On April 8, 2016, the IRS and Treasury took additional action against corporate inversions and issued temporary, proposed, and final regulations targeting: (1) transactions structured to avoid the purposes of IRC Sections 7874 and (2) certain post-inversion tax avoidance transactions. [T.D. 9761 (final and temporary regulations) and 81 FR 20858 and 81 FR 20912 (proposed regulations)].

1. May 2016
Treasury and IRS Continue Action
Against Corporate Inversions: Here’s
What the New Regulations Mean
By Neil Aragones, Esq., LL.M.
On April 8, 2016,the IRS and Treasury took additional action againstcorporate inversions and issued temporary,
proposed,and final regulations targeting:(1) transactions structured to avoid the purposes ofIRC Sections 7874 and (2)
certain post-inversion tax avoidance transactions.[T.D. 9761 (final and temporary regulations) and 81 FR 20858 and 81
FR 20912 (proposed regulations)].
Included in the temporary regulations in T.D. 9761 are prior rules issued in Notices 2014-52 and 2015-79 and earlier
notices,and the temporaryregulations also serve as the text of proposed regulations in 81 FR 20858. Other proposed
regulations in 81 FR 20912 contain guidance not previously issued in the notices. Along with these temporaryand
proposed regulations,the IRS and Treasury also issued final regulations in T.D. 9761 to coordinate the application
of the temporary regulations.
As noted, the temporaryregulations include prior rules issued in the notices thataddress both certain transactions
structured to avoid the purposes ofIRC Sections 7874 and also certain post-inversion taxavoidance transactions. The
temporary regulations also include rules on issues not addressedin the notices. These new rules:
(1) identify a foreign acquiring corporation when a domestic entityacquisition involves multiple steps;
(2) disregard stock ofthe foreign acquiring corporation thatis attributable to certain prior domestic
entity acquisitions;
(3) require a controlled foreign corporation (CFC) to recognize all realized gain upon certain transfers
of assets
described in IRC Section 351 that shift ownership ofthose assets to a related foreign person that is not
a CFC; and
(4) clarify the definition ofgroup income for purposes ofthe substantial business activities test.[See
Preamble,T.D. 9761].
The temporary regulations also include new definitions for terms used throughoutthe regulations.Per the preamble
to T.D. 9671, the applicabilitydates for the rules previouslyissued in Notices 2014-52 and 2015-79 are consistentwith
the previously-announced dates,and the new rules in the temporaryregulations generallyapplyto acquisitions or post-
inversion tax avoidance transactions completed on or after April 4, 2016.
TransactionsStructuredtoAvoidIRC Section7874
The preamble to T.D. 9761 is in two parts,and Part I describes rules for transactions structured to avoid the purposes of

2. IRC Section 7874. The preamble states thatthese rules:
(1) identify domestic entity acquisitions and foreign acquiring corporations in certain multiple-step transactions;
(2) calculate the ownership percentage and,more specifically,disregard certain stock ofthe foreign acquiring
corporation for purposes ofcomputing the denominator ofthe ownership fraction and,in addition,take into
accountcertain non-ordinarycourse distributions (NOCDs) made bya domestic entity for purposes of
computing the numerator ofthe ownership fraction;
(3) determine when certain stock of a foreign acquiring corporation is treated as held by a member ofthe
expanded affiliated group (EAG); and
(4) determine when an EAG has substantial business activities in a relevant foreign country. [Preamble,T.D.
9761].
Multiple-StepAcquisitionRule
The temporaryregulations provide a new Multiple-Step Acquisition Rule,which,as stated in the preamble,treats the
subsequentacquisition as a domestic entityacquisition and the subsequentacquiring corporation as a foreign acquiring
corporation.This rule addresses the Treasury’s and IRS’s concern for certain transactions thattaxpayers may conte nd
are not domestic entityacquisitions butthat are in essence contraryto the purposes ofIRC Section 7874.The preamble
states that as a resultof this rule, the stock of the subsequentacquiring corporation thatis received, pursuantto the
subsequent acquisition,in exchange for stock of the initial acquiring corporation will be treated as stock of the
subsequentacquiring corporation held byreason ofholding stock in the domestic entity. In addition,the preamble
provides that if a foreign corporation,pursuantto the same plan or a series ofrelated transactions,acquires directlyor
indirectly all of the properties held by a subsequentacquiring corporation in a transaction thatoccurs after the
subsequentacquisition,the further acquisition will be treated under the multi-step acquisition rule as a domestic entity
acquisition and the foreign corporation thatmade such acquisition will be treated as a foreign acquiring corporation.
