Tax Implications of Cross-Border Restructurings from a US Perspective: Hidden Tax Traps in Inversions, COD and Section 956

This episode builds on a previous podcast, where Weil Tax partners Jenny Doak and Benjamin Pique, along with Counsel Stuart Pibworth, explored the tax implications of distressed situations from a European perspective. The US rules that are the focus of this episode, often complex and sometimes counterintuitive, can create unexpected tax liabilities if not properly navigated.

Bodoh begins by unpacking how the US anti-inversion regime – Section 7874 – can unexpectedly apply in distressed cross-border situations. Originally intended to deter US companies from relocating offshore to avoid taxes, these rules now ensnare restructuring deals where foreign creditors become controlling shareholders. In particular, when a US company in distress is restructured and its debt is recharacterised as equity (especially in bankruptcy or insolvency), the IRS may treat foreign creditors as equity holders.

If their post-restructuring ownership exceeds certain thresholds (60% or 80%), the new foreign parent may be treated as a US corporation for tax purposes, with global tax consequences. Bodoh warns this “trap for the unwary” is not theoretical but rather a real and recurring issue in market transactions.

Featherman then turns to COD income, which arises when debt is settled for less than its face value. Under normal US rules, COD income may be excluded if the debtor is insolvent or in bankruptcy. However, in cross-border settings, COD income recognised by a foreign subsidiary (CFC) can still have US tax implications through subpart F or GILTI (global intangible low-taxed income) rules. A 1997 IRS ruling suggests COD income is not subpart F income – but if the forgiven debt previously reduced taxable income, it may be pulled back in under the tax benefit rule. COD may also increase tested income, thus inflating GILTI exposure, and reduce asset basis, which could create tax friction in the future.

Foreign investors in the United States also face uncertainty. It remains legally unclear whether COD income is US-sourced. Conservative market practice generally assumes a US source – meaning withholding and dry income issues may arise, particularly in partnerships where there is no cash accompanying the income.

Featherman wraps up by revisiting Section 956, which deems a US shareholder to receive a taxable dividend if a CFC invests in US property, including through guarantees or pledges of credit support. While the 2017 tax reform significantly reduced the practical impact of this rule (via the 245A dividends-received deduction), traps still exist. Notably, individual shareholders, certain hybrids and technical mismatches in earnings and profits calculations may lead to unexpected tax. Lenders and borrowers must still carefully structure guarantees, pledges and upstream loans to avoid adverse tax consequences.

Bodoh closes by encouraging listeners to consult Weil’s tax blog for deeper dives and examples. As cross-border restructurings grow more complex, these “old” rules are more relevant – and riskier – than ever.