United States - Taxation of cross-border mergers and acquisitions

Taxation of cross-border mergers and acquisitions for United States.

Taxation of cross-border mergers and acquisitions for United States.


United States (US) tax law regarding mergers and acquisitions (M&A) is extensive and complex. Guidance for applying the provisions of the Internal Revenue Code of 1986, as amended (Code), is generally provided by the US Treasury Department (Treasury) and Internal Revenue Service (IRS) by means of Treasury Department regulations, revenue rulings, revenue procedures, private letter rulings, announcements and notices. The courts and the relevant legislative histories provide further interpretation of the tax law and relevant guidance.

Parties may structure a transaction in a non-taxable, partially taxable or fully taxable form. In structuring a transaction, the types of entities involved in the transaction generally help determine the tax implications.[1]

A non-taxable corporate transaction generally allows the acquiring corporation to take a carryover basis in the assets of the target entity. In certain instances, a partially taxable transaction allows the acquiring corporation to take a partial basis step-up in the assets acquired, rather than a carryover basis. A taxable asset or share purchase provides a basis step-up in all the assets or shares acquired. Certain elections made for share purchases allow the taxpayer to treat a share purchase as an asset purchase and take a basis step-up in the acquired corporation’s assets.

Taxpayers generally are bound by the legal form they choose for the transaction. The particular legal structure selected by the taxpayer has substantive tax implications. Further, the IRS can challenge the tax characterization of the transaction on the basis that it does not clearly reflect the substance of the transaction.

Recent developments

This section summarizes US tax developments that occurred from 1 February 2018 to 1 January 2021. To stay up-to-date on the 2017 Tax Cuts and Jobs Act (the ‘2017 Tax Law’ – TCJA), refer to the KPMG US external website dedicated to the 2017 Tax Law. To stay up-to-date on US COVID-19-related tax legislation, refer to the KPMG US COVID-19: Insights on tax impacts external website. Please note that due to a new Congress and Administration under President Joe Biden as of January 2021, more US tax policy changes may be forthcoming. To stay up-to-date on US tax legislation, refer to the KPMG US TaxNewsFlash website.

The 2017 Tax Law

The 2017 Tax Law, enacted in December 2017, significantly affected US cross-border taxation. This legislation is the most extensive rewrite of the US federal tax laws since the Tax Reform Act of 1986. The 2017 Tax Law, which affected both common US inbound and outbound structures, has a significant impact on many foreign buyers of US companies.

For corporations, the centerpiece of the 2017 Tax Law is the permanent reduction in the corporate income tax rate from 35 percent to 21 percent, which generally took effect on 1 January 2018.

The 2017 Tax Law is highly complex in that it layers new law over years of existing US federal tax law as well as eliminates and modifies various sections of existing tax law. The US Treasury and the IRS have been engaged in a lengthy and time-consuming process of drafting interpretative regulations and guidance that address the legislation’s provisions. Additionally, there has been discussion as to whether the US Congress will enact a ‘technical corrections’ bill that makes retroactive changes to the 2017 Tax Law; prospects remain uncertain.

The 2017 Tax Law fundamentally changed the taxation of US multinational corporations and their foreign subsidiaries. US multinational corporations under the old law were subject to immediate and full US income taxation on all income from sources within and without the US. The earnings of foreign subsidiaries under the old law, however, generally were not subject to US income tax until the earnings were repatriated through dividend distributions (although under an anti-deferral regime (subpart F), which dated back to 1962, certain categories of foreign subsidiary earnings were taxed in the hands of the US corporate owners as if such amounts had been repatriated via dividend distribution).

By contrast, the earnings of foreign subsidiaries under the 2017 Tax Law are either subject to immediate taxation under expanded anti-deferral provisions or are permanently exempt from US taxation. The 2017 Tax Law generally retains the existing subpart F regime that applies to passive income and related-party sales and services income, and it creates a new, broad class of income (‘global intangible low-taxed income’ — GILTI) that is also deemed repatriated in the year earned and, thus, is also subject to immediate taxation. While GILTI is effectively taxed at a reduced rate, subpart F income is subject to tax at the full US rate.

To accomplish this shift to the new regime, the new law included several key features, including:

  • a 100 percent deduction for dividends received from 10 percent-owned foreign corporations
  • a tax on GILTI
  • a one-time transition tax or deemed repatriation tax on the accumulated earnings of certain foreign corporations.

Some of the stated goals in enacting the 2017 Tax Law were simplification and a shift from a worldwide system of taxation to a territorial tax system (i.e. a tax system that taxes profits where they are earned). Whether the 2017 Tax Law achieves these goals is debatable. The 2017 Tax Law contains complex new provisions that require significant reasoned analysis and judgment, as well as additional administrative guidance to properly implement. While it might be nominally accurate to state that the new tax system moves towards a territorial system — because certain profits earned by foreign subsidiaries are not subject to immediate taxation and will not be taxed when repatriated — the non-taxable profits are (in most situations) a small portion of the profit pool. Moreover, by expanding the anti-deferral regime to include GILTI (albeit at a reduced effective rate), the 2017 Tax Law expands the base of cross-border income that is subject to immediate US income taxation.

Other key provisions of the 2017 Tax Law are a reduced tax rate for a new class of income earned directly by US corporations (‘foreign-derived intangibles income’ — FDII) and a new tax (the ‘base erosion and anti-abuse tax’ — BEAT) on deductible payments made by US corporations to related foreign persons.

Various provisions of the 2017 Tax Law are discussed in further detail throughout this report. As a general matter, it is important to keep in mind that many of the 2017 Tax Law’s provisions affect foreign buyers of US targets and, more generally, foreign multinationals that have significant US operations. In practice, some of the provisions will operate to increase US taxable income when applicable. Due to the significant changes, consideration of the 2017 Tax Law is especially important when completing tax due diligence reviews, defining tax indemnities, and undertaking acquisition integration planning. From a tax due diligence perspective, areas of key focus from the 2017 Tax Law perspective include, for example, consideration of:

  • whether the US target has properly calculated its mandatory repatriation tax (if applicable)
  • whether the US target has any structures or transaction flows in place that would give rise to US tax exposures, for example, under the BEAT regime and/or the new hybrid mismatch rule
  • whether the US target is highly leveraged
  • whether the US target has any intellectual property (IP) planning structures in place.

For those foreign companies with significant US operations that did not plan accordingly (e.g. through supply chain restructuring), the collective application of certain provisions of the 2017 Tax Law could have resulted in an unfavorable impact on a foreign company’s global effective tax rate despite the US corporate tax rate reduction.

Asset purchase or share purchase

The decision to acquire assets or stock is relevant in evaluating the potential tax exposures that a buyer may inherit from a target corporation. A buyer of assets generally does not inherit the US tax exposures of the target, except for certain successor liability for state and local tax purposes and certain state franchise taxes. Also, an acquisition of assets constituting a trade or business may result in amortizable goodwill for US tax purposes. However, there may be adverse tax consequences for the seller in an asset acquisition (e.g. depreciation recapture and double taxation resulting from the sale followed by distribution of the proceeds to foreign shareholders).

By contrast, in a stock acquisition, the target’s historical liabilities, including liabilities for unpaid US taxes, generally remain with the target (effectively decreasing the value of the buyer’s investment in the target’s shares). In negotiated acquisitions, it is usual and recommended that the seller allow the buyer to perform a due diligence review, which, at a minimum, should include review of:

  • the adequacy of tax provisions/reserves in the accounts, identifying open years and pending income tax examinations
  • the major differences in the pre-acquisition book and tax balance sheets
  • the existence of special tax attributes (e.g. ‘net operating loss’ — NOL), how those attributes were generated and whether there are any restrictions on their use
  • issues relating to acquisition and post-acquisition tax planning.

Under US federal tax principles, the acquisition of assets or stock of a target may be structured such that gain or loss is not recognized in the exchange (tax-free reorganization). Such transactions allow the corporate structures to be rearranged from simple recapitalizations and contributions to complex mergers, acquisitions and consolidations.

Typically, a tax-free reorganization requires a substantial portion of the overall acquisition consideration to be in the form of stock of the acquiring corporation or a corporation that controls the acquiring corporation. However, for acquisitive asset reorganizations between corporations under common control, cash and/or other non-stock consideration may be used.

There may be restrictions on the disposal of stock received in a tax-free reorganization. The buyer generally inherits the tax basis and holding period of the target’s assets, as well as the target’s tax attributes. However, where certain built-in loss assets are imported into the US, the tax basis of such assets may be reduced to their fair market value.

In taxable transactions, the buyer generally receives a cost basis in the assets or stock. Thus, the buyer may obtain higher depreciation deductions if the acquired item is an asset with a built-in gain, or immediate expensing for certain tangible assets under the 2017 Tax Law for taxable asset acquisitions.

In certain types of taxable stock acquisitions, the buyer may elect to treat the stock purchase as a purchase of the assets (section 338 election discussed later — see ‘Purchase of shares’ section).

Generally, US states and local municipalities respect the federal tax law’s characterization of a transaction as a taxable or tax-free exchange.

Careful consideration must be given to cross-border acquisitions of stock or assets of a US target. Certain acquisitions may result in adverse tax consequences under the corporate inversion rules. Depending on the amount of shares of the foreign acquiring corporation issued to the US target shareholders, the foreign acquiring corporation may be treated as a US corporation for all US federal income tax purposes. In some cases, the US target may lose the ability to reduce any gain related to an inversion transaction by the US target’s tax attributes (e.g. NOLs and ‘foreign tax credits’ — FTCs).

Purchase of assets

In a taxable asset acquisition, the purchased assets have a new cost basis for the buyer (if not immediately expensed under the 2017 Tax Law). The seller recognizes gain (either capital or ordinary) on the amount that the purchase price exceeds its tax basis in the assets. An asset purchase generally provides the buyer with the opportunity to select the desired assets, leaving unwanted assets behind. While a section 338 election (described later) is treated as an asset purchase, it does not necessarily allow for the selective purchase of the target’s assets or avoidance of its liabilities.

