The Treasury Department issued temporary regulations to curb corporate tax inversions while continuing to call on Congress to pass legislation to limit the ability of companies to merge with foreign partners to avoid taxes.
The new rules also address earnings stripping, a technique used by some companies to minimize their taxes after an inversion.
“For years, companies have been taking advantage of a system that allows them to move their tax residences overseas to avoid U.S. taxes without making significant changes in their business operations,” Treasury Secretary Jacob Lew said during a conference call with reporters Monday. “After an inversion, many of these companies continue to take advantage of the benefits of being based in the United States—including our rule of law, skilled workforce, infrastructure, and research, and development capabilities—all while shifting a greater tax burden to other businesses and American families."
The Treasury Department has taken action twice before to make it harder for companies to invert and reduce the economic benefits of doing so. Lew believes those actions helped slow the pace of inversion transactions, but he noted that the Treasury has been continuing to explore its administrative authority to address inversions, including potential guidance on earnings stripping, while waiting for Congress to pass legislation.
“Today, we are taking further action to make it more difficult to invert,” said Lew. “Some companies are serial inverters. They acquire multiple U.S. firms in stock-based transactions over a short period of time. This increases their size and reduces the negative tax consequences of a subsequent inversion. Today’s action takes away a significant amount of the tax benefits of these serial inversions.”
Among the targets is the use of earnings stripping by companies, focusing on transactions that generate large interest deductions by transferring debt between subsidiaries without financing new investment in the United States.
The Treasury is also issuing formal regulations implementing its previous two inversion actions in order to carry out the original intent of the notices.
“We will continue to explore additional ways to limit inversions,” said Lew. “But only new anti-inversion legislation can stop these transactions. Until that time, creative accountants and lawyers will continue to seek new ways for companies to move their tax residences overseas and avoid paying taxes here at home.”
He urged Congress to take action, saying the best way would be to enact comprehensive business tax reform with specific anti-inversion provisions. The Treasury also released an updated framework on business tax reform on Monday describing the key elements of President Obama’s approach to reform and detailing the specific proposals the administration has put forward, including a comprehensive approach to reforming the international tax system to serve as a guide for future action.
“While that work goes on, Congress should not wait to act as inversions continue to erode our tax base,” said Lew. “Only congressional action can fully address inversion transactions, and I urge Congress to act this year.”
The new rules issued Monday aim to limit inversions by disregarding foreign parent stock attributable to recent inversions or acquisitions of U.S. companies. This would prevent a foreign company (including a recent inverter) that acquires multiple American companies in stock-based transactions from using the resulting increase in size to avoid the current inversion thresholds for a subsequent U.S. acquisition.
To address earnings stripping, the regulations target transactions that generate large interest deductions by simply increasing related-party debt without financing new investment in the United States. The new rules would allow the IRS during an audit to divide debt instruments into part debt and part equity, rather than the current system that generally treats them as wholly one or the other.
The Treasury’s new rules would facilitate increased due diligence and compliance by requiring certain large corporations to do up-front due diligence and documentation with respect to the characterization of related-party financial instruments as debt. If these requirements are not met, instruments would be treated as equity for tax purposes. The Treasury also formalized on Monday its two previous actions on inversion in September 2014 and November 2015.
Rep. Lloyd Doggett, D-Texas, a senior member of the tax-writing House Ways and Means Committee, praised the Treasury’s action. Earlier this year, he led a group of lawmakers in writing a letter to Lew urging the Obama Administration to use its executive authority to deny the tax benefits of corporate inversions.
“Having made the initial Congressional request for Treasury to use its existing authority to prevent tax dodging shenanigans by Pfizer and others, I am pleased that Treasury has acted,” Doggett said in a statement Monday. “While this tax guidance is not as thorough as it should be, I hope that it will discourage serial inverters like Allergan and thereby the Pfizer merger. Asking this Republican Congress to act against corporate tax cheats is no substitute for comprehensive Administration action to stop corporations from avoiding taxes by renouncing their American charters while retaining the benefits of being American.”
In February, Rep. Sander Levin, D-Mich., the ranking Democrat on the House Ways and Means Committee, and House Budget Committee ranking member Chris Van Hollen, D-Md., introduced legislation – the Stop Corporate Earnings Stripping Act – to reduce the number of tax inversions by limiting the use of “earnings stripping.”
Levin and other House Democrats also previously introduced legislation – the Stop Corporate Inversions Act ( H.R. 4679 in 2014, H.R. 415 in 2015) – to amend Section 7874 of the tax code to tighten restrictions on inversions. The Joint Committee on Taxation estimates that the legislation would save the U.S. tax base nearly $41 billion over 10 years.
“Today's announcement shows that the Administration remains committed to stopping tax-motivated inversions by U.S. corporations,” said Levin in a statement. “It’s past time for Republicans in Congress to show the same commitment. Today’s announcement by the Treasury Department would make it more difficult for companies to engage in earnings stripping, something Rep. Van Hollen and I also addressed in legislation we introduced in February. As Secretary Lew repeated yet again, Treasury can only go so far – Congress must act now to stop inversions once and for all.”
Senate Finance Committee ranking member Ron Wyden, D-Ore., also issued a statement on the Treasury Department’s new guidance on tax inversions. “Tax games continue to plague our economy,” said Wyden. “Treasury’s actions today to address the inversion virus are another step in the right direction, but only Congress can cure the disease. I’m working on a proposal that cracks down on inversions and tax games as we work towards a broader cure.”
House Ways and Means chairman Kevin Brady, R-Texas, was more critical of the Treasury Department's actions. “Instead of unveiling commonsense policies to help American employers compete globally and create new jobs for our workers, the Obama Administration just announced punitive regulations that will make it even harder for American companies to compete and will further discourage businesses from locating and investing in the United States,” he said. “This approach continues to be a misguided, missed opportunity that will hurt American workers and their families. While I’m pleased the Administration continues to stress the need for tax reform, it’s clear the minor updates they have proposed to their existing framework still aren’t what is needed to fix our broken tax code. Ways and Means members will continue to move forward on a bold, pro-growth tax agenda that finally improves our economy and helps the American people."
Senate Finance Committee chairman Orrin Hatch, R-Utah, also expressed some skepticism. “The administration continues to tinker along the regulatory edges with unilateral proposals to address the symptoms of inversions, but not the disease,” Hatch said. “Proposed regulations aimed at curbing earnings stripping may limit some incentives of inverting, but it will not prevent companies from restructuring for tax purposes. Such proposals paired with a business tax reform framework that lacks substantive details on how to achieve bipartisan reform goals put into question its effectiveness in fully addressing the problem. A better approach would be for the administration to work with Congress in good faith to address the disease causing our companies to move offshore: our outdated tax code that burdens our job creators with the highest corporate tax rate in the developed world. A comprehensive tax overhaul that reduces the rate, transitions to a territorial tax system with base erosion protections, and addresses earnings stripping will equip American businesses with the certainty they need to invest in a future here at home. While I will carefully scrutinize this latest proposal from the administration, if we want to make our tax system globally competitive, we need a strong partner in the White House that is more interested in creating real bipartisan results to address the disease of inversions than issuing unilateral band aids that only attempt to alleviate the symptoms.”
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