US multinationals are at risk of losing US tax deferral after a change in ownership of offshore subsidiaries | Norton Rose Fulbright
The risk is to offshore subsidiaries that have existed since at least May 1996.
American companies are subject to income tax in the United States on worldwide earnings. However, most adopt ownership structures that delay any US tax on profits earned in other countries until the profits are repatriated to the United States. This requires operating abroad through an offshore holding company — for example, in Holland or the Cayman Islands — and ensuring that all legal entities formed in other countries as subsidiaries of the offshore holding company are considered “transparent” for US tax purposes. Transparency is usually a matter of making an election on a tax form filed with the Internal Revenue Service. However, the IRS publishes a list of legal entities for which an election is not allowed. There is generally one such entity in each country. An example of an entity that cannot be transparent is an S.A. or sociedad anonima in a Latin American country.
An offshore subsidiary that has existed since at least May 1996 may be “grandfathered.” Thus, for example, an S.A. in Argentina that has existed since at least May 1996 might be allowed to be treated as transparent.
But beware: the IRS said in late October that such a subsidiary will lose its grandfather protection after a change of 50% or more in the ownership of the subsidiary. The IRS had proposed such a rule in November 1999. It formally adopted the rule in late October. The agency said any such change in ownership since November 29, 1999 will cause loss of grandfather protection. It does not matter if the change was incremental and spread over a period of years. Once the 50% threshold is reached, grandfather protection is lost. Loss of grandfather protection where too much change has already occurred will be effective as of October 22, 2003.
The agency also said that changes in indirect ownership can trigger this result — not just direct changes.