An asset purchase may be recommended where a target has potential liabilities and/or such transaction structure helps facilitate the establishment of a tax-efficient structure post-acquisition. For example, under certain conditions, a tax basis step-up resulting from a transaction treated as an asset purchase can help mitigate exposure to the so-called GILTI tax on a go-forward basis. For a discussion of GILTI, see ‘Integration planning for US target-owned intellectual property’ section.

Purchase price

In a taxable acquisition of assets that constitute a trade or business, the buyer and seller are required to allocate the purchase price among the purchased assets using a residual approach among seven asset classes described in the regulations. The buyer and seller are bound by any agreed allocation of purchase price among the assets.

Contemporaneous third-party appraisals relating to asset values can be beneficial.

Depreciation and amortization

The purchase price allocated to fixed assets and to certain intangible assets provides future tax deductions in the form of depreciation or amortization.

As stated earlier, in an asset acquisition, the buyer receives a cost basis in the assets acquired for tax purposes. Frequently, this results in a step-up in the depreciable basis of the assets but could result in a step-down in basis where the asset’s fair market value is less than the seller’s tax basis.

Most tangible assets are depreciated over tax lives ranging from 3 to 10 years under accelerated tax depreciation methods, thus resulting in enhanced tax deductions.

Buildings are depreciable using a straight-line depreciation method generally over 39 years (27.5 years for residential buildings). Other assets, including depreciable land improvements and many non-building structures, may be assigned a recovery period of 15 to 25 years, with a less accelerated depreciation method.

In certain instances, section 179 allows taxpayers to elect to treat as a current expense the acquired cost of tangible property and computer software used in the active conduct of a trade or business. Under the 2017 Tax Law, the deductible section 179 expense limitation is generally 1 million US dollars (US$. This limitation, which is adjusted annually for inflation, is reduced dollar-for-dollar to the extent the total cost of section 179 property placed in service during the year exceeds USD2.5 million (this limitation is also adjusted annually for inflation).

Separately from section 179, so-called ‘qualified property’ used in a taxpayer’s trade or business or for the production of income may be subject to an additional depreciation deduction (‘bonus depreciation’) in the first year the property is placed into service. The 2017 Tax Law expands bonus depreciation to include a 100 percent deduction for the cost of qualified property (generally software and tangible depreciable property with a depreciation life of 20 years or less) that is either original use property or acquired by purchase from unrelated persons. Such property must be acquired and placed in service after 27 September 2017 and before 1 January 2023. The 2017 Tax Law includes a 20 percent incremental phase-down of the ‘bonus’ depreciation percentage for property acquired after 2022, generally allowing businesses to expense 80 percent, 60 percent, 40 percent and 20 percent of the cost of property placed in service in 2023, 2024, 2025 and 2026, respectively. Under the 2017 Tax Law, bonus depreciation is completely phased out in 2027.

Unlike under prior law, the 2017 Tax Law does not limit bonus appreciation to ‘original use property’ that begins with the taxpayer. Specifically, under the 2017 Tax Law, both original-use and used tangible property that is ‘new’ to the taxpayer qualifies for bonus depreciation if certain conditions are met. In general, property is ‘new’ to a taxpayer if the taxpayer and its predecessor did not have a depreciable interest in the property within a look-back period of 5 years. This change governing immediate expensing provides an incentive for foreign buyers of asset-intensive US companies (e.g. manufacturing businesses) to structure business acquisitions as asset purchases or deemed asset purchases (e.g. section 338 elections) instead of stock purchases in those cases where the US target has significant assets that would qualify for 100 percent expensing. When applicable, the 100 percent bonus depreciation rule provides buyers of qualifying US assets with the opportunity to essentially deduct a portion of the purchase price allocable to qualifying tangible property.

Due to the enhanced bonus depreciation provision, it is also anticipated that a seller of a US target company may be more willing to sell assets than before due to the US corporate tax rate reduction and 100 percent expensing for qualifying purchases of depreciable tangible property. Under the 2017 Tax Law, a C corporation that sells an asset and reinvests the proceeds into qualifying depreciable tangible property receives a cash tax benefit due to acceleration of deductions. Specifically, under the 2017 Tax Law, the net effect is a 21 percent tax on the gain realized on the sale, and a 21 percent deduction for the reinvested proceeds if the property qualifies for 100 percent expensing.

Bonus depreciation automatically applies to qualified property, unless a taxpayer elects to forego bonus depreciation in whole or with respect to certain asset recovery classes. Where this election is made, the taxpayer depreciates assets subject to the election under the normal depreciation rules, including accelerated depreciation, if applicable. Taxpayers that wish to further reduce depreciation deductions may elect to use the ‘alternative depreciation system’ under which assets are depreciated using the straight-line method over a longer recovery period. The taxpayer may also elect to use the straight-line depreciation method to determine the adjusted basis of the taxpayer’s qualified business asset investment for FDII and GILTI purposes only, without causing the taxpayer’s property to be ineligible for bonus depreciation for US federal taxable income purposes.

On the other hand, bonus depreciation may not always yield the best results due to potential interactions with other tax provisions. For example, in some situations bonus depreciation might cause a very large NOL, which may offset only 80 percent of taxable income in future years after 1 January 2021, or claiming bonus depreciation deductions in an acquisition year may preclude or limit the deductibility of interest (with respect to tax years after 1 January 2022), GILTI and charitable contributions for the year. Therefore, under certain circumstances, it may be preferable to elect out of bonus depreciation for one or all classes of property.

Where both the section 179 expense and bonus depreciation are claimed for the same asset, the asset basis must first be reduced by the section 179 expense before applying the bonus depreciation rules.

Land is not depreciable for tax purposes. Also, accelerated depreciation, the section 179 deduction and bonus depreciation are unavailable for most assets considered predominantly used outside the US.

Generally, the capitalized cost of most acquired intangibles, including goodwill, going-concern value and non-compete covenants, are amortizable over 15 years. A narrow exception — the so-called ‘anti-churning rules’ — exists for certain intangibles that were not amortizable prior to 10 August 1993, where they were held, used or acquired by the buyer (or related person) before such date or if acquired by an unrelated party but the user of the intangible did not change.

Under the residual method of purchase price allocation, any premium paid that exceeds the aggregate fair market value of the acquired assets generally is characterized as an additional amount of goodwill and is eligible for the 15-year amortization.

Costs incurred in acquiring assets — tangible or intangible — are typically added to the purchase price and considered part of their basis, and they are depreciated or amortized along with the acquired asset. A taxpayer that produces or otherwise self-constructs tangible property may also need to allocate a portion of its indirect costs of production to basis; this can include interest expense incurred during the production period.

Tax attributes

The seller’s NOLs, capital losses, tax credits, disallowed business interest expense and other tax attributes are not transferred to the buyer in a taxable asset acquisition. In certain circumstances where the target has substantial tax attributes, it may be beneficial to structure the transaction as a sale of its assets so that any gain recognized may be offset by the target’s tax attributes. Such a structure may also reduce the potential tax for the target’s stockholder(s) on a sale of its shares when accompanied by a section 338 or 336(e) election to treat a stock purchase as a purchase of its assets for tax purposes (assuming the transaction meets the requirements for such elections; see ‘Purchase of shares’ section).

Value Added Tax

The US does not have a Value Added Tax (VAT). Certain state and local jurisdictions impose sales and use taxes, gross receipts taxes, and/or other transfer taxes.

Transfer taxes

The US does not impose stamp duty taxes at the federal level on transfers of intangible assets, including stock, partnership interests and membership interests in limited liability companies (LLCs). The US does not impose sales/use tax on transfers of tangible assets nor does it impose real estate transfer tax on transfers of real property at the federal level.

Forty-five states, the District of Columbia, and hundreds of localities impose sales/use tax on transfers of tangible personal property for consideration. However, exemptions from sales/use tax may apply to transfers of tangible personal property. For example, many states adopt an exemption from sales/use tax applicable to casual, isolated or occasional sales of tangible business assets. Moreover, exemptions from sales/use tax applicable to machinery and equipment used in manufacturing or sales of inventory (sale for resale) may apply to the transaction.

Most states and/or localities impose real estate transfer tax (RETT) on direct transfers of a possessory interests in real property, including real estate held in fee simple and certain leasehold interests. Some states or localities impose RETT on the transfer of intangible assets, such as stock, partnership interests and LLC membership interests. However, some of these state/localities require the entity meet certain qualifications before imposing RETT, such as qualifying as a defined ‘real estate company’ in a particular jurisdiction.

Purchase of shares

As stated earlier, in a stock acquisition, the target’s historical tax liabilities remain with the target, which affects the value of the buyer’s investment in target stock. In addition, the target’s tax basis in its assets generally remains unchanged. The target continues to depreciate and amortize its assets over their remaining lives using the methods it previously used. Although the target retains its tax attributes in a stock acquisition, its use of its NOLs and other favorable tax attributes may be limited where it experiences what is referred to as an ‘ownership change’ (see ‘Tax losses and other attributes’ section).

Additionally, many of the costs incurred by the buyer and the target in connection with the stock acquisition generally cannot be deducted (but are capitalized into the basis of the shares acquired).

In a taxable purchase of the target stock, an election can be made to treat the purchase of stock as a purchase of the target’s assets, provided certain requirements are satisfied. The buyer, if eligible, can make either a unilateral election under section 338(g) (338(g) election) or, if available, a joint election (with the common parent of the consolidated group of which the target is a member or with shareholders of a target S corporation) under section 338(h)(10) (i.e. 338(h)(10) election).

Alternatively, the seller and target can make a joint election, provided they satisfy the rules under section 336(e) (336(e) election). Similar to a section 338 election, the section 336(e) election treats a stock sale as a deemed asset sale for tax purposes, thereby providing the buyer a basis in the target’s assets equal to fair market value. Unlike the rules under section 338, however, the buyer does not have to be a corporation.

In certain circumstances involving a taxable stock sale between related parties, special rules (section 304) may re-characterize the sale as a redemption transaction in which a portion of the sale proceeds may be treated as a dividend to the seller. Whether the tax consequences of this recharacterization are adverse or beneficial depends on the facts. For example, if tax treaty benefits are not available, the dividend treatment may result in the imposition of US withholding tax (WHT) at a 30 percent rate on a portion of the sale proceeds paid by a US buyer to a foreign seller. On the other hand, the dividend treatment may be desirable on sales of foreign target stock by a US seller to a foreign buyer, both of which are controlled by a US parent corporation. In this case, with proper planning, a portion of the resulting deemed dividend from the foreign buyer and/or foreign target may be exempt from US federal income tax under the participation exemption implemented by the 2017 Tax Law as long as certain conditions are met.