[Preamble,T.D. 9761].
Multiple-DomesticEntityAcquisitionRule
The temporaryregulations also contain a new Multiple-Domestic EntityAcquisition Rule,which addresses the Treasury’s
and IRS’s concern that a single foreign corporation mayacquire multiple domestic entities over a relatively shortperiod
of time to avoid the application ofIRC Section 7874, where Section 7874 would otherwise applyif the acquisitions were
completed atthe same time or as part of a series ofrelated transactions.This new rule is importantbecause in its
absence,a foreign acquiring corporation could increase its value with each “successive domestic entityacquisition” and
therefore enable the foreign acquiring corporation “to complete another,potentiallylarger,domestic entityacquisition to
which section 7874 will notapply.” [Preamble,T.D. 9761].
The new rule affects the calculation of the ownership percentage of the foreign acquiring corporation with respectto
a domestic entityacquisition.For purposes ofmaking the calculation,the rule excludes from the denominator ofthe
ownership fraction the stock of the foreign acquiring corporation attributable to certain prior domestic entityacquisitions.
The multiple-domestic entity acquisition rule employs a 36-month look-back period pursuantto which the foreign
acquiring corporations’ prior domestic entityacquisitions thatoccurred within the 36-month look-back period will be
excluded from the denominator ofthe ownership fraction.By operation ofthe rule, the stock attributable to the prior
domestic entityacquisitions will be disregarded.[Preamble,T.D. 9761].
Non-OrdinaryCourse Distributions(NOCD) Rule
The temporaryregulations contain the rule,promised in Notice 2014-52 and Notice 2015-79,thatwill in effect
disregard certain distributions made by a domestic entity prior to its acquisition by the foreign acquiring
corporation that would otherwise reduce the numerator ofthe ownership fraction.This rule is aimed atpre -inversion
efforts by a domestic entityto avoid the application ofSection 7874 by making certain,non-ordinarycourse contributions
to essentiallyreduce its size. As stated in the preamble:“The NOCD rule is intended to address transactions in which a
taxpayer elects to reduce its size by making distributions outside ofthe ordinary course to shareholders in order to
reduce the amountof foreign acquiring stock that would have to be provided to such shareholders in a subsequent
domestic entityacquisition.The new rule, found in new Temporary Regulations Section 1.7874-10(b),states that... for
purposes ofdetermining the ownership percentage byvalue …. former domestic entity shareholders or former domestic
entity partners,as applicable,are treated as receiving, by reason ofholding stock or partnership interests in a domestic

3. entity, stock of the foreign acquiring corporation with a fair marketvalue equal to the amountof the non-ordinarycourse
distributions (NOCDs),determined as ofthe date of the distributions,made bythe domestic entity during the look-back
period.” The temporaryregulations also include rules for determining the amountofNOCDs and a “predecessor rule”,
pursuantto which a domestic entity “inherits” distributions made bythe domestic entity’s predecessor.[Preamble,T.D.
9761].
Clarificationof “GroupIncome”
The temporaryregulations clarifythe definition of “group income” for purposes ofthe substantial business activities test
for an EAG. As noted in the preamble to T.D. 9761, to have substantial business activities in the relevant foreign country,
25 percent of an EAG’s group employees, group assets,and group income must be located or derived in the
relevant foreign country. The preamble notes that,under Treasury Regulations Section 1.7874-3,generallygroup
income is gross income from transactions occurring in the ordinarycourse of business with unrelated customers.With
respectto group income determined using the EAG’s financial statements,the preamble states thatthe temporary
regulations “clarifythat financial reporting principles are onlyrelevant for determining the amountofitems ofincome that
are taken into account, as an EAG musttake into account all items thatits members recognized for financial accounting
purposes during the testing period.” [Preamble,T.D. 9761].
Post-InversionTax Avoidance Transactions.
Part II of the preamble to T.D. 9671 describes rules thatare aimed atcertain post-inversion tax avoidance transactions.
Among the temporary regulations addressing certain post-inversion tax avoidance transactions notcovered in prior
guidance is the new asset dilution rule, which requires a CFC to recognize all realized gain upon certain transfers of
assets described in Section 351 that shift ownership ofthose assets to a related foreign person that is not a CFC.
