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Cross-Border Stock Swap Acquisitions in Vogue

Dec. 18, 2020, 8:01 AM

A long-standing Treasury Regulation generally permits U.S. public shareholders of a target U.S. corporation to achieve nonrecognition upon the exchange of their shares for originally issued shares, constituting a minority in vote and value, of a larger foreign corporate acquirer. Recently closed and pending transactions by foreign acquirers BioNTech, Clever Leaves, and Brookfield Renewable illustrate reliance on this Treasury Regulation by a foreign operating business to acquire a smaller U.S. business; by a foreign operating business to obtain access to cash previously raised by a U.S. Special Purpose Asset Corporation; and by a foreign operating business group to shift the U.S. public’s minority interest in a U.S. subsidiary to a minority interest in a foreign member of the foreign acquiring group.

Treasury Regulation Section 1.367(a)-3(c)(1), whose origins date back to 1995 Treasury Decision 8638, lists the criteria whereby U.S. shareholders generally can qualify for non-recognition on the exchange of their shares of a U.S. target corporation for originally issued shares of an acquiring foreign corporation, with a greater or equal market capitalization, conducting an active business, in an exchange that otherwise qualifies as a reorganization or a Section 351 transaction. For example, Treas. Reg. Section 1.367(a)-3(c)(1) can apply to a merger of a U.S. target with a transitory subsidiary of the acquiring foreign corporation, with the U.S. target surviving as a wholly owned subsidiary of the foreign corporate acquirer, in a transaction described in Sections 368(a)(1)(A) and 368(a)(2)(E), with the exchanging U.S. public shareholders receiving no more than 50% of the vote and value of acquiring foreign corporation shares, such as in the 2020 BioNTech transaction described below. Treas. Reg. Section 1.367(a)-3(c)(1) can also apply to a contribution of some U.S. target shares to a newly created foreign holding corporation, in exchange for no more than 50% in vote and value of that acquiring foreign holding corporation shares, with a simultaneous contribution of property by other foreign corporation shareholders likewise in exchange for that acquiring foreign holding corporation’s shares, in a transaction described in Section 351, as in the 2020 Clever Leaves and Brookfield Renewable transactions described below.

Treas. Reg. Section 1.367(c)-1(c)(1) has certain other rules, involving such matters as: prohibited post-exchange control of the foreign corporate acquirer by the exchanging 5%-or-greater U.S. target shareholders and U.S. officers and U.S. directors of the U.S. target corporation; execution of gain recognition agreements by exchanging U.S. shareholders seeking non-recognition who, post-acquisition, own 5% or more of the vote or value of the foreign corporate acquirer; a requirement that the foreign corporate acquirer’s market capitalization is at least that of the U.S. target corporation; the active and continuing nature of the foreign corporate acquirer’s foreign business; and reporting requirements.

BioNTech (Germany) Acquires Neon Therapeutic (U.S.)

BioNTech SE (BioNTech) electrified the world when it announced in November 2020 that it had co-developed a Covid-19 vaccine with over a 90% effectiveness rate in clinical trials. More routine was BioNTech’s use of Treas. Reg. Section 1.367(a)-3(c)(1) in May 2020.

BioNTech is a NASDAQ-traded German-headquartered Societas Europaea organized under the laws of Germany. Neon Therapeutics, Inc. (Neon) was a much smaller market capitalization NASDAQ-traded Cambridge, Massachusetts-headquartered Delaware corporation also engaged in biotechnology. BioNTech desired to acquire all the shares of Neon.

In May 2020, a share exchange was effectuated whereby the shareholders of Neon exchanged all their shares in Neon with BioNTech, receiving in exchange from BioNTech an aggregate of about 1% of BioNTech’s post-exchange shares. The exchange took place through a reverse triangular merger of a transitory U.S. subsidiary of BioNTech with and into Neon, with Neon, then being wholly owned by BioNTech, as the survivor. The apparent structuring goal was qualifying as a Section 368(a)(1)(A) and 368(a)(2)(E) reorganization (and possibly also a Section 368(a)(1)(B) reorganization) that met the non-recognition rules of Treas. Reg. Section 1.367(a)-3(c)(1).

Clever Leaves (Canada) and Arrival (Luxembourg) To Acquire SPACs (U.S.)

Special purpose acquisition companies (SPACs), sometimes called blank-check companies, are U.S. publicly traded U.S. corporations that have raised cash and seek operating businesses to combine with. For an operating business seeking cash and a U.S. public listing during the Covid-19 environment, combining with a SPAC offers advantages over an initial public offering. These include a quicker time to establish a valuation and a quicker and more certain time to close the transaction.