Tax indemnities and warranties

In a stock acquisition, the target’s historical tax liabilities remain with the target. As such, it is important that the buyer procures representations and warranties from the seller (or its stockholders) in the stock purchase agreements to protect itself from risk of being exposed to any post-transaction liabilities (e.g. the 2017 Tax Law mandatory repatriation tax) arising from the target’s pre-transaction activities.

Where significant sums are at issue, the buyer generally performs a due diligence review of the target’s tax affairs. Generally, the buyer seeks tax indemnifications for a period through at least the expiration of the statute of limitations, including extensions. The indemnity clauses sometimes include a cap on the indemnifying party’s liability or specify a dollar amount that must be reached before indemnification occurs. Please note that KPMG LLP in the US cannot and does not provide legal advice. The purpose of this paragraph is to provide general information on tax indemnities and warranties that should be addressed and tailored by the client’s legal counsel to the client’s facts and circumstances.

Tax losses and other attributes

The 2017 Tax Law modifies the rules that govern the utilization of NOLs, and these rules were further modified by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), signed into law on 27 March 2020. In general:

1) NOLs arising in taxable years beginning on or before 31 December 2017 may be carried back 2 years and carried forward 20 years, and can offset up to 100 percent of a corporation’s taxable income.

2) NOLs arising in taxable years beginning after 31 December 2017 and before 1 January 2021 may be carried back 5 years and carried forward indefinitely, and can offset up to 100 percent of a corporation’s taxable income in taxable years beginning before 1 January 2021 (up to 80 percent of the corporation’s taxable income in taxable years beginning after 31 December 2020).

3) NOLs arising in taxable years beginning on or after 1 January 2021 can be carried forward indefinitely but cannot be carried back, and can offset up to 80 percent of a corporation’s taxable income.

As a result of differing carryback and carryforward rules and taxable income limitations, corporations (and potential acquirors) may need to track NOLs separately, based on their vintage.

Rules for utilization of capital losses remain unchanged under the 2017 Tax Law and CARES Act, which continues to allow corporations to carry capital loss back for 3 years and carry it forward for 5 years to the extent of available capital gains.

Section 382 imposes one of the most significant limitations on the utilization of a target’s NOLs (as well as capital losses and credits and disallowed business interest expense carryovers). Section 382 generally applies where a target that is a loss corporation undergoes an ‘ownership change.’ Generally, an ownership change occurs when more than 50 percent of the beneficial stock ownership of a loss corporation has changed hands over a prescribed period (generally 3 years).

The annual limitation on the amount of post-change taxable income that may be offset with pre-change NOLs (‘section 382 limitation’) is generally equal to the adjusted equity value of the loss corporation multiplied by a long-term tax-exempt rate established by the IRS. The adjusted equity value used in calculating the annual limitation is generally the equity value of the loss corporation immediately before the ownership change, subject to certain potential downward adjustments. Common adjustments include acquisition debt pushed down to the loss corporation and certain capital contributions to the loss corporation within the 2-year period prior to the ownership change.

If the aggregate fair market value of the target’s assets exceeds the target’s aggregate tax basis in its assets immediately prior to the ownership change (‘net unrealized built-in gain’ – NUBIG), and the target realizes some or all of its built-in gain during a 5-year recognition period following the ownership change (‘recognized built-in gain’ – RBIG), subject to certain limitations, the annual section 382 limitation can be increased by the amount of the RBIG. Currently, the excess of the target’s hypothetical depreciation and amortization based on fair market value allocable to depreciable and amortizable assets immediately prior to the ownership change over the target’s actual depreciation and amortization during the 5-year recognition period, can be treated as RBIG and can increase the annual limitation. However, newly proposed regulations under section 382(h) seek to eliminate the method that would allow for this result, with respect to ownership changes occurring 30 days after the release of the final regulations. (These proposed regulations are controversial and may be significantly modified prior to being published as final.)

On the contrary, if the fair market value of target assets is less than the tax basis immediately prior to the ownership change (’net unrealized built-in loss’ – NUBIL), any built-in loss realized during the 5-year recognition period following the ownership change (‘recognized built-in loss’ – RBIL), including any excess of actual depreciation and amortization over hypothetical depreciation and amortization based on fair market value allocable to depreciable and amortizable assets, can be subject to the section 382 annual limitation.

Similar to section 382, it is important to note that section 383 also seeks to restrict monetization of a loss corporation’s tax attributes by another profitable corporation, and section 384 seeks to restrict a loss corporation’s ability to utilize its pre-acquisition tax attributes against pre-acquisition built-in gain of an acquired profitable corporation.

In addition to changing the NOL rules, the 2017 Tax Law also repealed the US corporate alternative minimum tax (AMT) regime for tax years beginning after 2017. Excess AMT credits that have not yet been claimed are generally refundable. Under the CARES Act, a 50 percent refundable credit is allowed for 2018 with the remaining credit becoming fully refundable in 2019. Alternatively, corporate taxpayers may also elect to claim the entire refundable credit amount for 2018. As a practical matter, utilizing excess AMT credits and generating cash refunds as a result of such credits may be difficult for some taxpayers that face a section 383 limitation.

Consequences of a member of a consolidated group leaving such group

A corporation’s departure from a consolidated group is subject to the complex regulations that apply to US consolidated groups. Very generally, one consequence of a corporation’s departure from a consolidated group is the acceleration of any deferred items from transactions between the departing corporation and other members of the consolidated group. For example, gain on the sale of an item of property by one member of a consolidated group (S) to another consolidated group member (B) will generally be deferred under the consolidated return regulations until that property is transferred out of the consolidated group. If, however, either S or B leaves the consolidated group, S’s deferred gain will be accelerated and includible in taxable income (if S is the departing member, the deferred gain will be taken into account by S immediately before S leaves the consolidated group). There is an exception to this acceleration of deferred items for certain cases in which the entire consolidated group having the deferred items is acquired by another consolidated group.

Within a consolidated group, it is possible for a company (S) to have a negative tax basis in the shares of another company (B). This is referred to as an excess loss account and can arise as a result of debt leveraged distributions (e.g. B borrows in order to fund a dividend distribution) or debt leveraged generation of losses (e.g. B borrows and spends the proceeds on operating its business). Like the deferred intercompany items previously discussed, immediately before either B or S leaves the consolidated group, any excess loss account must be recognized as taxable income. There is an exception to this excess loss account recognition for certain cases in which the entire consolidated group having the excess loss account(s) is acquired by another consolidated group.

The departure of a corporation from a consolidated group raises numerous issues besides the acceleration of deferred items described above. For example, when a corporation ceases to be a member of a consolidated group during the tax year, the corporation’s tax year ends and consideration must be given to the allocation of income, gain, loss, deduction, credit, and potentially other attributes between the departing corporation and the consolidated group. The consolidated return regulations also contain complex rules that may reduce or eliminate loss realized (and/or certain tax attributes) on the departure of a consolidated group member. In addition, note that the departing corporation is potentially liable for the consolidated group’s entire tax liability for each year in which the departing corporation was a member of the consolidated group (even for a day), including the year in which the subsidiary leaves the consolidated group.

Pre-sale dividend

In certain circumstances, the seller may prefer to realize part of the value of its investment in the target through a pre-sale dividend. This may be attractive where the dividend is subject to tax at a rate that is lower than the tax rate on capital gains.

Generally, for corporations, dividends and capital gains are subject to tax at the same federal corporate tax rate of 21 percent. However, depending on the ownership interest in the subsidiary, a seller may be entitled to various amounts of dividend-received deduction (DRD) on dividends received from a US subsidiary if certain conditions are met. However, certain dividends may also result in reducing the tax basis of the target’s stock by the amount of the DRD.

An individual is generally taxed on capital gains and dividends from domestic corporations and certain foreign corporations based on their marginal income tax bracket. See below for long-term capital gains rates for tax years beginning 2018. Qualified dividends are generally taxed at the general long-term capital gains rate.

Individuals are not entitled to DRDs on dividends. Thus, the tax effect of a pre-sale dividend may depend on the recipient‘s circumstances. Each case must be examined on its facts. In certain circumstances, proceeds of pre-sale redemptions of target stock may also be treated as a dividend by the recipient stockholder (see ‘Equity’ section).

US table 1

Tax clearances

Generally, a clearance from the IRS is not required prior to engaging in an acquisition of stock or assets. A taxpayer can request a private letter ruling, which is a written determination issued to a taxpayer by the IRS national office in response to a written inquiry about the tax consequences of the contemplated transactions.

Although it provides a measure of certainty on the tax consequences, the ruling process can be protracted and time-consuming and may require substantial expenditures on professional fees. Thus, the benefits of a ruling request should be carefully considered beforehand.

Private letter rulings are taxpayer-specific and can only be relied on by the taxpayers to whom they are issued. Pursuant to section 6110(k)(3), such items cannot be used or cited as precedent. Nonetheless, such rulings can provide useful information about how the IRS may view certain issues.

Choice of acquisition vehicle

A particular type of entity may be better suited for a transaction because of its potential tax treatment. Previously, companies were subject to a generally cumbersome determination process to establish entity classification. However, the IRS and Treasury issued regulations that allow certain eligible entities to elect to be treated as a corporation or a partnership (where the entity has more than one owner) or as a corporation or disregarded entity (where the entity has only one owner). Rules governing the default classification of domestic entities are also provided under these regulations.

A similar approach is available for classifying eligible foreign business organizations, provided such entities are not included in a prescribed list of entities that are per se corporations (i.e. always treated as corporations).

Taxpayers are advised to consider their choice of entity carefully, particularly when changing the classification of an existing entity. For example, where an association that is taxable as a corporation elects to be classified as a partnership, the election is treated as a complete liquidation of the existing corporation and the formation of a new partnership. The election could thus constitute a material realization event that might entail substantial adverse immediate or future US tax consequences.