AssetDilutionRule
The preamble notes thatwithoutthe assetdilution rule “… the transfer could dilute a United States shareholder’s indirect
interestin the property and,as a result,could allow the United States shareholder to avoid U.S. federal income tax on
realized gain that is not recognized at the time of the transfer.” [Preamble,T.D. 9761]. The preamble states thatthe IRC
Section 367(b) assetdilution rule applies when specified propertyis transferred by an expatriated foreign subsidiaryto a
foreign transferee corporation in an exchange described in IRC Section 351 that occurs within the applicable period.
[Preamble,T.D. 9761]. The preamble states thatunder the assetdilution rule,the expatriated foreign subsidiarymust
recognize all realized gain with respectto the specified propertythat is not otherwise recognized,unless an exception
applies.The rule does notapply to realized loss with respectto the specified property.
The temporaryregulations also provide an exception to the assetdilution rule for transfers to a non-CFC foreign related
persons in which there is only a de minimis shiftofownership ofthe specified property.[Preamble,T.D. 9761].
EarningsStrippings
The goal of the proposed regulations in 81 FR 20912 is to discourage post-inversion,earnings strippings transactions,
which attemptto lower a multinational corporation’s U.S.tax liabilityby using payments ofdeductible interestto its new
foreign parentor one of its foreign affiliates in a tax-friendlier jurisdiction.[See,“Fact Sheet: Treasury Issues Inversion
Regulations and Proposed Earnings Strippings Regulations,” 4/4/2016].
As stated in the Treasury’s Fact Sheet, the proposed regulations curb earnings strippings by:
1. Targeting transactions thatincrease related-partydebt that is not used to finance new investmentin the
U.S.
2. Allowing the IRS on auditto divide a purported debtinstrumentinto partdebt and part stock.
3. Requiring documentation for members oflarge groups to include key information for debt-equity tax analysis.
The proposed regulations in 81 FR 20912 are issued under IRC Section 385, the provision of the Code which allows the
Treasury “to prescribe such regulations as maybe necessaryor appropriate to determine whether an interestin a
corporation is to be treated . . . as stock or indebtedness (or as in part stock and in part indebtedness)”.[IRC § 385(a)].
Under IRC Section 385, the regulations issued bythe Treasury are to “. . . setforth factors which are to be taken into
accountin determining with respectto a particular factual situation whether a debtor-creditor relationship exists or a
corporation-shareholder relationship exists.” [IRC §385(b)]. These recentproposed regulations are the firstregulations
issued under IRC Section 385.

4. As noted in the preamble to the proposed regulations,the Treasury and IRS mentioned in the 2014 and 2015 notices
that they were considering guidance aimed at“strategies thatavoid U.S. tax on U.S. operations by shifting or ‘stripping’
U.S.-source earnings to lower-taxjurisdictions,including through inter-companydebt”,and these proposed regulations
follow through on that consideration.[Preamble,81 FR 20912].Although the proposed regulations in 81 FR 20912 were
issued atthe same time as the proposed,final,and temporaryregulations issued specificallywith respectto corporate
inversions,the proposed regulations pointoutthat they also applyto excessive debtbetween two domestic entities.The
preamble to 81 FR 20912 states thatthe proposed regulations under IRC Section 385 apply to “purported indebtedness
issued to certain related parties,withoutregard to whether the parties are domestic or foreign.” [Preamble,81 FR 20912].
SubstantiationandTreatmentof Related-PartyInterestasStock
The key provisions ofthe proposed regulations address:(1) the requirements taxpayers mustmeetto substantiate the
treatmentof related-party interestas debt for federal tax purposes,and (2) the circumstances under which the IRS can
treat the related-party interestas stock, in whole or in part, rather than debt for federal tax purposes.
The preamble to 81 FR 20912 states thatthe proposed regulations provide guidance on the substantiation bya taxpayer
of the treatmentof:
(1) certain interests issued between related parties as indebtedness for federal tax purposes,
(2) certain interests in a corporation as in part indebtedness and in partstock,and
(3) distributions ofdebtinstruments and similar transactions thatfrequently have only limited non-tax effects.
[Preamble,81 FR 20912].
