A pair of Democratic senators said they intend to close loopholes in the corporate inversion tax rules that encourage multinational corporations to move their headquarters outside the U.S. by acquiring a company overseas.

The practice was recently highlighted by news that the pharmaceutical giant Pfizer is seeking to cut its taxes by proposing a hostile takeover of a rival drug maker, AstraZeneca, which is based in the United Kingdom (see Pfizer Bids for U.K. Address as U.S. Tax Reform Stalls). Sen. Carl Levin, D-Mich., who chairs the Senate Armed Services Committee and the Senate Permanent Subcommittee on Investigations, has introduced a series of bills in recent years aimed at preventing U.S. corporations from using offshore tax havens, and he released a statement Thursday warning that he and his colleagues plan to introduce a bill focused on inversions.

“I’ve long been concerned about inversions—companies moving offshore on paper, for tax purposes, while the management and operations remain in the United States,” said Levin. “It’s become increasingly clear that a loophole in our tax laws allowing these inversions threatens to devastate federal tax receipts. We have to close that loophole. I am talking to my colleagues about legislation to close the loophole, which I intend to introduce soon. Companies that exploit this loophole benefit from the protections and services the federal government provides, including patent protection, research and development tax credits, national security and more; they shouldn’t be allowed to shift their tax burden onto others.”

Sen. Ron Wyden, D-Ore., who chairs the Senate Finance Committee, wrote an opinion column for The Wall Street Journal indicating that he wants to curb corporate inversions as part of a larger tax reform overhaul that would include lowering the corporate tax rate. “Legal or not, this loophole must be plugged,” Wyden said Thursday. “Current law requires that U.S. companies reincorporating overseas must ensure that at least 20 percent of their stock is owned by their new, foreign partner. As chairman of the Senate Finance Committee, I am committed to raising this floor to at least 50 percent for all inversions taking place from May 8, 2014, on. I don’t approach retroactivity in legislation lightly, but corporations must understand that they won’t profit from abandoning the U.S.”

Wyden pointed out that approximately 50 U.S. companies have leveraged the inversion tactic over the past 50 years and more than 20 have done so in the past two years. He would like to lower the corporate tax rate to 24 percent from its current high of 35 percent to discourage U.S. companies from moving overseas. “Comprehensive tax reform will entice leading companies to invest further in the U.S. and reduce the ability, as well as the need, to manipulate the system,” he said. “I’m committed to making this happen and including changes in the inversion rules as part of a tax overhaul. Tax reform is a heavy lift and won’t be done overnight, but it has been done before and it can be done again.”

Wyden said that over the next few months, he will be working closely with other members of the Senate Finance Committee to delve into the areas necessary for modernizing the Tax Code, including international taxes, building on the tax reform efforts of House Ways and Means Committee chairman Dave Camp, R-Mich., and Wyden’s predecessor, former Senate Finance Committee chairman Max Baucus, D-Mont.

Patrick Cox, a partner at the law firm Withers Bergman, also sees the high U.S. corporate tax rate as one of the main culprits behind corporate inversions.   

“Companies are concerned about their nominal tax rate,” said Cox. “In the U.S. it is amongst the highest in the world, at 35 percent. Therefore companies are motivated to try to find a jurisdiction in which their corporate tax rate would be lower, which is not difficult to do.”

He pointed out that inversion transactions have been going on for decades, including companies such as Tyco and Arthur Andersen’s former consulting arm, which was renamed Accenture. Cox noted that the rules have evolved over the years in Sections 367 and 7874 of the Tax Code to require companies to demonstrate real business substance in such transactions so they aren’t purely for tax purposes. Those include requiring there to be activities in the foreign jurisdiction, or a certain amount of ownership in the entity by foreign owners. Those rules continue to evolve, including a new notice that came out from the IRS late last month, Notice 2014-32, promising to further clarify the rules relating to triangular reorganizations involving foreign corporations, commonly known as the “Killer B regulations” (see IRS Modifies ‘Killer B Regulations’).

