A US parent company sold warrants for $X to an unrelated investor. The investor then sold similar warrants to an offshore subsidiary of the US parent. At the end of the day, $X left the offshore subsidiary and ended up with the US parent.

Many US companies try to defer US taxes from foreign operations by placing the operations under an offshore holding company. The earnings remain offshore. Tax directors at these companies are under pressure to find ways to bring the money home without triggering taxes. Unfortunately, section 956 of the US tax code treats offshore earnings as having been repatriated to the US — thereby triggering US taxes — if the earnings are invested in “United States property.” A loan by the offshore holding company to a US affiliate would be caught by this rule.

The IRS national office discussed the use of back-to-back warrants in a field service advice made public in March. It said the transaction would not necessarily trigger taxes under section 956. “The key factor in determining whether we could successfully collapse a set of transactions is how closely tied the set of transactions is.” In this case, the offshore subsidiary had not made a loan to its parent “because there appears to exist no obligation for US parent to repay” the money, and there was no purchase of the parent’s stock until the warrants are exercised. “With the exercise price of the warrants so high, they may never be exercised.”

The IRS told the district counsel wondering whether to litigate the issue that he would need “further factual development” showing the investor merely facilitated the transfer of funds from the offshore subsidiary to the US parent because the terms of the warrants “were such that the investor would not have been able to involve an entity not related to US parent on the same terms and conditions.”