DefinitionsandOperatingRules
Definitions for purposes ofthe proposed regulations are provided in Proposed Regulations Section 1.385 -1.The
definitions are for the terms controlled partnership, disregarded entity,expanded group,modified controlled partnership,
and modified expanded group.Section 1.385-1 of the proposed regulations also provides operating rules pertaining to
the treatmentof certain directand indirectinterests in corporations as stock or debtfor federal tax purposes,including
rules regarding the treatmentof a deemed exchange and the treatmentof an expanded group instrumentas partdebt
and part stock after an analysis by the Commissioner.
SubstantiationforDebt-EquityAnalysisbyCommissioner
Section 1.385-2 of the proposed regulations provides certain threshold preparation and maintenance requirements thata
taxpayer mustsatisfywith respectto documentation and information in order to substantiate the treatmentof an interest
between members ofan expanded group as debt for federal tax purposes.Per Proposed Regulations Section 1.385 -2,
the purpose for the requirements is to enable the Commissioner to make an “analysis” as to whether an expanded group
instrumentis “appropriatelytreated as stock or indebtedness for federal tax purposes.” [Prop.Treas. Reg.§ 1.385-
2(a)(1)]. Also, per Section 1.385-2 of the proposed regulations,meeting the threshold requirements is onlythe beginning
of the analysis.Section 1.385-2 states:“Satisfying the requirements ofthis section does notestablish thatan interestis
indebtedness;such satisfaction serves as a minimum standard thatenables this determination to be made under general
federal tax principles.” [Prop.Treas. Reg.§ 1.385-2(a)(1)].
Proposed Regulations Section 1.385-2 provides thatnothing in the section prevents the Commissioner from making a
substance over form assertion with respectto a transaction involving an EGI or the EGI itself,from disregarding the
transaction or the EGI, or from treating the transaction or EGI according to its substance for federal tax purposes.
Section 1.385-2 of the proposed regulations further provides thata determination ofthe federal tax treatmentof the EGI
can only be made after the threshold requirements are metand thatafter that point, the Commissioner mayanalyze “the
documentation and information prepared and maintained,other facts and circumstances relating to the EGI, and general
federal tax principles”.[Prop.Treas. Reg. § 1.385-2(a)(1)].Proposed Regulations Section 1.385-2 states that:“If the
requirements of[Section 1.385-2] are not satisfied with respectto an EGI the substance ofwhich is regarded for federal
tax purposes,the EGI will be treated as stock.” [Prop. Treas.Reg. § 1.385-2(a)(1)].

5. Stock TreatmentforCertainInterestsOtherwise TreatedasDebt
Under Section 1.385-3 of the proposed regulations,certain interests in a corporation thatare held by a member ofthe
corporation’s expanded group and thatotherwise would be treated as debtfor federal tax purposes can be treated as
stock. [Prop. Reg. § 1.385-3(a)].Section 1.385-3 of the proposed regulations provides several rules to determine
whether such interests can be treated as stock rather than purported debt and also several examples illustrating the
application ofthe rules.Proposed Regulations Section 1.385-3 sets forth scenarios when a debtinstrumentwill be
treated as stock under the section and states that if a debt instrumentis treated as stock under the section,the debt
instrumentwill be treated as stock for all federal tax purposes.[Prop.Reg.§ 138-3(b)].
Under the general rule of Section 1.385-3 of the proposed regulations,a debtinstrumentgenerallywill be treated as
stock to the extent the debtinstrumentis issued bya corporation to a member ofthe corporation’s expanded group in:
(1) a distribution,
(2) an exchange for expanded group stock,other than in exchange that is exempt, or
(3) to a certain extent, an exchange for property in an assetreorganization.[Prop.Treas. Reg. § 1.385-3(b)(2)].
In the case of an exchange for property in an assetreorganization,the debtinstrumentwill be treated as stock only to the
extent that, pursuantto the reorganization plan,“a shareholder thatis a member ofthe issuer’s expanded group
immediatelybefore the reorganization receives the debt instrumentwith respect to its stock in the transferor corporation.”
[Prop. Treas. Reg.§ 1.385-3(b)(2)(iii)].