Local holding company

A US incorporated corporation is often used as a holding company and/or acquisition vehicle for the acquisition of a US target or a group of assets. Under the 2017 Tax Law, a corporation is subject to an entity-level federal corporate income tax rate of 21 percent, plus any applicable state and/or local taxes.

Despite the entity-level tax, a corporation may be a useful vehicle to achieve US tax consolidation to offset income with losses between the target group members and the buyer, subject to certain limitations (see ‘Group relief/consolidation’ section). Moreover, a corporation may be used to push down acquisition debt in certain circumstances, so that interest may offset the income from the underlying companies or assets. However, as noted earlier, a debt pushdown may limit the use of a target’s pre- acquisition losses under the section 382 regime (see ‘Tax losses and other attributes’ section).

Where a non-US person is a shareholder in a corporation, consideration should also be given to the Foreign Investment Real Property Tax Act (FIRPTA) (see next section).

Foreign parent company

Where a foreign corporation is directly engaged in business in the US through a US branch (or owns an interest in a fiscally transparent entity that conducts business in the US), it may be subject to net basis US taxation at the 21 percent corporate rate on income that is effectively connected to the US business (but only in the case of an entity entitled to benefits under a tax treaty, if that income is attributable to a US permanent establishment). The US also imposes additional tax at a 30 percent rate on branch profits deemed remitted overseas (subject to tax treaty rate reductions or exemptions). In addition, the foreign corporation will generally be subject to tax return filing obligations in the US.

Alternatively, a foreign corporation may be used as a vehicle to purchase US target stock, as foreign owners are generally not taxed on the corporate earnings of a US subsidiary corporation. However, dividends or interest from a US target remitted to a foreign corporation may be subject to US WHT at a 30 percent rate (which may be reduced under a tax treaty). Thus, careful consideration may be required where, for example, distributions from a US target are required to service debt of the foreign corporation (e.g. holding the US target through an intermediate holding company, as discussed later).

Generally, the foreign corporation’s sale of US target stock should not be subject to US taxation unless the US target was a US real property holding corporation (USRPHC) at any time during a specified measuring period. US target would be treated as USRPHC if the fair market value of the target’s US real property interests was at least 50 percent of the fair market value of its global real property interests plus certain other property used in its business during that specified measuring period. The specified measuring period generally is the shorter of the 5-year period preceding the sale or other disposition and the foreign corporation’s holding period for the stock.

A foreign seller of USRPHC stock may be subject to US income tax on the gain at standard corporate tax rates (generally 21 percent) and a 15 percent US WHT on the amount realized, including assumption of debt (the WHT is creditable against the tax on the gain). In addition, a sale of USRPHC stock gives rise to US tax return filing obligations.

Non-resident intermediate holding company

An acquisition of the stock of a US target may be structured through a holding company resident in a jurisdiction that has an income tax treaty with the US (an intermediate company) potentially to benefit from favorable US and foreign tax treaty WHT rates.

However, the benefits of the structure may be limited under anti-treaty shopping provisions found in most US treaties or under the US federal tax rules (e.g. Code, regulations).

Joint venture

Multiple buyers may use a joint venture vehicle to purchase a US target or US assets. A joint venture may be organized either as a corporation or a fiscally transparent entity (a flow-through venture), such as a partnership or LLC. A joint venture corporation may face issues similar to those described earlier (see ‘Local holding company’ section).

A flow-through venture generally is not subject to US income tax at the entity level (except in some states). Instead, its owners are taxed directly on their proportionate share of the flow-through venture’s earnings, whether or not distributed. Where the flow-through venture conducts business in the US, the foreign owners may be subject to net basis US taxation on their share of its earnings, as well as US WHT and US tax return filing obligations.

Choice of acquisition funding

Generally, a buyer (or an acquisition vehicle) finances the acquisition of a US target with its own cash, issuance of debt or equity, or a combination of these. The capital structure is critical due to the potential deductibility of debt interest. Certain 2017 Tax Law developments raise tax exposure concerns for a number of common US inbound acquisition financing structures (e.g. US inbound acquisition financing structures involving Luxembourg entities). The section 385 Regulations (see ‘Deductibility of interest’ section) also raise various considerations for US inbound acquisition financing.

Buyers of US target companies should carefully consider both 2017 Tax Law developments and recommendations from the Organisation for Economic Co-operation and Development (OECD) to counter base erosion and profit shifting (BEPS), as well as the section 385 Regulations when deciding on what acquisition funding structure to use.


An issuer of debt may be able to deduct interest against its taxable income (see ‘Deductibility of interest’ section), whereas dividends on stock are non-deductible. Additionally, debt repayment may allow for tax-free repatriation of cash, whereas certain stock redemptions may be treated as dividends and taxed as ordinary income to the stockholder. Similar to dividends, interest may be subject to US WHT.

The debt placement and its collateral security should be carefully considered to help ensure that the debt resides in entities that are likely to be able to offset interest deductions against future profits. The debt should be adequately collateralized to help ensure that the debt will be respected as a genuine indebtedness. Moreover, the US debtor may recognize current income where the debt is secured by a pledge of stock or assets of controlled foreign companies (CFC). See ‘Foreign investments of a US target company’ section.

Deductibility of interest

Interest paid or accrued during a taxable year on a genuine indebtedness of the taxpayer generally is allowed as a tax deduction during that taxable year, subject to several exceptions, some of which are described below.

For interest to be deductible, the instrument (e.g. notes) must be treated for US tax purposes as debt and not as equity. The characterization of an instrument is largely based on facts, judicial principles and IRS guidance. Although a brief list of factors cannot be considered complete, some of the major considerations in the debt-equity characterization include:

  • the intention of the parties to create a debtor-creditor relationship
  • the debtor’s unconditional obligation to repay the outstanding amounts on a fixed maturity date
  • the creditor’s rights to enforce payments
  • the thinness of the debtor’s capital structure in relation to its total debt.

Shareholder loans generally should reflect arm’s length terms. Where a debtor has limited capability to service bank debt, its guarantor may be treated as the primary borrower. As a result, the interest accrued by the debtor may be re-characterized as a non-deductible dividend to the guarantor. This may entail additional US WHT consequences where the guarantor is a foreign person.

Interest deductions may be limited for certain types of acquisition indebtedness where interest paid or incurred by a corporation during the taxable year exceeds US$ million, subject to certain adjustments. However, this provision generally should not apply if the debt is not subordinated or convertible.

A US debtor’s ability to deduct interest on debt (whether extended or guaranteed by a related foreign person or third-party lender) may be further limited under the section 163(j) limitation on business interest. Except for the modifications discussed below resulting from changes made by the CARES Act, for taxable years beginning after 31 December 2017, the 2017 Tax Law substantially amended the earnings-stripping provision provided by section 163(j) (the section 163(j) limitation to generally disallow US tax deductions for the net business interest expense of any taxpayer in excess of 30 percent of a business’s ‘adjusted taxable income’). If certain conditions are met, the section 163(j) limitation can result in disallowance of interest expense deductions regardless of a taxpayer’s business form and whether the interest is owed to a related or third party.

For purposes of the section 163(j) limitation, business interest of a corporation includes any interest paid or accrued on indebtedness properly allocable to a trade or business. Under the 2017 Tax Law, disallowed business interest expense can be carried forward indefinitely to subsequent taxable years. However, future utilization of disallowed business interest expense carryforwards may be subject to limitation (including the section 382 limitation). Thus, during the tax due diligence phase, a buyer of a company that has a disallowed business interest expense carryforward should consider the extent to which section 382 imposes limitations on the utilization of this tax attribute.

The CARES Act temporarily modified the section 163(j) limitation under the 2017 Tax Law, increasing the limitation from 30 percent to 50 percent of ATI for tax years beginning in 2019 and 2020, for corporations. In addition, for tax years beginning in 2020, the CARES Act allows taxpayers to elect to use their ATI from their last tax year beginning in 2019 for their ATI in the 2020 tax year.

Depending on a US target’s facts, the section 163(j) limitation (and certain other 2017 Tax Law provisions — e.g. the hybrid mismatch rule) could result in increased taxable income for a US target. During the tax due diligence phase, it is important to evaluate a US target company’s US and global debt levels and to test the US target’s section 163(j) deductibility threshold. This analysis will help the foreign buyer determine potential US tax impact of existing debt levels, new debt and refinancings. This analysis will also help the foreign buyer evaluate the viability of alternative tax planning options for financing the acquisition of a US target company. Depending on the facts and circumstances, some planning opportunities to mitigate the impact of interest deduction limitations under revised section 163(j) may exist.

For testing purposes, the section 163(j) limitation is performed at the level of the tax filing entity. Regulations under the section 163(j) limitation generally provide that the limitation should be applied ‘after’ other interest disallowance, deferral, capitalization or other limitation provisions. Similar to NOLs, utilization of a US target’s disallowed interest expense carryforwards is subject to limitations following a change of control.

As a general matter, foreign companies with highly leveraged US operations should consider whether an excess interest situation currently exists or might exist in the foreseeable future. During the tax due diligence phase, a foreign buyer should consider undertaking this same inquiry for potential US target companies as well. If an excess interest situation does exist, it may make sense for the foreign company to explore ways to shift the debt burden from the US to an overseas affiliate that has sufficient debt capacity under local country rules. Also, other planning opportunities for further consideration may also exist. For example, by agreeing to a higher cost of goods sold (COGS) from suppliers in exchange for 90 days of trade credits (as opposed to borrowing in order to finance COGS on a real-time basis), it might be possible to convert interest expense that would otherwise be disallowed as a deduction under the section 163(j) limitation provision into a recoverable business expense. (Before undertaking any COGS planning, it is important to consider whether such planning could give rise to unanticipated US trade and customs costs).

Regulations under the final section 163(j) limitation confirm that a corporation can treat interest expense that had been deferred and carried forward under the legacy section 163(j) earnings-stripping provision as business interest paid or accrued in a tax year beginning after 2017 if it otherwise qualifies as business interest expense. These regulations also require that a CFC with business interest expense be subject to section 163(j) for the purpose of computing subpart F income (including GILTI) and income effectively connected with the conduct of a US trade or business.

