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JOURNAL of INTERNATIONAL TAXATION the Transfer of Shares by Non-U.S

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JOURNAL of INTERNATIONAL TAXATION the Transfer of Shares by Non-U.S 26 JOURNAL OF INTERNATIONAL TAXATION The transfer of shares by non-U.S. individuals of an existing U.S. corporation owning U.S. real estate to a newly formed foreign corporation in exchange for shares of the foreign corporation can have disastrous U.S. estate tax consequences for the non-U.S. domiciliary on death. When Intended Estate Planning Results in an Accidental nversion Inversion ROBERT H. MOORE AND MICHAEL J. BRUNO not implemented properly, this structure This article will discuss one varia - For many years, could result in an “inversion” that would tion of the “inversion” transaction, the most common structure for non-U.S. result in the foreign corporation being which involves the transfer of shares by individuals 1 to hold U.S. business assets, treated as a U.S. corporation, for all pur - non-U.S. individuals of an existing U.S. such as U.S. real estate, has been to hold poses of the Code. In that case, the non- Subchapter C corporation owning U.S. such assets directly under a U.S. corpora - U.S. individual would not be protected real estate to a newly formed foreign tion and then to have the shares of the U.S. from U.S. federal estate tax. Given that corporation in exchange for shares of corporation owned by a foreign corpora - non-U.S. domiciliaries 2 have only a the foreign corporation (“Share Inver - tion. If implemented properly, this struc - $60,000 exemption on the value of their sion”). It then describes the effect of the ture protects the non-U.S. individual from U.S.-situs assets includable in their gross Share Inversion and associated anti- U.S. federal estate and gift tax, and also estate, structures such as the one inversion rules on the recipient foreign allows the non-U.S. individual to control described above, if they result in an inver - corporation and its non-U.S. individ - the timing of shareholder-level tax on div - sion, would have disastrous U.S. federal ual owners. This transaction will be idend distributions. Since the introduc - estate tax consequences to the non-U.S. referred to as the “Base Transaction” tion of Section 7874 in 2004, however, if domiciliary on death. throughout this article. JOURNAL OF INTERNATIONAL TAXATION 27 Summary of U.S. Federal Tax Rules To fully appreciate the inversion rules’ impact on the Base Transaction, follow - ing is a brief description of certain terms used throughout this article and the basic U.S. federal income, estate, and gift tax rules that apply to individuals. For U.S. federal income tax purpos - es, “U.S. person” includes U.S. corpora - tions 3 and individuals who are either U.S. citizens, U.S. green card holders, or considered to be substantially present in the United States. 4 Nonresident aliens and foreign corporations (“for - eign persons”) are not considered U.S. persons. 5 U.S. persons are subject to U.S. federal income taxation on their entire worldwide income, regardless of the source of the income. In contrast, foreign persons are subject to U.S. fed - eral income tax on only certain types of “U.S.-source” income. For these pur - poses, U.S.-source income generally includes (1) income effectively connect - ed to a U.S. trade or business, including gains from the sale of U.S. real proper - estate or gift tax only on the FMV of their situs for U.S. federal estate tax purposes ty (ECI) 6; and (2) certain types of pas - ownership interest in certain U.S.-situs but not for U.S. federal gift tax purpos - sive income from U.S. sources that are assets transferred during life or on death. es, whereas other assets are considered not derived from a U.S. trade or busi - U.S. citizens and U.S. domiciliaries are U.S. situs for both estate and gift tax pur - ness, such as dividends, rents, and inter - currently entitled to a $5,450,000 million poses. Shares of stock in U.S. corpora - est (“FDAP (fixed or determinable lifetime exemption (adjusted for infla - tions are U.S.-situs property for U.S. annual or periodical) income”). 7 tion); 10 however, a non-U.S. domiciliary federal estate tax, but not for U.S. federal Unlike the U.S. federal income tax, the is permitted to generally exclude only the gift tax purposes. 11 In contrast, certain U.S. federal estate and gift taxes are first $60,000 of his taxable U.S.