Using an “F” Reorganization to Domesticate a Foreign Corporation

An F reorganization offers a highly effective way for foreign corporations to transition into U.S. corporations while avoiding significant tax liabilities. This process, known as a “domestication transaction,” is particularly valuable when a company wants to move appreciated assets—such as intellectual property, real estate, or other valuable holdings—into a U.S. entity without triggering taxes on built-in gains. By meeting the specific conditions of an F reorganization, businesses can transform into U.S. corporations in a tax-efficient manner. This approach is often pursued to better manage assets in the U.S., facilitate future growth opportunities, or streamline the process of raising capital in the U.S. market.

Corporations that meet six requirements will be able to effectuate F reorganizations tax-free when those reorganizations involve a mere change of identity, form, or place of organization of one corporation, however effected, under final regulations issued by the IRS on Friday (T.D. 9739). The regulations also govern outbound F reorganizations with foreign corporations. They finalize proposed regulations issued in 1990 and 2004 governing which transactions qualify as a Sec. 368(a)(1)(F) reorganization.

The final rules apply a concept called a potential F reorganization, allowing the many steps of a corporate reorganization to be examined together to see if the transaction qualifies to be an F reorganization. The IRS believes that, because the statute contains the phrase “however effected,” the rules should permit a series of transactions to qualify as an F reorganization.

Under the final rules, an F reorganization has occurred if the transactions meet six requirements. Four of the requirements were in the 2004 proposed regulations, and the last two were added in response to comments.

1. The first and second requirements reflect the concept that a transaction that shifts the ownership of the proprietary interests in a corporation cannot qualify as a mere change. Thus, a transaction that introduces a new shareholder or new equity capital into the corporation does not qualify as an F reorganization. Therefore, the final regulations require that immediately after the potential F reorganization, all the stock of the new corporation must have been distributed (or deemed distributed) in exchange for stock of the old transferor corporation in the potential F reorganization.
2. The second requirement, which is subject to certain exceptions (including a de minimis exception), is that the same person or persons must own all the stock of the old corporation at the beginning of the potential F reorganization and all of the stock of the new corporation at the end, in identical proportions.
3. The third and fourth requirements reflect the mandate that these reorganizations involve only one corporation. The third requirement limits the assets and attributes of the new corporation to those held immediately before the transaction. The fourth requires the old corporation to liquidate.
4. To facilitate the reorganization, however, the new corporation is permitted to hold a de minimis amount of assets to facilitate its organization or its existence before the reorganization and is also allowed to hold proceeds of money borrowed to facilitate the transaction. And the old corporation is not required to legally dissolve and may maintain a de minimis amount of assets to remain in existence.
5. Under the fifth requirement, which was added in response to comments, immediately after the potential F reorganization, no corporation other than the new corporation may hold property that was held by the old corporation immediately before the reorganization, if the new corporation would, as a result, succeed to the losses of the old corporation in Sec. 381(c). Thus, a transaction that divides the property or tax attributes of the old corporation between or among acquiring corporations, or that leads to potential competing claims to those tax attributes, will not qualify.
6. The sixth requirement is a variation on the fifth requirement. Immediately after the potential F reorganization, the new corporation may not hold property acquired from a corporation other than the old corporation if the new corporation would, as a result, succeed to and take into account the items of such other corporation described in Sec. 381(c). Thus, a transaction that involves simultaneous acquisitions of property and tax attributes from multiple transferor corporations will not qualify.

The final regulations also finalize proposed rules under Sec. 367 on F reorganizations in which the old, transferor corporation is a domestic U.S. corporation and the new, acquiring corporation is a foreign corporation. In those cases, most of the nonrecognition provisions do not apply. In addition, the transferor corporation’s tax year ends on the date of the transfer to the foreign corporation and the tax year of the acquiring corporation ends with the close of the date on which the transferor’s tax year would have ended but for the occurrence of the transfer.

U.S. Tax Consequences of an Inbound “F” Reorganization

Consequences to Oldco and Newco

In general, neither Oldco nor Newco would recognize gain on the transfer of Oldco’s assets and the receipt of Newco shares in connection with such transfer. However, an important exception to this rule comes into play if Oldco transfers an appreciated “United States real property interest” or “USRPI” to Newco in connection with the domestication. In such a case, Oldco would be required to recognize taxable gain under the “FIRPTA” provisions to the extent of such appreciation unless the shares received from Newco in connection with the exchange qualify as a USRPI (i.e., Newco is a U.S. Real Property Holding Company or USRPHC because of the reorganization).

Consequences to Shareholders of Oldco

1. If a shareholder of Oldco is a foreign person or foreign corporation, in general, no U.S. tax will be imposed in connection with the inbound F reorganization. However, an exception to this rule of nonrecognition applies where a foreign shareholder is a foreign corporation owned by one or more 10% U.S. shareholders. In this case, the foreign corporation must recognize a “deemed dividend” measured by its pro rata portion of the earnings and profits of the corporation. In certain cases, this could result in the recognition of “phantom” Subpart F income by the U.S. shareholder of the foreign corporate shareholder.
2. A shareholder who is a 10% U.S. shareholder must include in taxable income its attributable share of the earnings and profits of Oldco.
3. A U.S. shareholder who owns less than 10% has the option of including in income the gain realized on the stock of Oldco in connection with the domestication or the attributable earnings and profits of Oldco, whichever is less. If the value of such a shareholder’s stock is less than $50,000, no gain is required to be recognized in connection with domestication.

Conclusion

As a practical matter, in many (but not all) cases, the domestication of a foreign corporation in an inbound F reorganization can be accomplished on a tax-free basis for both the corporation and its shareholders. For example, in the case of a foreign corporation where the shareholders are all foreign individuals or foreign corporations which do not have a 10% or greater U.S. shareholder, U.S. taxable income is not required to be recognized in connection with the reorganization except in certain cases involving the “transfer” of a U.S. real property interest. On the other hand, if the foreign corporation to be domesticated has U.S. shareholders, it may not have significant earnings and profits due to the combined effect of the Subpart F, “GILTI” and mandatory repatriation provisions of the Internal Revenue Code. In this case, little or no U.S. taxable income would ordinarily result from the domestication transaction.

The foregoing is intended to familiarize the reader with the concept and potential usefulness of an inbound F reorganization and is not intended as tax advice. We emphasize that the successful implementation of a transaction of this type requires that the associated technical intricacies be carefully analyzed before proceeding.