SPAC transactions often involve the SPAC combining with another U.S. corporation. However, the recently announced proposed acquisition of the shares of Schultze Special Purpose Acquisition Corp. (Schultze SPAC), a Delaware-incorporated, NASDAQ-listed, SPAC, by Clever Leaves Holdings, Inc. (Clever Leaves) a corporation organized under the laws of British Columbia, Canada, involves a cross-border share acquisition. It is designed to meet the nonrecognition requirements of Section 351 and Treas. Reg. Section 1.367(a)-3(c)(1) for the U.S. public Schultze SPAC shareholders.

Clever Leaves International, Inc. and its subsidiaries operate federally and sub-federally legal cannabis businesses mainly outside the U.S., such as cannabis growing facilities in Colombia. In November 2020, a share exchange was proposed whereby the shareholders of Clever Leaves International, Inc. and the shareholders of Schultze SPAC, each exchange all their shares in Schultze SPAC and Clever Leaves International, Inc. for shares of Clever Leaves, a newly formed Canadian holding corporation, with the Clever Leaves International, Inc. shareholders apparently receiving a majority (even before the possible post-exchange issuance to them of additional Clever Leaves shares under an earn-out formula), and Schultz SPAC shareholders receiving the minority, of vote and value of Clever Leaves shares, in a transaction described in Section 351. Incident to the exchange, Clever Leaves shares will be listed on NASDAQ. This indirectly achieves for Clever Leaves International, Inc., the same key business objective as an initial public offering, namely a cash infusion plus a NASDAQ listing.

A similar Treas. Reg. Section 1.367(a)-3(c)(1) SPAC transaction is the pending Arrival SRL combination with CIIG Merger Corp., (CIIG SPAC) a Delaware-incorporated, NASDAQ-listed SPAC.

This transaction, like the Clever Leaves transaction, is designed to meet the nonrecognition requirements of Section 351 and Treas. Reg. Section 1.367(a)-3(c)(1) for the exchanging U.S. public SPAC shareholders.

Arrival SRL, a non-public traded Luxembourg company, manufactures electric vehicles. In November 2020, a share exchange was proposed whereby the shareholders of CIIG SPAC and the shareholders of Arrival SRL, each exchange all their shares in CIIG SPAC and Arrival SRL, for shares of newly formed Luxembourg holding company, Arrival Group, SA, (Arrival Group), with the shareholders of Arrival SRL receiving a majority, and CIIG SPAC shareholders receiving the minority, of Arrival Group shares in a transaction described in Section 351. Incident to this exchange, Arrival Group’s shares will be listed on NASDAQ. This indirectly achieves for Arrival SRL the same two key business objectives of an initial public offering, namely a cash infusion plus a NASDAQ listing.

Brookfield Renewable Corp. (Canada) Acquires the Minority of TerraForm (U.S.)

Brookfield Asset Management Inc. (Brookfield Asset) is a publicly traded Canadian alternative asset management company focusing on private equity, renewable power, real estate and other areas. In early 2020, affiliates of Brookfield Asset owned about 62% of the shares of TerraForm Power, Inc. (TerraForm), a U.S. corporation traded on NASDAQ engaged in the renewable power business, and the unrelated public shareholders of TerraForm owned about 38% of the shares of TerraForm. As part of a transaction designed to acquire this 38% minority public interest in TerraForm, in July 2020, a share exchange designed to qualify under Section 351 and Treas. Reg. Section 1.367(a)-3(c)(1) was undertaken. TerraForm was reincorporated in another U.S. state. Then some of TerraForm’s public shareholders exchanged their TerraForm shares for shares, constituting less than 50% of the vote and value, of Brookfield Renewable Corporation (BEPC), a newly formed Canadian holding corporation, and Brookfield Assets’ affiliates transferred other assets to BEPC, in exchange for BEPC shares, with both the public exchangors and the Brookfield Assets’ affiliate exchangors apparently together having the required Section 351 80% control of BEPC after the exchange. Incident to the transaction, BEPC was listed on the New York and Toronto Stock Exchanges.

Downstream Attribution Concern

In the BEPC transaction, apparently complicating the desired non-recognition for the exchanging U.S. TerraForm shareholders was a concern as to the IRS application of the attribution rules to Treas. Reg. Section 1.367(a)-3(c)(1). The BEPC transaction documents filed with the SEC refer to a request to the IRS for a private letter ruling, which seems to be the request that culminated in the favorable issuance of Private Letter Ruling 202045007 in May 2020.

