An F reorganization offers a highly effective way for foreign corporations to transition into U.S. corporations while avoiding significant tax liabilities. This process, known as a “domestication transaction,” is particularly valuable when a company wants to move appreciated assets—such as intellectual property, real estate, or other valuable holdings—into a U.S. entity without triggering taxes on built-in gains. By meeting the specific conditions of an F reorganization, businesses can transform into U.S. corporations in a tax-efficient manner. This approach is often pursued to better manage assets in the U.S., facilitate future growth opportunities, or streamline the process of raising capital in the U.S. market.

Additional reasons for transforming a foreign corporation into a U.S. corporation may be due to a perception that it is easier to raise capital in a U.S. company or that an eventual sale of the business will be facilitated by converting the entity into a U.S. corporation. While the details are beyond the scope of this writing, it may be the case that changing the status of the corporation from foreign to domestic may provide the company with the opportunity to take advantage of the U.S. tax benefit for certain export sales provided by the “foreign-derived intangible income” or “FDII” provision of the U.S. tax law. This provision, which is only available to a U.S. corporation, currently reduces the rate of tax on qualifying export sales to 13.125%. In a similar vein, domesticating a foreign corporation takes the often onerous Subpart F and “GILTI” provisions affecting certain foreign corporations “off the table.” Whether or not these considerations justify the domestication of a foreign corporation is a complex matter requiring careful analysis.

Reincorporating a Foreign Corporation as a U.S. Corporation Using an F Reorganization

Basic Requirements for a Valid F Reorganization

While there are several ways to reincorporate a foreign corporation in the U.S., it is necessary to satisfy six conditions specified in the regulations to achieve a valid F reorganization. In brief, they are:

1. The shares of Newco (the U.S. corporation) must be exchanged for shares of Oldco (the foreign corporation to be domesticated).
2. The same persons must own all the Oldco and Newco shares in the same proportion. In other words, new investors cannot be introduced in connection with the reorganization, and shareholders may not use the reorganization to change their relative interests in the corporation being domesticated.
3. Newco may not hold any property prior to the reorganization other than nominal amounts needed for the initial organization of Newco.
4. Oldco must be completely liquidated as part of the transaction.
5. Newco is the only person or entity that may hold the property previously held by Oldco prior to the reorganization.
6. Newco may not hold property acquired from a corporation other than Oldco. Simply put, Oldco must be the only “acquired” corporation.

In a nutshell, the above requirements of an F reorganization are designed to ensure that Newco succeeds to all of Oldco’s assets and liabilities and is owned in the same proportion by the same shareholders who previously owned Oldco. Simply put, the transaction must involve only one company and not involve the introduction of new investors or third parties.

Methods to Domesticate a Foreign Corporation (Oldco)

The domestication of a foreign corporation (Oldco) may be accomplished using any one of the following techniques:

1. Merge Oldco into Newco pursuant to a specific state statute.
2. Reincorporate Oldco in a U.S. state under a reincorporation statute by filing a certificate of reincorporation with such state.
3. Transfer Oldco shares to Newco in exchange for Newco shares followed by liquidation of Oldco into Newco.
4. Transfer Oldco assets and liabilities to Newco in exchange for Newco shares followed by the distribution of Newco shares to Oldco shareholders in liquidation of Oldco.

Provided that there is a good business purpose for the reorganization and the six conditions of the regulations are satisfied, each of the above approaches will be treated in the same manner as a valid F reorganization.

U.S. Tax Consequences of an Inbound “F” Reorganization

Consequences to Oldco and Newco

In general, neither Oldco nor Newco would recognize gain on the transfer of Oldco’s assets and the receipt of Newco shares in connection with such transfer. However, an important exception to this rule comes into play if Oldco transfers an appreciated “United States real property interest” or “USRPI” to Newco in connection with the domestication. In such a case, Oldco would be required to recognize taxable gain under the “FIRPTA” provisions to the extent of such appreciation unless the shares received from Newco in connection with the exchange qualify as a USRPI (i.e., Newco is a U.S. Real Property Holding Company or USRPHC because of the reorganization).

Consequences to Shareholders of Oldco

If a shareholder of Oldco is a foreign person or foreign corporation, in general, no U.S. tax will be imposed in connection with the inbound F reorganization. However, an exception to this rule of nonrecognition applies where a foreign shareholder is a foreign corporation owned by one or more 10% U.S. shareholders. In this case, the foreign corporation must recognize a “deemed dividend” measured by its pro rata portion of the earnings and profits of the corporation. In certain cases, this could result in the recognition of “phantom” Subpart F income by the U.S. shareholder of the foreign corporate shareholder.

2. A shareholder who is a 10% U.S. shareholder must include in taxable income its attributable share of the earnings and profits of Oldco.
3. A U.S. shareholder who owns less than 10% has the option of including in income the gain realized on the stock of Oldco in connection with the domestication or the attributable earnings and profits of Oldco, whichever is less. If the value of such a shareholder’s stock is less than $50,000, no gain is required to be recognized in connection with domestication.

Conclusion

As a practical matter, in many (but not all) cases, the domestication of a foreign corporation in an inbound F reorganization can be accomplished on a tax-free basis for both the corporation and its shareholders. For example, in the case of a foreign corporation where the shareholders are all foreign individuals or foreign corporations which do not have a 10% or greater U.S. shareholder, U.S. taxable income is not required to be recognized in connection with the reorganization except in certain cases involving the “transfer” of a U.S. real property interest. On the other hand, if the foreign corporation to be domesticated has U.S. shareholders, it may not have significant earnings and profits due to the combined effect of the Subpart F, “GILTI” and mandatory repatriation provisions of the Internal Revenue Code. In this case, little or no U.S. taxable income would ordinarily result from the domestication transaction.

The foregoing is intended to familiarize the reader with the concept and potential usefulness of an inbound F reorganization and is not intended as tax advice. We emphasize that the successful implementation of a transaction of this type requires that the associated technical intricacies be carefully analyzed before proceeding.

How AbitOs Can Help

At AbitOs, we provide comprehensive support for businesses looking to navigate the complexities of an inbound F reorganization to domesticate a foreign corporation. Our experienced international tax team is equipped to handle every aspect of this intricate process, from ensuring compliance with U.S. tax regulations to minimizing tax liabilities. We can guide you through the specific technical requirements, including meeting the six conditions for a valid F reorganization and addressing potential challenges like Subpart F income, GILTI provisions, and FIRPTA implications.

Additionally, our experts will work with you to assess the business purposes behind the domestication, whether it’s to facilitate raising capital, enhance asset management, or take advantage of U.S. tax benefits like the reduced tax rate on export sales under FDII. We understand the potential tax traps and the need for careful analysis, and we will ensure that your reorganization is structured in the most tax-efficient manner possible.

We also offer ongoing support to help you stay compliant post-domestication, including guidance on reporting requirements and maintaining proper corporate structures.

If you’re considering an F reorganization or have any questions about transitioning a foreign entity into a U.S. corporation, our team is ready to assist. Reach out to us today, and let’s explore how we can help streamline your corporate restructuring and optimize your tax position for future growth.

Originally published at: https://abitos.com/inbound-f-reorganization-foreign-corporation-domestication