* The concepts discussed in this blog are complex and require careful consideration to ensure compliance with Australian and US tax laws. Unless otherwise stated, all monetary references are to US dollar amounts, and all legislative references are to the Australian Income Tax Assessment Act (ITAA) 1997 and to the United States’ Internal Revenue Code (IRC).
Continuing on from last week’s blog Mergers & Acquisitions: Interposing an Australian Holding Company – Part 1: Scrip for Scrip in a Cross-Border Context, this week we consider the US tax implications with interposing an Australian holding company (AU HoldCo) to hold the equity interests in US Inc., with the stockholders of US Inc. exchanging their interests in US Inc. for equivalent interests in AU HoldCo:
US Corporate Reorganization Relief
We have previously discussed the corporate reorganization rules in the context of converting an LLC into an Inc. in Restructuring your US operations – Part 2: US corporate reorganization relief
As noted, the IRC provides for tax relief (“nonrecognition”) for corporate “reorganizations” (under IRC sections 354-368).
To qualify for nonrecognition, a restructure must satisfy:
- a statutory definition of “reorganization” IRC section 368(a)(i)); and
- Treasury Regulation requirements.
The definition of “reorganization” in the IRC includes a “scrip for scrip” type restructure – an exchange of stock in once corporation for stock in another, where immediately after the acquisition, the acquiring corporation has “control” of the other corporation (by possessing at least 80% of the total combined voting power and shares of all classes of stock) regardless of whether the acquiring corporation had control immediately before the acquisition (IRC section 368(a)(i)(B)).
Section 354(a)(1) states that no gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
Similarly, section 361(a) states that no gain or loss shall be recognized to a corporation if it is a party to a reorganization and exchanges property in pursuance of the plan of reorganization, solely for stock in another corporation, a party to the reorganization. Such property could consist of stock or securities, other property or money (IRC section 361(b)(1))
The restructure can involve one or more “domestic corporations” or a domestic corporation and a “foreign corporation”. “Corporation” is defined to include associations, joint-stock companies, and insurance companies (IRC section 7701(a)(3)). US Inc. would qualify as a “domestic corporation” for US tax purposes as it is created or organized in the US (IRC sections 7701 (a)(4)). AU HoldCo would qualify as a “foreign corporation” as it is not a “domestic corporation”, if registered in Australia (IRC sections 7701 (a)(5)).
An exchange involving AU HoldCo acquiring all of the stock in, and control of, US Inc. in exchange for all of its stock, could qualify as a reorganization under either IRC sections 354 or 361.
The Treasury Regulations
The Treasury Regulation requirements for a reorganization (Treas Reg. 1. 368-1) consist of 3 requirements – the continuity of interest (COI), continuity of business enterprise (COBE), and business purpose (BP).
The COI requirement stipulates that a substantial part of the value of the proprietary interests in the “target corporation” (US Inc.) be preserved by, for example, an exchange by the “acquiring corporation” (AU HoldCo) for a direct interest in the target corporation (US Inc.) (Reg. 1. 368-1(e)). A proprietary interest in the target is preserved by the acquisition of stock.
The COBE requirement to be satisfied the transactoin “must be an ordinary and necessary incident of the conduct of the enterprise and must provide for a continuation of the enterprise” (Reg. 1. 368-1(c)). This requirement would be satisfied if AU HoldCo continues the historic business of US Inc. or uses a significant portion of US Inc.’s historic business assets in a business (Reg. 1. 368-1(d)). This requirement is generally not satisfied with a foreign holding company. However, a reorganization may qualify as tax-free if in an otherwise qualifying corporate reorganization, the assets and the businesses of the members of a “qualified group of corporations” are treated as assets and businesses of the issuing corporation (Reg. 1. 368-1(d)(4)(i)). A “qualified group of corporations” is a chain of corporations connected through stock ownership, with the issuing corporation (AU HoldCo) owning directly, stock in at least one other corporation (US Inc.) meeting the “control” requirements of section 368(c)).
The “Business purpose” requirement stipulates that the transaction must have a bona fide business purpose – if not, it would not qualify for relief even if all other requirements for a reorganization are satisfied (Regs. 1. 368-1(b),(c), and (g)). This is especially the case where the parties to the transaction are related and a collateral tax benefit may be obtained from the transaction. The IRS has stated that private letter ruling requests in this regard must include “a complete statement of the business reasons for the transaction” with evidence that the transaction is logical from a business standpoint, and those tax considerations are secondary (Rev. Proc. 2019-1, §7.01(1)(d)). For the stockholders of US Inc., the commercial rationale for the exchange is paramount – can the exchange be justified other than for tax purposes? For example, is the exchange a means to separate core business lines by jurisdiction? How will the businesses operate following the exchange? Is it a means of capital raising? What is the global effective tax rate before and after the exchange?
Assuming that the exchange satisfies these requirements above and is not subject to the anti-avoidance provisions (as will be discussed in Part 3), no gain or loss would be recognized by the stockholder if the stock exchange involves stock in a “party to a reorganization” exchanged pursuant to a “plan of reorganization” (IRC section 354(a)(i)).
“Party to a reorganization” includes both the corporation acquiring the stock (i.e., the “Acquirer”, AU HoldCo) and the corporation whose stock is acquired (i.e., the “Target”, US Inc.) (IRC section 368(b)).
A “plan of reorganization” requires written or oral recognition of the reorganization plan and an identification of the constituent transactions (C. T. Inv. Co. v. Commissioner, 88 F.2d 582 (8th Cir. 1937)). Each party must adopt the plan and file IRS statements for the tax year in which the reorganization occurs (Reg. 1.368-3(a)).
The basis (cost base) of each stock received in the exchange is generally the same as that for which it was exchanged (IRC section 358(b)(1); Reg. 1.358-2).
In next week’s blog, we will consider how the US anti-avoidance rules could operate to this exchange.
For more information on US-Australia cross-border M&A, please contact:
Head, US-Australia Tax Desk