Lew Takes On Inversions

Treasury Secretary Jacob Lew proposed administrative rules this week that would limit the benefits of tax inversions, where companies move their headquarters overseas for tax reasons. The rules target abusive practices where deals were often structured solely to skirt U.S. tax law. They eliminate some incentive for companies to invert, but many of the basic incentives to invert will remain until fundamental tax reform passes Congress and is signed by the President. 

Recent months have seen a wave of actual and proposed corporate "tax inversions," where U.S. companies merge with a foreign corporation to move their headquarters overseas and avoid the high statutory U.S. tax rate on corporate income. Inversions are estimated to cost about $20 billion in lost corporate tax revenue over the next ten years. The Obama Administration had been pushing for legislation to address the issue, but after Congress left town for campaign season without addressing the issue, the Treasury Department moved forward in areas where they believe they have clear legal authority.

While the proposal reduces some benefits to inversions and may cause some companies to rethink their plans, inversions are a small symptom of an outdated tax code.

As CRFB President Maya MacGuineas said in a statement:

The most effective way to stop inversions and address a host of other problems will be to enact comprehensive tax reform that broadens the tax base, lowers rates, and creates a competitive international tax system in order to help grow the economy and build jobs at home.

The proposal makes changes in two broad areas. First, it limits the use of procedures that allowed inverted companies to bring foreign income back to the U.S. without paying the tax they would normally owe.  Inverted companies were able to circumvent these rules through "hopscotching" and "de-controlling," which let them repatriate funds tax-free through loans and stock purchases. The new rules would prevent companies from receiving any tax benefit from these procedures.

Second, the proposal makes it harder for companies to circumvent existing limits on inversions. Since 2004, a company loses all tax benefits of inversion if the new inverted company was owned by largely the same people before the merger (if the original shareholders owned at least 80 percent of the new firm). Treasury could not change the percentage threshold (as a proposal by Sen. and Rep. Levin would), which is written into law. However, the new rules prevent companies from getting around the 80 percent limit by either counting unused assets to artificially inflate the size of the foreign company or paying massive dividends to artificially decrease the size of the U.S. company.

These regulations apply to deals finalized after September 22, so deals still being discussed will be affected. The Treasury department indicated that any future administrative action will affect the same group of inversions.

The proposed rule differs from many of the legislative proposals circulating in Congress. It does not place additional limits on "earnings stripping", as the Schumer-Durbin legislation would do. Companies can still use the procedure to take massive loans from their parent company to gain interest deductions here and move income overseas. Lew left the door open for future administrative action on earnings stripping.

Finally, the proposal does not change the basic math of an inversion. Although it limits the tax benefits for the most flagrant tax avoidance, the basic benefit of inversions is still the same: companies will no longer pay tax on their worldwide income. When merging, companies still have an incentive to choose the foreign headquarters.

In the final analysis, the new regulations may help reduce the number of inversions and their cost to the federal government. But legislation would be necessary to more seriously address the issue. These rules are not a substitute for the Administration and the Congress coming together to do the hard and important work of fundamental tax reform.

Related Posts