In addition to the limitations discussed above, other limitations apply to interest on debt owed to foreign related parties and to certain types of discounted securities. For example, in October 2016, Treasury released regulations that seek to prevent companies from eroding the US tax base via deductible intercompany loans (the section 385 Regulations). As a general matter, the section 385 Regulations restrict the tax benefit of using intercompany debt in M&A transactions that involve foreign entity acquisitions of US target companies. Due to the nature of how the section 385 Regulations operate, these regulations can impact transaction structuring, tax due diligence and general tax planning.

Unless an exception applies, the general ‘Recast Rule’ of the section 385 Regulations can treat a debt instrument issued (or deemed reissued) by a US corporation to a related party after 4 April 2016, as equity if the debt instrument was issued:

  • as a distribution of property
  • to purchase related-party stock from a related-party seller
  • in exchange for property from a related party in an asset reorganization.

The Recast Rule also provides a so-called funding rule that treats a debt instrument issued by a US corporation to a related party after 4 April 2016 as stock if it is issued for property (e.g. cash) and with a principal purpose of funding one of the transactions listed above. Under one subset of the funding rule, referred to as the ‘per se rule’, a debt instrument can be recast as equity if one or more of the following activities occur during the 36-month period before and after the loan issuance:

  • making distributions in an aggregate amount that exceeds earnings and profits (E&P) earned in taxable years ending after 4 April 2016
  • purchasing stock of a related party
  • engaging in other transactions prohibited by the section 385 Regulations with a related party.

The Treasury has announced its intention to revise the Recast Rule to potentially replace the per se rule with a more streamlined and targeted set of rules that would apply to certain related-party debt instruments issued with a sufficient factual connection to a distribution or economically similar transaction. Treasury has requested comments from the public in this regard. However, no new rule has been proposed at this point, and any change is expected to be effective solely on a prospective basis.

The Treasury had also issued a series of documentation rules as part of the section 385 Regulations. These rules have been withdrawn.

Though the Recast Rules are primarily relevant to foreign-parented multinationals that own or acquire US corporations (or to buyers of such foreign- parented multinational groups), these rules can also apply to:

  • debt between related US corporations that do not join together in filing a consolidated return
  • members of a US-parented group that incur indebtedness, including pursuant to cash pooling arrangements, with foreign group members
  • a US parent that incurs indebtedness to a foreign subsidiary (section 956 debt).

For debt issued before 4 April 2016, the section 385 Regulations do not apply, provided that the debt was not significantly modified or deemed reissued after 4 April 2016.

As a general matter, foreign parent entities (whether top-tier parents or intermediate parents) that have US subsidiaries should review their intercompany debt for section 385 compliance. To the extent that debt will be affected by the section 385 Regulations, the effective tax rate of the international group could be affected. For taxpayers to whom the Recast Rules apply — principally foreign multinationals — it is important that appropriate processes (i.e. internal tracking systems) be in place in order to track covered debt issuances and de-funding transactions, and to prevent unintended recasts. For potential acquisition targets, enhanced tax due diligence may be necessary to determine:

  • whether the Recast Rules apply
  • if the Recast Rules do apply, whether any debt is properly recast as equity under this rule
  • the tax impact of any potential recast of debt as equity.

As a general matter, the following implications (among others) can arise if debt is recast as equity under the Recast Rules:

  • disallowance of interest deductions
  • US withholding tax consequences
  • inability to treat cash repatriations from a US subsidiary to its foreign parent as a tax-free return of principal.

Withholding tax on debt and methods to reduce or eliminate it

The US imposes a 30 percent US WHT on interest payments to non-US lenders unless a statutory exception or favorable US treaty rate applies. Further, structures that interpose corporate lenders in more favorable tax treaty jurisdictions may not benefit from a reduced WHT because of the conduit financing regulations of section 1.881-3 and anti-treaty-shopping provisions in most US treaties. (See ‘Non-resident intermediate holding company’ section.)

No US WHT is imposed on portfolio interest. Portfolio interest constitutes interest on debt held by a foreign person that is not a bank and owns less than 10 percent (by vote) of the US debtor (including options, convertible debt, etc., on an as-converted basis).

Generally, no US WHT is imposed on interest accruals until the US debtor pays the interest or the foreign person sells the debt instrument. Thus, US WHT on interest may be deferred on zero coupon bonds or debt issued at a discount, subject to certain limitations discussed below (see ‘Discounted securities’ section).

Considerations for debt funding

Some of the important factors to consider:

  • Debt should be borne by US debtors that are likely to have adequate positive cash flows to service the debt principal and interest payments.
  • Debt should satisfy the various factors of indebtedness to avoid being reclassified as equity.
  • Debt must be adequately collateralized to be treated as genuine indebtedness of the issuer.
  • The interest expense must qualify as deductible under the various rules limiting interest deductions discussed earlier.
  • Debt between related parties must be issued under terms that are consistent with arm’s length standards.
  • Guarantees or pledges on the debt may trigger the current inclusion of income under the subpart F rules.


The acquisition of a US target may be financed by issuing common or preferred equity. Distributions may be classified as dividends where paid out of the US target’s current or accumulated E&P (similar to retained earnings). Distributions in excess of E&P are treated as the tax-free recovery of tax basis in the stock (determined on a share-by-share basis). Distributions exceeding both E&P and stock basis are treated as capital gains to the holder.

US issuers of stock interests generally are not entitled to any deductions for dividends paid or accrued on the stock. Generally, US individual stockholders are subject to tax on dividends from a US target based on their relevant income tax bracket (see ‘Pre-sale dividend’ section for the applicable tax rates). Stockholders who are US corporations are subject to tax at the 21 percent rate applicable to corporations, but they are entitled to DRDs when received from US corporations depending on their ownership interest (see ‘Pre-sale dividend’ section).

Generally, dividends paid to a foreign shareholder are subject to US WHT at 30 percent unless eligible for favorable WHT rates under a US treaty. The WHT rules provide limited relief for US issuers that have no current or accumulated E&P at the time of the distribution and anticipate none during the tax year. Such a US issuer may elect out of the WHT obligation where, based on reasonable estimates, the distributions are not paid out of E&P.

Generally, no dividend should arise unless the issuer of the stock declares a dividend or the parties are required currently to accrue the redemption premium on the stock under certain circumstances. Of course, US WHT is also imposed on US-source constructive (i.e. deemed paid) dividends. For example, where a subsidiary sells an asset to its parent below the asset’s fair market value, the excess of the fair market value over the price paid by the parent could be treated as a constructive dividend.

Generally, gains from stock sales (including redemptions) are treated as capital gains and are not subject to US WHT (but see the discussion of FIRPTA in the ‘Foreign parent company’ section).

Certain stock redemptions may be treated as giving rise to distributions (potentially treated as dividends) where the stockholder still holds a significant amount of stock in the corporation post-redemption of either the same class or another class(es). Accordingly, the redemption may result in ordinary income for the holder that is subject to US WHT. See this report’s sections on ‘Purchase of assets’ and ‘Purchase of shares’ for discussion of certain tax-free reorganizations.

Hybrid instruments and entities

Instruments (or transactions) may be treated as indebtedness (or a financing transaction) of the US issuer, while receiving equity treatment under the local (foreign) laws of the counterparty. This differing treatment may result in an interest deduction for the US party while the foreign party benefits from the participation exemption or FTCs that reduce its taxes under local law. Alternatively, an instrument could be treated as equity for US tax purposes and as debt for foreign tax purposes.

Similarly, an entity may be treated as a corporation for US tax purposes and a transparent entity for foreign tax purposes (or vice versa).

Under certain circumstances, this differing treatment can give rise to ‘stateless income’ (income that is taxed nowhere).

Certain provisions of the 2017 Tax Law seek to discourage use of hybrid entities and instruments that give rise to stateless income. Specifically, the 2017 Tax Law contains a ‘hybrid mismatch rule’ that generally disallows deductions for related-party interest or royalties paid or accrued in connection with certain hybrid transactions or by, or to, hybrid entities if (i) the related party does not have a corresponding income inclusion under local tax law, or (ii) such related party is allowed a deduction with respect to the payment under local tax law. This provision, which incorporates the concepts of the OECD BEPS Action 2, generally applies to tax years beginning after 31 December 2017, but with a 1-year delay for purposes of the ‘imported mismatch’ rules.

For purposes of this hybrid mismatch rule, a hybrid transaction includes any transaction or instrument under which one or more payments are treated as interest or royalties for US federal income tax purposes but are not treated as such under the local tax law of the recipient. A hybrid entity is one that is treated as fiscally transparent for US federal income tax purposes (e.g. a disregarded entity or partnership) but not for purposes of the foreign country of which the entity is resident or is subject to tax (hybrid entity), or an entity that is treated as fiscally transparent for foreign tax law purposes but not for US federal income tax purposes (reverse hybrid entity). Treasury issued regulations under the hybrid mismatch rule, which would broaden the reach of the hybrid mismatch rule to encompass reverse hybrids and branch payments and, at the same time, requires a link between hybridity and the deduction/non-inclusion outcome. The regulations also apply the hybrid mismatch concept to ‘imported mismatches’ where the US taxpayer makes a non-hybrid deductible payment to a foreign affiliate that is connected to a hybrid mismatch between the foreign payee and some other foreign party. Finally, the regulations implementing the hybrid mismatch rule also modified the ‘check-the-box’ regulations for US domestic reverse hybrids to treat such entities as having consented to be treated as dual resident corporations under the dual consolidated loss rules (further details in ‘Dual residency’ section below), thereby addressing a long-standing gap in those rules.

In practical terms, the hybrid mismatch rule eliminates the US tax benefits of some hybrid structures that foreign multinationals have commonly used in the past to finance US operations. Foreign multinationals should consider revisiting their US inbound financing structures in view of the new rule and also consider this rule when determining the acquisition funding structure for US target companies.

Buyers of US target companies should also carefully consider the OECD BEPS recommendations concerning hybrids during the tax due diligence phase and before implementing any structures concerning acquisition finance planning and/or acquisition integration planning. Where hybrid instruments and entities are concerned, many jurisdictions have already implemented some of the OECD’s BEPS recommendations (and at the EU level, under the ATAD 1 and ATAD 2 initiatives) that undo some of the tax benefits of hybrid structures commonly implemented by US multinationals. It is important to keep this in mind when acquiring a US multinational that has significant operations in such jurisdictions.