Section 1.385-3 of the proposed regulations further provides thatunless an exception applies,a debtinstrumentwill be
treated as stock to the extent it is a “principal purpose debtinstrument”.[Prop.Treas. Reg.§ 1.385-3(b)(3)(i)].The
section states thata “principal purpose debtinstrument” is a debt instrument“issued bya corporation (a “funded
member”) to a member ofthe funded member’s expanded group in exchange for property with a principal purpose of
funding a distribution or acquisition …” described in the section.[Prop. Treas.Reg. § 1.385-3(b)(3)(ii)].
An anti-abuse provision is found in Proposed Regulations Section 1.385-3,which provides thata debt instrument,or an
interestthat is not a debt interestfor purposes ofSection 1.385-3 or Section 1.385-4 of the proposed regulations,will be
treated as stock if it is issued with the principal purpose ofavoiding the application ofSection 1.385 -3 or Section 1.385-4
of the proposed regulations.[Prop.Treas.Reg. § 1.385-3(b)(4)].
As referenced above, there are exceptions to the application ofthe stock treatmentrules of Section 1.385 -3 of the
proposed regulations.Section 1.385-3(c) of the proposed regulations provides the following exceptions:
(1) exception for current year earnings and profits,
(2) threshold exception,and
(3) exception for funded acquisitions ofsubsidiarystock by issuance.[See Prop.Treas. Reg.§ 1.385-3(c)].
Section 1.385-3 of the proposed regulations also provides operating rules for when a debtinstrumentis treated as stock
under Section 1.385-3(b) of the proposed regulations.[See Prop.Treas. Reg.§ 1.385-3(d)]. In addition,Section 1.385-3
of the proposed regulation provides definitions for terms used in the section and also several examples,as mentioned.
[See Prop. Treas.Reg. § 1.385-3(f) and (g)].
ConsolidatedGroups
Special rules on the treatmentof transactions involving consolidated groups are provided in Section 1.385-4 of the
proposed regulations.Section 1.385-4 states thatit provides rules for applying Section 1.385-3 to consolidated groups
when an interestceases to be a consolidated group debtinstrumentor when an interestbecomes a consolidated group
debt instrument.[Prop. Treas.Reg. § 1.385-4(a)].Section 1.385-4 of the proposed regulations states thatmembers ofa
consolidated group are treated as one corporation for purposes ofthe regulations under IRC Section 385. [Prop. Treas.
Reg. § 1.385-4(a)].Proposed Regulations Section 1.385-4 states thatwhen a corporation stops being a member ofthe
consolidated group butcontinues to be a member ofthe expanded group, a debt instrumentissued or held by such
corporation,referred to as departing member,will be treated as indebtedness or stock.[Prop. Treas.Reg. § 1.385-4(b)].
Section 1.385-4 of the proposed regulations also provides a rule for when a debt instrumentthatis treated as stock
under Section 1.385-3 enters a consolidated group and becomes a consolidated group debtinstrument.Proposed
Regulations

6. Section 1.385-4 states that “immediatelybefore that debt instrumentbecomes a consolidated group debtinstrument,the
issuer is treated as issuing a new debtinstrumentto the holder in exchange for the debt instrumentthatwas treated as
stock in a transaction thatis disregarded for purposes of§ 1.385-3(b).”
Examples ofthe application of the rules ofSection 1.385-4 of the proposed regulations are also provided in the section.
Conclusion
In summary,manyof the issues covered in the new regulations from the IRS and Treasury were previously addressed in
the 2014 and 2015 notices,which constituted the government’s first,significantstrikes againstcorporate inversions.The
new regulations do,however, take on previously-unaddressed areas and clarifyand follow-up on other areas and also
provide new rules with respectto earnings strippings transactions,and,therefore,a careful review of this latestsetof
guidance from the governmenton corporate inversions is critical.
AboutThe Author
Neil Aragones,Esq., LL.M., is a member ofthe LexisNexis® Tax Editorial team,specializing in U.S. Federal and
International Taxation,curating federal tax contentand writing on federal tax issues.He joined LexisNexis as an editor in
2000 and joined the tax group in 2005.Mr. Aragones attended the University of Pittsburgh for his undergraduate degree
and the Cleveland-Marshall College ofLaw, Cleveland State University for his law degree.In addition,he attended the
Case Western Reserve University School of Law for his LL.M. in Taxation. He is admitted to the Ohio Bar and is also
admitted to the U.S. District Court, Northern District of Ohio. Prior to obtaining his LL.M., Mr. Aragones was an associate
with a law firm in Pittsburgh.
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