning stock owned by a non-U.S. person) of the foreign corporation.

Subparagraph (a)(10) defines a foreign acquiring corporation as the foreign corporation described in section 7874(a)(2)(B). A reference to a foreign acquiring corporation includes a successor, including a corporation that succeeds to and takes into account amounts of the foreign acquiring corporation under section 381.

Subparagraph (a)(11) defines a foreign related person as a foreign person that is related to the expatriated entity (within the meaning of section 267(b) or 707(b)(1)) or is under the same common control (within the meaning of section 482).

Subparagraph (a)(12) defines a former U.S. entity partner of a U.S. partnership as a person that held an interest in the partnership before the U.S. entity acquisition, including a person that holds an interest in the partnership both before and after the U.S. entity acquisition.

Subparagraph (a)(13) defines a former U.S. entity shareholder of a U.S. corporation as a person that held stock in the U.S. corporation before the U.S. entity acquisition, including a person that holds stock in the U.S. corporation both before and after the U.S. entity acquisition.

Subparagraph (a)(14) defines an interest in a partnership to include a capital or profits interest.

Subparagraph (a)(15) defines an inversion transaction as a U.S. entity acquisition in which the foreign acquiring corporation is treated as a surrogate foreign corporation under section 7874(a)(2)(B), taking into account section 7874(a)(3).

Subparagraph (a)(16) defines a non-EFS foreign related person as a foreign related person that is not an EFS.

Subparagraph (a)(17) defines the ownership fraction as the ownership percentage described in section 7874(a)(2)(B)(ii) expressed as a fraction.

Subparagraph (a)(18) defines a specified related person as:

• a non-EFS foreign related person;
• a U.S. partnership in which a non-EFS foreign related person is a partner; and
• a U.S. trust having a non-EFS foreign related person as a beneficiary.

Subparagraph (a)(19) defines a U.S. person as a person described in section 7701(a)(30). This includes U.S. citizens, residents, partnerships, and corporations.

Subparagraph (a)(20) defines a U.S. shareholder by cross-reference to section 951(b).

Reg. section 1.7874-10(b) provides that reg. section 1.7874-12 generally applies to U.S. entity acquisitions completed on or after September 22, 2014, unless an exception applies.

The following provisions apply only to U.S. entity acquisitions completed on or after April 4, 2016: subparagraph (a)(8) (definition of expatriated entity), the reference in subparagraph (a)(6) (definition of domestic entity) to corporations that succeed to and take into account amounts of domestic entities under section 381, and the second sentence of paragraph (a)(10) (referring to successor corporations of foreign acquiring corporations). However, taxpayers may elect to apply these provisions to U.S. entity acquisitions completed between September 22, 2014, and April 4, 2016.