The IRS has issued temporary and proposed regulations (T.D. 9592 and REG-107889-12) adopting a bright line test for determining whether a foreign corporation satisfies the substantial business activities test of Section 7874(a)(2)(B)(iii) to avoid treatment as an inverted corporation. The IRS also finalized regulations (T.D. 9591) under other areas of Section 7874.
The bright line test in the new temporary regulations replaces temporary regulations in 2009, which permitted the determination of whether an expanded affiliated group (EAG) has substantial business activities in the relevant foreign jurisdiction to be based on all the facts and circumstances.
Under the new temporary regulation, an EAG will have substantial business activities in the relevant foreign country only if at least 25 percent of each of the group employees, group assets and group income are located in or derived in the relevant foreign country, determined as follows:
Group employees — Two tests must be met: (1) The number of employees of members of the EAG (group employees) based in the foreign jurisdiction must be at least 25 percent of the total number of group employees as of the applicable date; and (2) the employee compensation incurred with respect to the group employees based in the foreign jurisdiction must be at least 25 percent of the total employee compensation incurred with respect to all group employees during a one-year testing period. Group assets — At least 25 percent of the value of the EAG's assets (group assets) must be located in the relevant foreign jurisdiction. For this purpose, the term "group assets" generally means tangible personal property or real property used or held for use in the active conduct of a trade or business by members of the EAG. Group income — At least 25 percent of the EAG's income (group income) must be derived from the foreign jurisdiction during a one-year testing period. For this purpose, the term "group income" means gross income of...