-situs assets are considered U.S. situs for both applied based on an individual’s citizen - property from the calculation of his U.S. U.S. federal estate and gift tax purposes. ship or domicile (instead of residence). federal estate tax. No similar exemption These assets include interests in real U.S. citizens and U.S. domiciliaries 8 are from U.S. federal gift tax exists for non- property located in the United States. 12 subject to the U.S. federal estate and gift U.S. domiciliaries. On the other hand, a non-U.S. domicil - tax on the fair market value (FMV) of Noncitizens who are not considered iary is not subject to U.S. federal estate or their worldwide assets (wherever locat - domiciled in the United States are sub - gift tax on his interests in foreign situs ed throughout the world) that they trans - ject to U.S. federal estate or gift tax only property. Shares of stock in foreign cor - fer during life or at death. 9 On the other on the value of their ownership interests porations are considered foreign-situs hand, individuals who are neither U.S. in certain U.S.-situs assets transferred property, and thus, not subject to U.S. citizens nor considered domiciled in the during their lifetime or on death. Proper - federal estate or gift tax. 13 United States are subject to U.S. federal ty that is considered U.S.-situs property For many foreign individual in- for estate and gift tax purposes varies vestors, the most important U.S. tax con - ROBERT H. MOORE is a partner, and MICHAEL J. BRUNO is an associate, in Baker & McKenzie LLP’s Tax depending on the type of property trans - sideration when considering an in- Practice Group. ferred. Some assets are considered U.S. vestment in the United States is how to 28 JOURNAL OF INTERNATIONAL TAXATION l JUNE 2016 l ACCIDENTAL INVERSIONS For many foreign individual investors, the most important U.S. tax consideration is avoiding U.S. federal estate and gift taxes avoid the U.S. federal estate and gift tax - Base Transaction es. This is primarily because non-U.S. A non-U.S. individual owns stock in a domiciliaries are allowed to exclude only U.S. corporation, which primarily owns the first $60,000 in value of U.S.-situs interests in real estate located in the assets from their U.S. estates. Thus, most United States. In this case, the U.S. cor - non-U.S. domciliaries seek to hold their poration qualifies as a U.S. real proper - U.S.-situs assets, such as U.S. real estate, ty holding corporation (USRPHC) for under a foreign corporation, 14 as shares purposes of the Foreign Investment in in a foreign corporation are explicitly Real Property Tax Act of 1980 15 (FIRP - excluded from the definition of U.S.- TA), which is discussed below. situs assets. Further, foreign individuals The optimal U.S. tax structure to hold often prefer to have their U.S. invest - this U.S. real estate should avoid U.S. ments held directly by domestic entities, transfer tax exposure (gift, estate, and such as U.S. corporations, as domestic generation skipping transfer tax) for the entities typically have an easier time non-U.S. individual and his future estate. conducting business in the United States Thus, the non-U.S. domiciliary may form and, where the U.S. branch profits tax a foreign corporation to hold the USR - might apply to a foreign corporation PHC stock (and possibly other U.S. engaged in business in the United States, assets) because stock in a foreign corpo - holding U.S. business assets under a ration is not included in the non-U.S. domestic corporation also allows a non- domiciliary’s U.S. gross estate and is not U.S. investor to control the timing of subject to U.S. federal estate or gift tax. 16 shareholder-level taxation that applies to To accomplish the estate and gift tax dividend distributions. planning goal, the non-U.S. domiciliary would then contribute the shares of the 1 ities are ignored. See Swan Est. , 247 F.2d 144 Section 7701(b)(1)(B). USRPHC to the foreign corporation. 2 (CA-2, 1957); Fillman , 355 F.2d 632 (Ct. Cl., Reg. 25.2501-1(b); see also Estate of Jack , 54 1966). This “Base Transaction” is permitted Fed. Cl. Ct. 590 (2002). 17 3 See Notice 2006-46, 2006-1 CB 1044. under FIRPTA and, until 2004, success - Section 7701(a)(4). 18 4 The same issue can arise if an interest in a fully converted what otherwise was a Sections 7701(a)(30), (b)(1)(A). domestic partnership is transferred to a foreign 5 U.S.-situs asset (stock in the USRPHC) Sections 7701(a)(5), 7701(b)(1)(B). corporation. However, we will only address the 6 Section 871. transfer of stock in a U.S. corporation for pur - to a foreign-situs asset (stock in the for - 7 poses of this article.
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