The Treasury Department’s new steps to curb the tide of corporate inversion deals and the Organization of Economic Cooperation and Development’s recently released recommendations aimed at combating tax base erosion and profit shifting signal increasing momentum in the battle to prevent corporate tax revenues from eroding.
On Monday, Treasury Secretary Jacob Lew announced a series of measures the Obama administration will be taking to discourage U.S. companies from using mergers with foreign companies to reduce their corporate taxes (see Treasury Crackdown Targets Inversions Designed to Limit U.S. Taxes).
“These are transactions in which a U.S. based multinational restructures so that the U.S. parent establishes a foreign tax domicile, in large part to avoid U.S. taxes,” said Lew during a conference call with reporters Monday. “This shifting of a firm's tax address is not the same as a merger driven by business reasons, such as efficiency or expansion. These transactions may be legal, but they are wrong, and our laws should change. To be clear, genuine cross-border mergers make the U.S. economy stronger by enabling U.S. companies to invest overseas and encouraging foreign investment to flow into the United States. But these transactions should be primarily driven by genuine business strategies and economic efficiencies, not a desire to shift the tax residence of a parent company to a low-tax jurisdiction to avoid U.S. taxes.”
Among the measures targeted by the Treasury is the use of so-called “hopscotch” loans in which a controlled foreign corporation makes a loan to its new foreign parent instead of its U.S. parent in order to get around the rules on taxation of deferred earnings. Another tax strategy that is being targeted is the so-called “decontrolling” strategy to prevent inverted companies from restructuring a foreign subsidiary in order to access the subsidiary’s earnings tax-free.
The Treasury is also moving against the use of so-called “cash boxes,” passive assets such as cash or marketable securities, to artificially inflate the size of the foreign acquirer to get around the requirement that the former owners of the U.S. entity own less than 80 percent of the combined entity. Another technique that will be forbidden is the use of “skinny-down dividends” in which a U.S. entity pays out large dividends in order to reduce its size before the inversion to meet the 80 percent requirement. The Treasury rules also aim to prevent a U.S. entity from inverting a portion of its operations by transferring assets to a newly formed foreign corporation that it spins off to its shareholders, a practice known as “spinversion.”
Lew said he would prefer for Congress to pass comprehensive tax reform legislation, but as that hasn’t happened yet, the Treasury is issuing the new rules.
“Comprehensive business tax reform that includes specific anti-inversion provisions is the best way to address these transactions,” he said. “While that work continues, I have been urging Congress to pass anti-inversion legislation, which is the only way to close the door on these transactions entirely. Now that it is clear that Congress won’t act before the lame-duck session, we are taking initial steps that we believe will make companies think twice before undertaking an inversion to try to avoid U.S. taxes. Inversion transactions erode our corporate tax base, unfairly placing a larger burden on all other taxpayers, including small businesses and hardworking Americans. It is critical that this unfair loophole be closed.”
Sen. Chuck Grassley, R-Iowa, a former chairman of the Senate Finance Committee, who managed to enact a previous set of reforms in 2004 aimed at preventing inversions, issued a statement objecting to the Treasury Department’s new approach. “The Treasury Secretary first said he didn’t have the authority to do something on inversions,” he said. “Now he’s found the authority. That’s consistent with the President’s approach to use his pen and phone instead of working with Congress. Unfortunately, that approach might give the President a short-term gain but it’s bad for the country in the long term. The Obama Administration’s limited action on inversions might take the pressure off for tax reform. Just about everybody agrees comprehensive tax reform is necessary to make U.S. companies more internationally competitive. It’s important for the President to use his bully pulpit to work with Congress on tax reform and help build a consensus on the right approach, yet this President hasn’t done it. That’s too bad because tax reform is something Congress and the executive branch could accomplish instead of jumping from inversion crisis to crisis.”
