Treasury plans to weaken rules meant to stop corporate tax avoidance

The U.S. Treasury Department plans to pare back regulations championed by President Barack Obama that were intended to prevent American companies from moving profits offshore to avoid taxes, according to guidance released Thursday.

The instructions mark a change in U.S. tax policy that has in recent years focused on imposing stricter rules on American corporations using complex transactions to move money overseas to skirt taxes. The Treasury Department said parts of the regulations, implemented in the final months of the Obama administration, are no longer necessary because of the 2017 tax law enacted under President Donald Trump.

“Because tax cuts made our business environment more competitive, we are now able to remove regulatory burdens that have been rendered obsolete, further reduce costs for job creators and hardworking Americans, and protect the U.S. tax base,” Treasury Secretary Steven Mnuchin said in a statement.

Offshore offices

Treasury’s regulations address rules preventing American firms from lowering their U.S. tax bills by shifting income to offshore related companies, loaning that money back to their domestic companies, and then deducting the interest off their Internal Revenue Service bills.

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A pedestrian walks near the U.S. Treasury building in Washington, D.C.

A senior Treasury official on a call with reporters Thursday said the agency intends to repeal a part of the rules that automatically re-characterize tax-deductible loans as taxable stock if a U.S. company is receiving loans from and distributing cash to a foreign branch within a 72-month window.

The rule made it more likely companies would face higher tax bills as they moved money in and out of the country. Treasury plans to replace it with a standard that is more specific and gets rid of some complex exceptions, the official said.

The new rule would give companies some leeway to prove that two transactions aren’t related and don’t deserve adverse tax consequences.

Businesses resisted the original rules, published in 2016, arguing that the IRS was overstepping its authority. The regulations, commonly called tax code section 385 rules, were some of the most controversial tax rules ever written at the time, prompting companies to send thousands of letters to the IRS in opposition.

Replacing a test that was solely based on timing with a more fact-specific test will make it harder for the IRS to enforce the 385 regulations, said Mark Mazur, who was the assistant secretary for tax policy at Treasury in the Obama administration when the initial rules were issued.

“It’s not like the IRS knows more about the workings of the firm than the firm does,” he added. “So there’s an information asymmetry that creates a disadvantage.”

Reporting requirements

Treasury will also eliminate requirements for businesses to report their inter-company loans to the IRS, a change the agency had previously proposed.

The moves could make it easier for firms to use accounting tactics to minimize their U.S. earnings and inflate their foreign profits, which are frequently taxed at rates lower than the current 21 percent domestic corporate levy. The existing regulations were aimed at stopping American companies from moving their headquarters to a lower-tax country, a process known as a corporate inversion.

The removal of the reporting requirements “may increase the propensity for foreign acquisitions and ownership of U.S. assets that are motivated by tax considerations, rather than economics,” the rules said.

Treasury remains cognizant of the need to prevent incentives for U.S. companies to move offshore and for foreign companies to takeover domestic corporations, the official said.

The Treasury Department should tread cautiously in weakening these rules now while Democratic lawmakers are eager to repeal large portions of the 2017 tax overhaul, said Matt Gardner, a senior fellow at the left-leaning Institute on Taxation and Economic Policy. If the next Congress makes changes to the overhaul, these rules might be an important backstop to prevent companies from moving offshore, he said.

“There is every reason to ask whether two or three years down the road that they might need these,” Gardner said.

Tracking loans

Critics of the regulations say the lower corporate rate and limits on how much interest companies can deduct have made these regulations unnecessary and are a burden on companies that have to track each of their loans.

Business groups, including the U.S. Chamber of Commerce and Organization for International Investment, have said the regulations go far beyond their stated purpose of curbing inversions and hit routine transactions.

The government projected in 2016 that the regulations would increase tax revenue by $600 million annually. Thursday’s proposal would decrease taxpayer compliance cost by $924 million over a decade, according to the guidance. There isn’t an updated estimate for how much the policy changes would affect tax collection.

Democrats have criticized Treasury’s efforts to cripple the inversion rules. Senator Ron Wyden of Oregon, the top Democrat on the Senate Finance Committee, has said the regulations should be made more stringent and weakening them could allow more corporations to cheat on their taxes.

In a statement on Thursday, Wyden said, “The corporations that got a massive taxpayer handout are getting another gift from Donald Trump. The Obama administration had essentially shut down inversions — transactions whose only purpose is to help big multinational corporations move overseas to avoid paying taxes. Weakening these rules only provides an opening for corporations to again dodge their taxes.”

— Laura Davison, Allyson Versprille and Isabel Gottlieb
Bloomberg News