In addition to the new hybrid mismatch rule, the 2017 Tax Law also precludes CFC hybrid dividends from qualifying for the DRD. The 2017 Tax Law broadly defines the term ‘hybrid dividend’ to mean a payment for which a CFC receives a deduction or other tax benefit in a foreign country. The 2017 Tax Law generally treats hybrid dividends between tiered CFCs as subpart F income. Despite this subpart F income treatment, the 2017 Tax Law does not allow utilization of FTCs resulting from hybrid dividends. Under the issued regulations, US shareholders are required to maintain a hybrid deduction account to track foreign deductions (arising after 2017) with respect to the CFC’s hybrid equity, and the CFC’s otherwise DRD-eligible earnings are rendered ineligible by an amount corresponding to the foreign deductions. The hybrid deduction account is a tax attribute associated with the CFC stock that can be succeeded to by acquirers of the CFC stock in certain transactions.

Discounted securities

A US issuer may issue debt instruments at a discount to increase the demand for its debt instruments. The issuer and the holder are required currently to accrue deductions and income for the original issue discount (OID) accruing over the term. However, a US issuer may not deduct OID on a debt instrument held by a related foreign person unless the issuer actually paid the OID.

A corporate issuer’s deduction for the accrued OID may be limited (or even disallowed) where the debt instrument is treated as an applicable high yield discount obligation (AHYDO). In that case, the deduction is permanently disallowed for some or all of the OID if the yield on the instrument exceeds the applicable federal rate (for the month of issuance) plus 600 basis points. Any remaining OID is only deductible when paid.

Deferred settlement

In certain acquisitions, the parties may agree that the payment of a part of the purchase price should be made conditional on the target meeting pre-established financial performance goals after the closing (earn-out). Where the goals are not met, the buyer can be relieved of some or all of its payment obligations. An earn-out may be treated as either the payment of the contingent purchase price or ordinary employee compensation (where the seller is also an employee of the business). Buyers generally prefer to treat the earn-out as compensation for services, so they can deduct such payments from income.

In an asset acquisition, the buyer may capitalize the earn-out payment into the assets acquired but only in the year such earn-out amounts are actually paid. Such capitalized earn-out amounts should be depreciated/amortized over the remaining depreciable/amortizable life of the applicable assets. In a stock acquisition, the earn-out generally adds to the buyer’s basis in the target stock. Interest may be imputed on deferred earn-out payments unless the agreement specifically provides for interest.

Other considerations


Documentation of each step in the transaction and the potential tax consequences is recommended. Taxpayers generally are bound by the form they choose for a transaction, which may have material tax consequences. However, the government may challenge the characterization of a transaction on the basis that it does not reflect its substance. Thus, once parties have agreed on the form of a transaction, they are well advised to document the intent, including the applicable Code sections. Parties should also maintain documentation of negotiations and appraisals for purposes of allocating the purchase price among assets.

Contemporaneous documentation of the nature of transaction costs should also be obtained.

Although the parties to a transaction generally cannot dictate the tax results through the contract, documentation of the parties’ intent can be helpful should the IRS challenge the characterization of the transaction.

Concerns of the seller

Generally, the seller’s tax position influences the structure of the transaction. The seller may prefer to receive a portion of the value of the target in the form of a pre-sale dividend for ordinary income treatment or to take advantage of DRDs. A sale of target stock generally results in a capital gain, except in certain related-party transactions (see ‘Purchase of shares’ section) or on certain sales of shares of a CFC. In addition, a foreign seller of a USRPHC may be subject to tax and withholding based on FIRPTA, as discussed in the ‘Foreign parent company’ section.

A sale of assets could also result in capital gains treatment except for depreciation recapture, which may have ordinary income treatment. Where the seller has no tax attributes to absorb the gain from asset sales, gains may be deferred where the transaction qualifies as a like-kind exchange, in which the seller exchanges property for like-kind replacement property (e.g. exchange of real estate). As previously mentioned, it seems likely that the seller of a US target company may be more willing to sell assets than before due to the US corporate tax rate reduction and 100 percent expensing for qualifying purchases of depreciable tangible property. Under the 2017 Tax Law, a C corporation that sells an asset and reinvests the proceeds into qualifying depreciable tangible property receives a cash tax benefit due to acceleration of deductions.

Alternatively, the transaction may be structured as a tax-free separation of two or more existing active trades or businesses formerly operated, directly or indirectly, by a single corporation for the preceding 5 years (spin-off). Stringent requirements must be satisfied for the separation to be treated as a tax-free spin-off.

Company accounting[2]

This discussion is a high-level summary of certain accounting considerations associated with business combinations and non-controlling interests.

Accounting Standards Codification (ASC) Topic 805, Business Combinations (ASC 805) and ASC Subtopic 810-10, Consolidations — Overall (ASC 810-10) require most identifiable assets acquired, liabilities assumed and non-controlling interest in the acquiree to be recorded at ‘fair value’ in a business combination and require non-controlling interests to be reported as a component of equity.

ASC 805-10-20 defines a ‘business combination’ as a transaction or other event in which an entity (the acquirer) obtains control of one or more businesses (the acquiree or acquirees). A business combination may occur even where control is not obtained by purchasing equity interests or net assets, as in the case of control obtained by contract alone. This can occur, for example, when a minority shareholder’s substantive participating rights expire and the investor holding the majority voting interest gains control of the investee.

ASC 805-10-55-3A defines a business as an integrated set of activities and assets that is capable of being conducted and managed to provide a return in the form of dividends, lower costs, or other economic benefit directly to investors or other owners, members or participants.

Under ASC 805-10-55-5, an integrated set of activities and assets (set) is a business if it has, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. ASC 805-10-55-5A also has an initial screening test that reduces the population of transactions that an entity needs to analyze to determine whether there is an input and a substantive process in the set.

Business combinations are accounted for by applying the acquisition method. Companies applying this method:

  • identify the acquirer
  • determine the acquisition date and acquisition-date fair value of the consideration transferred, including contingent consideration
  • recognize, at their acquisition-date fair values (with limited exceptions), the identifiable assets acquired, liabilities assumed and any non-controlling interests in the acquiree
  • recognize goodwill or, in the case of a bargain purchase, a gain.

ASC 805 allows for a measurement period for the acquirer to obtain the information necessary to enable it to complete the accounting for a business combination. Until necessary information can be obtained, and for no longer than 1 year after the acquisition date, the acquirer reports provisional amounts for the assets, liabilities, equity interests or items of consideration for which the accounting is incomplete.

A company that obtains control but acquires less than 100 percent of an acquiree records 100 percent of the acquiree’s assets (including goodwill), liabilities and non-controlling interests, measured at fair value with few exceptions, at the acquisition date.

ASC 810-10 specifies that non-controlling interests are treated as a separate component of equity, not as a liability or other item outside of equity. Because non-controlling interests are an element of equity, increases and decreases in the parent’s ownership interest that leave control intact are accounted for as equity transactions (i.e. as increases or decreases in ownership) rather than as step acquisitions or dilution gains or losses.

When there is a change in the parent’s ownership interest but control is retained, the carrying amount of the non-controlling interests is adjusted to reflect the change in ownership interests. Any difference between (i) the fair value of the consideration received or paid and (ii) the amount by which the non-controlling interest is adjusted is recognized directly in equity attributable to the parent (i.e. additional paid-in capital).

A transaction that results in the loss of control generates a gain or loss comprising a realized portion related to the portion sold and an unrealized portion on the retained non-controlling interest, if any, that is re-measured to fair value. Similarly, a transaction that results in obtaining control could result in a gain or loss on previously held equity interests in the investee since the acquirer would account for the transaction by applying the acquisition method on that date.

Group relief/consolidation

Affiliated US corporations may elect to file consolidated federal income tax returns as members of a consolidated group.

Generally, an affiliated group consists of chains of 80 percent-owned (by vote and value) corporate subsidiaries (members) having a common parent that owns such chains directly or indirectly.

The profits of one member may be offset against the current losses of another member. In most cases, gains or losses from transactions between members are deferred until the participants cease to be members of the consolidated group or otherwise cease to exist. Complex rules may limit the use of losses arising from the sale of stock of a member to unrelated third parties (i.e. unified loss rules).

Transfer pricing

Following an acquisition of a target, all transactions between the buyer and the target must be consistent with arm’s length standards. If related parties fail to conduct transactions at arm’s length, the IRS may reallocate gross income, credits, deductions or allowances between the participants to prevent tax avoidance or to reflect income arising from such transactions. Such transactions may include loans, sales of goods, leases or licenses. Contemporaneous documentation must be maintained to support intercompany transfer pricing policies.

Net investment income tax

Section 1411 imposes a 3.8 percent tax on net investment income (NII) of individuals, estates and trusts with gross income above a specified threshold. The NII tax does not apply to S corporations and partnerships (but may apply to their owners), C corporations, non-resident aliens, foreign trusts and estates, grantor trusts, tax-exempt trusts (e.g. charitable trusts), and certain other types of trusts and funds (e.g. REITs, electing Alaska native settlement trusts, and common trust funds).

In the case of an individual, the NII tax is applied to the lesser of the NII or the modified adjusted gross income in excess of the threshold amounts as follows:

US table 2

Source: Code section 1411(b)

NII includes three major categories of income:

  1. income from passive trades or businesses and from the business of trading financial instruments and commodities
  2. interest, dividend, annuities, royalties and rents (unless derived in the ordinary course of a trade or business not listed in category 1 above)
  3. net gains from the disposition of property other than property held in a trade or business not listed in category 1 above.

The 2017 Tax Law left the 3.8 percent NII tax in place.

Dual residency

Generally, the NOLs of a dual resident corporation (DRC) and a net loss attributable to a separate unit cannot be used to offset the taxable income of a US affiliate or the domestic corporation that owns the separate unit. Any such loss is a dual consolidated loss (DCL) subject to Treasury regulations under section 1.1503(d)-1 through 8.

A DRC is a domestic corporation subject to income tax in a foreign country on a worldwide income basis or as a resident of the foreign country. A separate unit is a foreign branch or a hybrid entity (i.e. an entity not subject to tax in the US but subject to tax in a foreign country at the entity level) that is either directly owned by a domestic corporation or indirectly owned by a domestic corporation through a partnership, trust or disregarded entity.