The Internal Revenue Service issued Notice 2014-52 on Monday detailing the regulations that the IRS and Treasury Department intend to issue with respect to inversion transactions. The IRS said the regulations will (i) for purposes of section 7874 of the Tax Code, disregard certain stock of a foreign acquiring corporation that holds a significant amount of passive assets; (ii) for purposes of sections 7874 and 367, disregard certain non-ordinary course distributions; (iii) for purposes of section 7874, provide guidance on the treatment of certain transfers of stock of a foreign acquiring corporation (through a spin-off or otherwise) that occur after an acquisition; (iv) prevent the avoidance of section 956 through post-inversion acquisitions by controlled foreign corporations (CFCs) of obligations of (or equity investments in) the new foreign parent corporation or its non-CFC foreign affiliates; (v) prevent the avoidance of U.S. tax on pre-inversion earnings and profits of CFCs through post-inversion transactions that otherwise would terminate the CFC status of foreign subsidiaries and/or substantially dilute the U.S. shareholder’s interest in those earnings and profits; and (vi) limit the ability to remove untaxed foreign earnings and profits of CFCs through related party stock sales subject to section 304.
Scott M. Adair, president of the New York State Society of CPAs, said the NYSSCPA is “pleased the Obama Administration has stopped blaming accountants for corporate tax inversions and is rightly placing the responsibility for them with the people who actually determine what is written in the U.S. tax code: members of Congress.
“Announced on Monday, the Treasury Department’s new set of regulations are meant to make inversions less appealing to U.S. companies for the time being; however, we continue to wait for Congress to find some agreement on long-term corporate tax reform,” Adair added in a statement. “Until that time, U.S. corporations will continue to rely on the expertise of certified public accountants to navigate the complexities of the code in order to fulfill their tax obligation according to U.S. laws. “
OECD BEPS Recommendations
The OECD issued its recommendations last week as part of its effort to combat base erosion and profit shifting, or BEPS, by multinationals (see OECD Recommends Approach to Combating Corporate Tax Avoidance and Google-Style Tax Dodging Targeted as OECD Drafts Battle Plan). The initial elements of the action plan focus on helping countries to ensure the coherence of corporate income taxation at the international level, in partr through new model tax and treaty provisions to neutralize hybrid mismatch arrangements.
Tax practitioners are going to need a while to digest all the new rules coming out from the Treasury and the OECD.
“It’s clearly an area that is generating a lot of conversation,” said Doug Wood, an international tax principal at Grant Thornton, in an interview last week about the OECD recommendations.
He didn’t see many big surprises in the OECD recommendations, though he noted that some observers were disappointed that there were no specific rules related to e-commerce.
“I think the view of the BEPS working group there seems to be that that they can adequately address the cross-border tax aspects of the digital economy by looking to already established tax principles and that we don’t necessarily need a new body of rules to deal with something that is viewed by some people as industry centric,” said Wood. “I do think there were some people that were expecting a little bit more formal guidance in that area.”
He sees more attention being paid to corporate tax strategies by government tax authorities and the public in general. “Based on what I’ve seen so far, I don’t see a lot of things running through the BEPS release that would say this particular strategy worked yesterday and it doesn’t work today,” said Wood. “What I would say is that the brighter the light that gets shone on tax planning in general and the more risk that is highlighted as part of that process, I do see a move to being a little more conservative perhaps. From that perspective, I think it is having an impact on the way certain corporate multinationals in the United States as well as their stakeholders view tax planning.”
He pointed to the impact on Starbucks, for example, after its low taxes in the United Kingdom prompted a public outcry and the company offered last year to pay 20 million pounds in taxes that it legally did not owe.
“It was difficult for me to imagine a day five years ago when I would wake up and what I did for a living—international tax planning—would become a conversation among non-tax people,” said Wood. “Now it quite clearly has. It’s been pretty interesting to watch the evolution of this.”
Wood sees the need for such tax reform to take place globally in order to work. “I think there’s a broad-based recognition that in order for a lot of these reforms to truly be effective, it needs to happen sort of on a global stage,” he said. “There needs to be a large measure of consensus, and you can’t have a lot of rogue countries acting outside the bounds of what people think the consensus ought to be. If you look at the difficulties we have in the United States establishing consensus as it relates to tax reform, you could play that out in any number of different ways. If you take that microcosm and blow it up onto the global stage and think that it’s going to be a straightforward exercise to get people to globally buy into this stuff, I think there’s at least cause to be a little skeptical.”
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