A Change in Form: F Reorganizations in Foreign Context

Reorganizations under IRC §368(a)(1)(F) (“F Reorganizations”) are mere changes in form, such as changing a state of incorporation.  This change may be made for any number of reasons, although choice of law or no longer doing business in the state are common.  F Reorganizations in the international context involve consideration of many more substantive issues.

One must consider international tax law as the backdrop. PLR 201328003 sets forth a factual background of a structure used in international settings. It involves a foreign entity that has several subsidiaries, all of whom are disregarded.  Taxpayers may obtain a  benefit from making the check-the-box election to convert a foreign business entity into an entity that is disregarded for federal income tax purposes (DRE). DREs allow taxpayers to navigate the complex world of international taxation more efficiently. Consider that Subpart F taxes income that is not derived from an active trade or business or is re-routed through or to tax advantaged jurisdictions. The essence of the Subpart F regime is the taxation of income that is not repatriated, for whatever reason, to the U.S.  Another set of rules faced by corporations is the foreign tax credit (FTC). The U.S. taxes worldwide income, which includes income earned and taxed in foreign jurisdictions. The FTC brings with it certain computational difficulties and limitations.

Some complexity can be eliminated through the use of DRE.  PLR 201328003 describes such a DRE structure that was crafted to adapt to these rules.  Foreign parent (“FP”) owns Target which is formed under the laws of a foreign country. Target owns several subsidiaries. Target filed to domesticate itself in a state, which was a taxable transaction. Despite the inbound taxable event, the tiered subsidiaries were all disregarded entities.  DREs are branches of the parent, in this case the Target. One of the unique features of DRE’s is that they allow what is, in effect, consolidated return groups to be formed across borders.  The benefit of this feature is the ability of a corporation to combine activities of entities in several different countries to avoid, to a degree, Subpart F and FTC.

Some jurisdictions allow for cross-border consolidations and advertise this attractive feature. Although the U.S. does not permit consolidated groups to include non-U.S. companies, use of DRE’s accomplishes the same.