If so, the issue in the BEPC transaction, which was the issue in PLR 202045007, was how the IRS would coordinate the TCJA’s 2017 repeal of Section 958(b)(4) with Treas. Reg. Section 1.367(a)-3(c)(1)(ii). Under Treas. Reg. Section 1.367(a)-3(c)(1)(ii), non-recognition on a Section 351 exchange of U.S. corporate shares for foreign corporate shares is denied if the 5%-or-greater U.S. shareholders of the acquired U.S. corporation, and U.S. officers and directors of the acquired U.S corporation, own, immediately after the exchange, more than 50% of the vote or value of the shares of the foreign corporate acquirer.

In applying Treas. Reg. Section 1.367(a)-3(c)(1)(ii), Treas. Reg. Section 1.367(a)-3(c)(4)(iv) applies the attribution rules of Section 318(a), “as modified by the rules of Section 958(b).” Treas. Reg. Section 1.367(a)-3(c)(9)(ii) permits the IRS to issue a private letter ruling allowing non-recognition where an exchanging U.S. shareholder is unable to satisfy any requirement of Treas. Reg. Section 1.367(a)- 3(c)(1) due to the application of the constructive ownership rules of Treas. Reg. Section 1.367(a)-3(c)(4)(iv).

An indirect wholly owned U.S. subsidiary (USSub1) of Brookfield Asset was the general partner of a Bermuda partnership that owned some TerraForm shares before the transaction. Brookfield Asset, though another, sister, downstream chain of ownership parallel to the USSub1 chain, also indirectly owned TerraForm shares before the transaction.

Prior to the 2017 enactment of the TJCA, Section 958(b)(4) provided that there was no Section 318(a)(3) downstream attribution from a foreign shareholder, such as Brookfield Asset, to its majority-owned U.S. corporation, such as USSub1. By contrast, by reason of the 2017 repeal of Section 958(b)(4), Section 318(a)(3) downstream attribution could be available to the IRS to attribute, downstream to USSub1, pre-exchange TerraForm shares and post-exchange BEPC shares, actually owned in the sister parallel chain of ownership to USSub1, which are attributed upstream to Brookfield Asset. PLR 200245007 indicates that solely by reason of this downstream attribution from Brookfield Asset under the TJCA 2017 repeal of Section 958(b)(4), USSub1 would be a pre-Section-351-exchange 5%-or-greater U.S. shareholder of TerraForm, and would be, immediately following the Section 351 exchange, a majority, by vote or value, U.S. shareholder of BEPC, thereby causing non-recognition for the exchanging public U.S. TerraForm shareholders to be unavailable under Treas. Reg. Section 1.367(a)-3(c)(1)(ii).

PLR 202045007 seems to have been issued in response to a request for the IRS to rule, based upon Treas. Reg. Section 1.367(a)-3(c)(9)(ii), that notwithstanding the TJCA 2017 repeal of Section 958(b)(4), non-recognition was available to the public TerraForm shareholders. In May 2020, the IRS issued PLR 202045007, granting the requested relief.

In September 2020, Treasury issued Proposed Treas. Reg. Section 1.367(a)-3(c)(4)(iv). Consistently with the earlier result in PLR 202045007, Proposed Treas. Reg. Section 1.367(a)-3(c)(4)(iv) provides that, in applying Treas. Reg. Section 1.367(a)-3(c)(1)(ii), there is no downstream attribution from a foreign entity to a U.S. entity. Proposed Treas. Reg. Section 1.367(a)-3(c)(4)(iv) also eliminates the application of the TJCA 2017 Section 958(b)(4) repeal to other provisions of Treas. Reg. Section 1.367(a)-3(c)(1), other than those identifying which exchanging U.S. shareholders must execute gain recognition agreements to achieve non-recognition by reason of owning, post-acquisition, 5% or more of the vote or value of the foreign corporate acquirer. Proposed Regulation 1.367(a)-3(c)(4)(iv) is generally proposed to be retroactive as well as prospective.

Conclusion

Cross-border stock swap combinations can offer business synergies and other advantages to the foreign acquirer and U.S. target following the exchange. When Treas. Reg. Section 1.367(a)-3(c)(1) can achieve these combinations without immediate interposition of a U.S. capital gains tax on exchanging U.S. target public shareholders, an otherwise undesirable economic toll charge on the transaction can be avoided.

This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Author Information

Alan S. Lederman is a shareholder at Gunster, Yoakley & Stewart, P.A. in Fort Lauderdale, Fla.