Limited use of a DCL may be possible where the consolidated group or domestic corporation (in the case of a standalone domestic corporation) files a special election that ensures that amounts deducted in computing the DCL will not be used to offset the income of a foreign person. As discussed above in the ‘Hybrid instruments and entities’ section, in order to address the double-deduction structures, proposed regulation under the new hybrid mismatch rule treats US domestic reverse hybrids as DRCs subject to DCL rules, i.e., entities electing corporate status under the ‘check-the-box’ regulations are deemed to be DRCs.

Foreign investments of a US target company

Often, a US target owns shares of one or more foreign corporations. As discussed above, the 2017 Tax Law made fundamental changes to the taxation of US multinationals and their foreign subsidiaries. Under the old law, the earnings of foreign subsidiaries generally were not subject to US income tax until the earnings were repatriated through dividend distributions (a ‘deferral’ system). Foreign subsidiary earnings generally were subject to immediate US taxation only if the earnings were subject to the US subpart F CFC rules.

Under the 2017 Tax Law, the earnings of foreign subsidiaries are either subject to immediate taxation under an expanded CFC regime or permanently exempt from US taxation. The 2017 Tax Law generally retained the existing subpart F CFC regime, but added onto it a new, broad class of income, GILTI, that is also subject to immediate taxation. Under a new participation exemption system, earnings of foreign subsidiaries that are not subject to tax under the subpart F or GILTI regimes generally are exempt from US tax when distributed to a corporate US shareholder as a dividend. In many cases, however, most foreign subsidiary earnings will be subject to tax either as subpart F income or GILTI.

Foreign buyers of US companies should carefully consider the subpart F and GILTI rules when undertaking acquisition integration planning for US targets that have foreign subsidiaries. As indicated above, when applicable, the subpart F rules accelerate US taxation of certain income (subpart F income) earned by a CFC. For purposes of the subpart F rules, a CFC is any foreign corporation more than 50 percent of whose stock (by vote or value) is owned by US shareholders (as defined below) on any day during the taxable year of the foreign corporation. Subpart F income generally includes passive income (e.g. dividends, interest, royalties, rents, annuities, and gains from sales of property) and related-party sales and services income. Under the subpart F rules, subpart F income earned by a CFC may be currently included in the income of a US target that is a ‘US shareholder’ of the CFC, even if the CFC has not distributed the income.

The 2017 Tax Law expands the reach of the subpart F rules through the following changes:

  • The 2017 Tax Law changed the constructive ownership rules which among other things could result in a US corporation having subpart F or GILTI inclusion from any member of its multinational group even if the US corporation owns less than 10 percent of a foreign corporation.
  • The 2017 Tax Law expanded the ‘US shareholder’ definition to include US persons that own directly, indirectly or constructively stock representing 10 percent or more of the ‘value’ or voting power of a foreign corporation. The test for ‘US Shareholder’ status previously was based solely on ownership of ‘voting power’. This expanded definition of ‘US shareholder’ applies for taxable years of foreign corporations that begin after 31 December 2017.

As indicated above, the 2017 Tax Law introduced a new anti- deferral regime that requires a US shareholder of a CFC to include its GILTI in income. Most foreign subsidiary earnings that had been eligible for deferral under the old law are now subject to immediate US income taxation under the new GILTI provision. Corporate shareholders are allowed a deduction equal to 50 percent of GILTI for 2018 through 2025, which will be decreased to 37.5 percent for tax years beginning in 2026. As a result, the effective tax rate on GILTI for a US corporate shareholder is 10.5 percent prior to 2026, and 13.125 percent after 2026.

A US corporation’s GILTI deduction, however, may be limited when its GILTI and foreign-derived intangible income amounts (discussed below) exceed the corporation’s taxable income.

In general, GILTI is the excess of all of the US corporation’s net income over a deemed return on the CFC’s tangible assets used to generate income (10 percent of depreciable tax basis). In many situations, most of a CFC’s gross income that is not subject to current taxation under the existing subpart F regime will be subject to immediate taxation as GILTI. The generally small sliver of income represented by the permitted return on tangible assets is not subject to US taxation when earned by the foreign subsidiary and, as discussed above, is eligible for a 100 percent dividends received deduction (DRD). A credit is also allowed for 80 percent of foreign taxes paid.

Although lowering the US statutory rate from 35 percent to 21 percent presumably reduces incentives to shift profits outside the US, the GILTI provision reflects a concern that a shift to a territorial tax system could exacerbate those incentives because any profits shifted offshore would be permanently exempt from US tax. The inclusion of GILTI in a US shareholder’s income is intended to reduce those incentives by ensuring at least a minimal rate of tax on those earnings of CFCs that exceed the permitted return on tangible assets.

The foreign earnings of a CFC that are not subject to tax under the subpart F or GILTI regimes generally are exempt from US taxation. Under the 2017 Tax Law’s participation exemption regime, a US target corporation is allowed a 100 percent DRD on dividends received from a foreign subsidiary, subject to certain conditions being met. As a general matter, the 100 percent DRD is only available to US C corporations and is limited to the foreign-source portion of dividends received from a foreign corporation in which the US corporation is a US shareholder (i.e. the US corporation owns 10 percent or more of the vote or value of the foreign corporation’s stock).

In addition to the subpart F and GILTI regimes, the US tax code also contains anti-deferral rules that govern passive foreign investment companies (the so-called ‘PFIC’ regime). A US target may be subject to taxation and interest charges resulting from owning stock in a PFIC. A PFIC is any foreign corporation (that is not a CFC) that satisfies either of the following income or asset tests:

  • at least 75 percent of its gross income for the taxable year consists of certain passive income
  • at least 50 percent of the average percentage of assets consists of assets that produce certain passive income.

A US target owning PFIC stock is subject to a tax and interest charge on gains from the disposal of PFIC stock or receipt of an excess distribution from a PFIC. To avoid the PFIC tax regime, the US target may elect to treat the foreign corporation as a qualified electing fund (QEF election), with the US target being currently taxed on the QEF’s earnings and capital gain, or may elect to recognize the built-in gain in the PFIC stock under a mark-to-market election.

During the acquisition planning phase, foreign buyers of US multinationals should consider whether it may be beneficial for the US target company to undertake pre-acquisition restructurings or to separately acquire the foreign subsidiaries of the US target so that those subsidiaries are ultimately owned outside of the US chain. Any pre-acquisition restructuring will require the cooperation of the seller. Failure to timely reorganize such a ‘sandwich structure’ can indirectly expose the foreign buyer to additional US taxes (and, therefore, a higher global effective tax rate) due to application of the subpart F, GILTI and/or PFIC rules. If pre-acquisition planning is not possible, then the foreign buyer should consider whether it is feasible to transfer foreign subsidiaries of a US target as part of its overall post-acquisition integration planning initiative.

Integration planning for US target-owned intellectual property

Acquisition integration planning often includes identifying alternatives for the tax-efficient transfer of target company IP to the buyer’s existing IP holding company structure. Following the 2017 Tax Law and other recent changes to the US Treasury regulations, a US corporation will be subject to US taxation on any transfer of IP to a foreign corporation.

This includes a transfer of goodwill, going-concern value or workforce in place.[3] The 2017 Tax Law also contains provisions that are either intended to reduce the incentives for a company to reduce its US tax base (e.g. the GILTI and BEAT provisions, as discussed in this report) or to encourage IP shifts into the US (e.g. the so-called FDII regime). As a complement to the new GILTI regime that imposes a minimum tax on excess returns earned by a CFC, the 2017 Tax Law provides a 13.125 percent effective tax rate (increasing to 16.406 percent in 2026) on FDII earned directly by a US corporation from foreign sales, leases, licenses and services to unrelated foreign persons. Presumably, the goal of the FDII provision is to provide an incentive for US companies to locate productive assets in the US, rather than offshore.

As in the GILTI regime, the reduced effective tax rates for FDII are achieved through a special deduction by the US corporation. At a high level, a US corporation’s FDII is its net income from export activities reduced by a fixed 10 percent return on its depreciable assets used to generate the export income. A US corporation’s FDII deduction may be limited, however, when its GILTI and FDII amounts exceed the corporation’s taxable income.

Together with the reduced US corporate tax rate of 21 percent and the GILTI regime, the FDII regime generally makes the US, as compared to before, a more attractive option for the establishment of an export base and may reduce the incentives for US companies to transfer or keep IP offshore. The table below summarizes the impact of the GILTI and FDII provisions on US effective tax rates. The effective tax rates noted in this table take into account the post-2017 Tax Law US corporate tax rate of 21 percent and, in the case of the effective tax rate noted for GILTI, an 80 percent foreign tax credit. The rates also rely on several assumptions that may not be true in many cases. For example, these rates assume that the US taxpayer in question has sufficient income to take the full GILTI deduction which may not be true due to current year losses or NOL carryforwards. Back in January 2018, several European countries have expressed their intentions to challenge the FDII regime. Representatives from these countries claim that the FDII regime is not in line with the international norms on patent boxes and violates international trade rules on export subsidies.[2] As of January 2021, the long-term viability of the FDII regime appears uncertain.

Before the 2017 Tax Law was enacted, the Treasury and IRS issued in September 2015 temporary regulations (T.D. 9738) under section 482 (the ‘US transfer pricing rules’) and, by cross-reference, new proposed regulations under section 367. These proposed regulations sought to significantly limit the application of the foreign goodwill exception. The 2017 Tax Law contains provisions that carry out the intent of these proposed regulations.

US table 3

As previously noted, the 2017 Tax Law eliminated the so-called goodwill exception that many companies previously relied upon to tax-efficiently integrate target company IP with a buyer’s existing IP holding company structure. To effect this change, the 2017 Tax Law broadened the definition of ‘intangible property’ to include among other things: 

  • any goodwill, going-concern value or workforce in place (including its composition and terms and conditions [contractual or otherwise] of its employment)
  • any other item the value or potential value of which is not attributable to tangible property or the services of any individual.

This broader definition of intangible property, which is in line with the OECD’s definition of intangibles, is intended to prevent the use of intangible property transfers to shift income between related parties. More specifically, the change was intended to make it more difficult for a US person to transfer intangible property to a foreign affiliate without incurring tax.

