(Bloomberg) The Treasury Department announced steps that will make it harder for U.S. companies to move their addresses outside the country to reduce taxes, clamping down on the practice known as inversions.
The rules, which apply to deals that close starting today, include a prohibition on “hopscotch” loans that let companies access foreign cash without paying U.S. taxes, and impose new curbs on actions that companies can use to make such transactions qualify for favorable tax treatment.
The changes will have the biggest effect on eight U.S. companies with pending inversions, including Medtronic Inc. and AbbVie Inc., which plan the two largest such deals in U.S. history. In its purchase of Covidien Plc, Medtronic is loaning some of its untaxed profits outside the U.S. to its new Irish parent company, and that transaction could be penalized by the new anti-hopscotch rule.
Treasury stopped short of making the rules retroactive to deals that have been completed.
Companies already reaping the benefits of a foreign tax address will face minimal changes except the risk of a second round of Treasury rules affecting maneuvers they use to reduce taxes on income earned in the U.S.
Even without more authority from Congress or aggressive steps that former government officials had advocated, the new rules are expected to give companies and their advisers pause and require recalculation of some pending deals. President Barack Obama and Treasury Secretary Jacob J. Lew have urged Congress to pass a bill that would curtail inversions.
“We’ve recently seen a few large corporations announce plans to exploit this loophole, undercutting businesses that act responsibly and leaving the middle class to pay the bill,” Obama said in a statement today. “I’m glad that Secretary Lew is exploring additional actions to help reverse this trend.”
Lew told reporters on a conference call today that he wanted to make companies think twice before considering inversions, in which companies seek foreign addresses though their executives and major operations remain in the U.S. He said Treasury is reviewing other actions it can take.
“This action will significantly diminish the ability of inverted companies to escape U.S. taxation,” Lew said. “For some companies considering deals, today’s action will mean that inversions no longer make economic sense.”
The changes may cause complications for companies including Medtronic that are counting on the benefits of tax-free access to foreign cash. Among the eight pending inversions is Burger King Worldwide Inc.’s planned merger with Tim Hortons Inc., which would put the combined company’s headquarters in Canada. Another inversion involving Horizon Pharma Inc. closed on Sept. 19.
Medtronic said in a statement today, “We are studying Treasury’s actions. We will release our perspective on any potential impact on our pending acquisition of Covidien following our complete review.”
Edward Kleinbard, a tax law professor at the University of Southern California, said in an e-mail that Treasury “has taken a very hard line on these transactions.”
He cited the government’s “very broad reading of its regulatory authority to address inversion deals involving accessing offshore cash” as well as “not grandfathering deals that are announced but not closed.”
Lew, who said in July that Treasury lacked authority to stem inversions, reversed himself in August and the administration began studying its options. In recent days, Lew said the department was completing its work.
Under current law, U.S. companies that invert through a merger are still treated as domestic for tax purposes if the former U.S. company’s shareholders own more than 80 percent of the combined company. The administration wants to reduce that 80 percent to 50 percent; that requires legislation.
In the absence of legislation, the Treasury Department looked for ways to make it harder for companies to get around the 80 percent limit.
The rules announced today seek to limit so-called spin-versions, in which U.S. companies spin off units into a foreign company.
It also would restrict the use of a technique known as skinnying down, in which companies make special dividends to reduce their size before a merger to meet the current law’s requirements. U.S. companies would be less able to seek out so-called old and cold foreign companies with cash and other passive assets as merger partners to meet the rules.
Other changes announced in the rules would make it harder for inverted companies to relinquish control of their foreign subsidiaries to get them out of the U.S. tax code’s orbit. U.S. companies must pay taxes when they repatriate foreign profits.
The changes to those control provisions and the hopscotch rules would apply to inversion deals where the former U.S. company’s shareholders own 60 percent to 80 percent of the combined business.
Investors have been watching for signs of what the Treasury would do because the changes could penalize or unravel some of the pending inversion deals.
Terry Haines, a policy analyst with ISI Group LLC, said Treasury risks exceeding its authority and may face a legal challenge from companies with pending inversions that are made invalid by the changes.
A senior Treasury official, speaking on condition of anonymity to discuss the development of the rules, told reporters today that the department’s actions were well-grounded in the statutes and their anti-abuse provisions.
Scott Bonikowsky, a spokesman for Tim Hortons, didn’t immediately respond to messages seeking comment. Burger King, based in Miami, declined to comment.
E-mails and calls to spokesmen at Mylan Inc., AbbVie Inc. and Pfizer Inc. after business hours weren’t immediately returned. Mylan and AbbVie have inversion deals pending. Pfizer’s bid for London-based AstraZeneca Plc failed in May though CEO Ian Read has said he is still looking for an inversion opportunity.
Lawmakers, who left Washington to campaign for the Nov. 4 election, haven’t shown much interest in writing bipartisan legislation to curtail inversions. Most Republicans say the issue should be addressed as part of a broader revamp of the U.S. tax code.
“We’ve been down this rabbit hole before, and until the White House gets serious about tax reform, we are going to keep losing good companies and jobs to countries that have or are actively reforming their tax laws,” Representative Dave Camp of Michigan, the Republican chairman of the House Ways and Means Committee, said in a statement.
“I fear this administration is only interested in doing the bare minimum—just enough to say they care,” Camp said.
The U.S. corporate income tax rate is 35 percent, and the U.S. is one of few industrialized nations that imposes its corporate tax on the foreign income of companies based in the country.
Those rules—along with the ability of inverted companies to reduce U.S. taxes on their future income—have made inversions attractive to companies.
The congressional Joint Committee on Taxation has estimated that legislation to curb inversions would raise about $20 billion over the next decade.
—With assistance from Drew Armstrong and Zachary R. Mider in New York and Kasia Klimasinska in Washington.
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