“People have been doing inversion transactions since the ’90s,” said Charles Kolstad, counsel with the law firm Venable LLP. “Then in 2004, in response to a number of inversions where people moved their headquarters offshore to a Cayman Islands or Bermuda holding company, but all the management was left in New York or Boston or Philadelphia or wherever, they enacted this code section, Section 7874. The IRS has issued a variety of regulations at different points in time under it in efforts to keep up with the ingenuity of the tax bar in continuing to do inversion transactions anyhow. Recently the IRS announced a new set of proposed regulations that are going to be effective as of Jan. 1, 2015. It would make it increasingly more difficult for U.S. companies to invert without have significant adverse tax consequences or being treated as remaining in the U.S. taxpayers, even though they’re now foreign. So I think we’re going to see a number of people doing things in response to that to try to get their transactions completed before the end of the year.”

President Obama’s 2015 budget proposal has also envisioned changes to Section 7874 that would result in more U.S. companies being prevented from doing an inversion, lowering the percentage of U.S. owners that would cause the newly constituted foreign corporation to be treated as a U.S. corporation for U.S. tax purposes, Cox pointed out. Instead of the current 80 percent threshold, the proportion would fall to 50 percent, so if even 51 percent of the stock owners were from the U.S. after the transaction, the company would still be treated as a U.S. corporation for tax purposes. The proposal also would treat the corporation as a U.S. company if it is still managed from the U.S.

“The commentators believe that would have a chilling effect on financial centers in the U.S. like New York, and various congressmen from New York obviously would not be too happy about the idea of accelerating executive flight,” said Cox. “There have already been a large number of executives and other high net worth individuals who left the United States in 2013, more so than in recent history.”

Nearly 3,000 people renounced their citizenship last year, according to the IRS, and in the first quarter of this year, over 1,000 U.S. citizens and long-term residents have renounced.

The latest IRS corporate tax proposals would have implications for both public and private companies. “Under the proposed rule, if after the merger U.S. shareholders own more than 50 percent of the company, then you would be treated as being U.S. and therefore the whole purpose would be defeated,” said Kolstad. “When you’ve got publicly traded companies, their ownership base tends to be broadly distributed, so for a publicly traded company to meet the 50 percent threshold, it might be more complicated, whereas in the privately held case you know who your shareholders are, and you can be clearer that they’re all in the country. The approvals of getting the transaction done are easier.”

The U.S. isn’t the only country trying to prevent corporations from dodging taxes. The Organization for Economic Cooperation and Development has been developing an action plan in an effort to reduce base erosion and profit shifting, or BEPS, by multinational corporations using tax strategies such as transfer pricing. The U.S. and many other countries, particularly in Europe, have signed on to the OECD efforts. But Cox pointed out that those proposals are years away from being implemented.

“To the extent that there’s rate arbitrage, there will continue to be companies that look to exploit the rules to their advantage to try to achieve the lowest effective tax rate,” said Cox. “It’s something that makes business sense to do that. To the extent that it’s consistent with what they do as a business, there should be nothing illegal or disparaging to be said about a company that’s trying to operate on a global basis in the most tax efficient way that they can. The BEPS, the base erosion and profit shifting, action plan from the OECD is going to be ongoing for a number of years. They’re making some progress, but essentially they’re going to get arguably everyone within the E.U. to get on board with that and probably non-E.U. I think they’ve got the G-20 plus maybe six or seven others that have signed up for it, but signed up for what at this point? There’s nothing that has come of that yet. There are some deadlines that are coming up, but I think the plan goes out for another couple of years, until 2016, on the timeline that things will happen between now and then. But they are moving at a glacial pace.”

Meanwhile, U.S. companies are likely to continue to look abroad for lower tax rates. “There’s an enormous compliance burden for large U.S. multinationals with significant non-U.S. operations to have to comply with all of the U.S. reporting requirements,” said Kolstad. “A lot of people that have significant non-U.S. operations are going to be looking at merger inversion as a way of trying to get out of the U.S., and not have to deal with Subpart F rules, the ongoing compliance burdens, transfer pricing issues and all the rest of it.”

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