Finally, in addition to the provisions discussed above, it is important that foreign buyers of US target companies consider the 2017 Tax Law’s hybrid mismatch rule and BEAT provision before implementing any transfers of IP owned by a US target company or its subsidiaries. As previously mentioned, the hybrid mismatch rule generally disallows deductions for related-party interest or royalties paid or accrued in connection with certain hybrid transactions or by, or to, hybrid entities if (i) the related party does not have a corresponding income inclusion under local tax law, or (ii) such related party is allowed a deduction with respect to the payment under local tax law. For additional details regarding the hybrid mismatch rule, see ‘Hybrid instruments and entities’ section.

Very generally, the BEAT is an additional tax that applies to large corporations that reduce their US tax liabilities below a certain threshold by making deductible payments (e.g. interest and royalties) to related foreign entities. If applicable, a US corporation will have a BEAT liability in addition to its regular income tax liability.

The BEAT generally applies to corporations that are not S corporations, Regulated Investment Companies (RICs) or Real Estate Interment Trusts (REITs), are part of a group with at least USD500 million of annual domestic gross receipts (over a 3-year averaging period), and that have a ‘base erosion percentage’ of 3 percent or higher (2 percent for certain banks and securities dealers). The base erosion percentage generally is determined by dividing deductions attributable to payments to related foreign persons by the total amount of the corporation’s deductions for the year.

Corporations that meet the USD500 million gross receipts test and the base erosion percentage are required to run a separate set of calculations to determine whether they are subject to a BEAT liability. The BEAT regime generally requires a taxpayer to recompute its taxable income as if it had not benefited from any base erosion payments and then multiplies that ‘modified taxable income’ amount by the applicable BEAT tax rate. The taxpayer generally will have a BEAT liability to the extent that amount exceeds the taxpayer’s post-credit regular tax liability (the BEAT rules provide preferential treatment for four types of tax credits).

The BEAT tax rate generally is 5 percent for 2018, 10 percent for 2019–2025 and 12.5 percent after 2025. The BEAT rate is 1 percent higher for banks and registered securities dealers.

Due to the post-2017 Tax Law BEAT regime, many foreign multinationals that receive substantial royalty, interest or service payments from US subsidiaries could have seen an increase in their effective tax rate. Companies subject to the BEAT may need to consider supply chain restructuring if the BEAT gives rise to an unmanageable cost that detrimentally impacts the company’s competitiveness. For some companies, such restructuring to address BEAT exposures may include, for example, converting a service fee procurement company structure into a buy-sell structure and/or transferring customer contracts to foreign subsidiaries. The restructuring options chosen will depend on each taxpayer’s particular facts, circumstances and operational goals. During the tax due diligence phase, foreign buyers of US target companies should consider the extent to which a target company’s intercompany transactions are subject to the BEAT regime. Unlike the GILTI regime, the BEAT applies to all US taxpayers that satisfy the USD500 million threshold test regardless of whether part of a US or non-US group.

Considerations from an OECD BEPS initiative perspective

It is important that foreign buyers of US companies consider not only the 2017 Tax Law developments but also global BEPS developments when planning the acquisition of a US company. Very generally speaking, the BEPS project was driven by a sense that the existing international tax framework was inadequate to address perceived abuses by multinational enterprises (MNEs). By establishing a set of coordinated cross-border taxing standards, the OECD believes that it can eliminate some of the existing opportunities for tax arbitrage, in order to better match the location and taxation of profits with the location of an enterprise’s economic value drivers. To this end, in October 2015, the OECD released a set of reports articulating 15 actions that would help achieve these objectives.

Consideration of country-specific BEPS developments is especially important when completing tax due diligence reviews, defining tax indemnities and undertaking acquisition integration planning. As of January, 2021, the US has implemented some but not all of the OECD BEPS recommendations. Even if the US implements no additional OECD BEPS recommendations in the future, it is important that foreign buyers of US companies consider BEPS-related issues when planning the acquisition of a US company due to the following reasons:

  • US companies often have foreign subsidiaries located in jurisdictions that have already implemented some or all of the OECD’s BEPS recommendations
  • implementation of the OECD’s BEPS recommendations by other countries can impact the tax cost of financing the acquisition of US target companies and value chain operational changes.

From a tax due diligence perspective, areas of key focus that may raise BEPS concerns include, for example, consideration of whether the US target company has any structures in place that include hybrid entities (e.g. an entity that is treated as a corporation for US tax purposes but as a disregarded entity for foreign tax purposes), hybrid instruments (e.g. an instrument that is treated as debt in the payor jurisdiction and equity in the recipient jurisdiction), hybrid transfers (e.g. a repo transaction treated as a secured financing in one jurisdiction and as a sale and repurchase in another), principal companies, limited risk distributors, commissionaires, and IP license and/or cost sharing arrangements.

Once BEPS exposures are identified, it is important for both the acquiring company and target company to determine a course of action. One possible approach may be for the seller of the target company to give the acquiring company a purchase price reduction in anticipation that the buyer will incur future ‘BEPS unwind costs.’ Alternatively, another approach may involve the target company addressing the BEPS exposures through pre-acquisition structuring. As a general matter, buyers should consider any BEPS exposures specific to both the target and acquiring companies’ structures during the acquisition integration planning phase.

As previously discussed, various provisions of the 2017 Tax Law (e.g. the new hybrid mismatch rule and revised transfer pricing guidelines) incorporate certain OECD BEPS recommendations. Also noteworthy, the updated US model income tax treaty released in 2016 (the 2016 Model Treaty) includes some BEPS-like provisions. For example, the 2016 Model Treaty includes provisions that would deny treaty benefits on deductible payments of mobile income made to related persons where that income benefits from low or no taxation under a preferential tax regime.

Global tax transparency is a cornerstone of the BEPS project. Accordingly, in addition to taking into account costs of maintaining or unwinding certain structures or transactions that have been affected by BEPS developments, buyers should also consider BEPS-related compliance burdens.

With the push for global transparency, buyers should also brace themselves for more BEPS-related controversy, particularly with respect to intangible property and permanent establishments. This is especially true with respect to emerging and developing markets, where taxpayers may not have previously encountered issues in the past.

Foreign Account Tax Compliance Act

The Foreign Account Tax Compliance Act (FATCA) was enacted into law to address tax evasion by US taxpayers that hold unreported assets in non-US financial accounts and undisclosed interests in foreign entities. Generally, FATCA affects three groups:

  1. foreign financial institutions (FFI)
  2. non-financial foreign entities (NFFE)
  3. withholding agents.

FFIs are required to identify their US account holders, obtain and track those account holders’ tax information, and report it annually to the IRS (or to local authorities for FFIs operating in jurisdictions that have signed a Model 1 Intergovernmental Agreement). NFFEs are generally required to identify and disclose their substantial US owners, unless they qualify for an exception (e.g. where the NFFE is an ‘Active NFFE’).

FATCA applies a 30 percent tax (effectively a penalty) that is enforced by withholding agents, who must generally withhold 30 percent from certain payments of US-source fixed, determinable, annual or periodical income (FDAP) made to non-compliant entities.

The 30 percent withholding tax may be eliminated in several ways. The simplest way is for the payee to be a type of entity that is not subject to withholding and for such payee to provide a properly completed withholding certification (e.g. Form W-8BEN-E, Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)), to the withholding agent identifying itself as an FATCA compliant entity (e.g. a participating FFI or active NFFE).

FATCA exempts certain payments from withholding (e.g. so-called ‘non-financial payments’). In this case, the withholding agent must independently determine whether the payment otherwise subject to withholding qualifies for an exception.

Because the 30 percent withholding under FATCA is not a substantive tax, the withholding agent is the only one liable if it fails to properly withhold.

The payment of US-source FDAP to a non-US person must be reported on Form 1042-S, Foreign Person’s US Source Income Subject to Withholding, and Form 1042, Annual Withholding Tax Return for US Source Income of Foreign Persons

Comparison of asset and share purchases

Advantages of asset purchases

  • The purchase price may be depreciated or amortized for tax purposes. Also, if certain conditions are met, the 2017 Tax Law allows a 100 percent deduction for the cost of qualified property (generally tangible depreciable property with a depreciation life of less than 20 years) acquired from unrelated persons and placed in service after 27 September 2017, and before 1 January 2023. The 2017 Tax Law includes a 20 percent increment phase-down of the ‘bonus’ depreciation percentage for property acquired after 2022.[6]
  • Previous liabilities (including income tax liabilities) of the target generally are not inherited.
  • Possible to acquire only part of a business.
  • Profitable operations can be absorbed by loss companies in the buyer’s group, thereby effectively gaining the ability to use the losses, subject to any applicable limitations.

Disadvantages of asset purchases

  • May need to renegotiate supply, employment and technology agreements, and change stationery, secure releases from bank liens, retitle assets, etc.
  • A higher capital outlay is usually involved (unless debts of the business are also assumed).
  • May be unattractive to the seller, thereby increasing the price.
  • The transaction may be subject to state and local transfer taxes.
  • Benefit of any losses incurred by the target remains with the seller.

Advantages of share purchases

  • Lower capital outlay (purchase net assets only).
  • May be more attractive to seller, so the price could be lower.
  • Buyer may benefit from tax losses of the target (subject to certain limitations).
  • Buyer may benefit from existing supply or technology contracts.

Disadvantages of share purchases

  • Liable for any claims or previous liabilities of the target.
  • No deduction for the purchase price (assuming no section 338 or 336(e) election).
  • Losses incurred by any companies in the buyer’s group in years prior to the acquisition of the target cannot be offset against certain recognized built-in gains recognized by the target.
  • The use of certain tax attributes of the target may be limited after the acquisition.
  • Target may have unwanted assets that can be difficult or expensive to dispose of.

The information in this report is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax advisor.

KPMG in the US

Howard Steinberg
1350 Avenue of the Americas
New York, New York 10019

T: +1 212 872 6562
E: hbsteinberg@kpmg.com

This country document does not include US COVID-19 tax developments. To stay up-to-date on US COVID-19-related tax legislation, refer to the below KPMG link: 

Click here — COVID-19 tax measures and government reliefs

This country document is updated as on
1 January 2021.