Inversion Rules Won't Stop Some Kinds of Deals

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April 6 — The Treasury Department's tough new guidance to curb inversions and earnings stripping won't stop some kinds of deals, practitioners and academics said.

Meanwhile, the Senate Finance Committee chairman is looking into the Obama administration's authority to issue the rules, saying questions exist about proposed and temporary regulations, which come as the U.S. has struggled to stop massive inversions where companies have structured their transactions around existing laws.

Many have said the language intended to stop companies from “stripping” income out of the U.S. casts a broad net that will catch many common planning transactions and affect all foreign companies doing business in the U.S.

But academics and practitioners told Bloomberg BNA April 6 that, while the rules take positive steps, they won't fully combat many deals that erode the U.S. tax base (65 DTR GG-1, 4/5/16).

Hatch: No Definite Answers

Their comments come as Senate Finance Committee Chairman Orrin G. Hatch (R-Utah) says he is looking at Treasury's authority to issue the guidance, which effectively derailed a $160-billion inversion involving Pfizer and Allergan Plc., but is taking a less definite stance on their legality (see related story in this issue).

Hatch's comments were less pointed a day after he said that Treasury might have been in the wrong. He said when asked: “They may have the authority. It's one of the questions you wonder about.”

“I've looked at it and there's, you know, some people argue they don't have the authority. They will argue that they do,” Hatch said.

White House spokesman Josh Earnest said April 5 that the administration is confident the law is on its side.

‘Combing Through It.’

A top Hatch aide told Bloomberg BNA April 6 that the Finance chairman continues to scrutinize the regulations closely. “The reg is over 200 pages and our folks are combing through it, so I don't think we're in a position to say that it is illegal,” Hatch communications director Julia Lawless said in an e-mail. “But attempts on this have been made for 47 years and nothing has ever come to fruition.”

A tax lobbyist familiar with the new regulations said they go way beyond the intent of tax code Section 7874, which was created in 2004 to limit inversions. “The intent was not to stop mergers and acquisitions,” the person said. “Just because you can do something, doesn't mean you should. Treasury is going overboard with this.”

The lobbyist called the new regulations a leap of faith.

Some Deals Still OK

Even though the earnings stripping rules do cut out some of the deals that caused Treasury to issue the guidance, some transactions are still on the table, academics and practitioners said.

The guidance reaches many common structures where U.S. multinationals use the tax benefits of debt in their planning, changing the landscape for these companies by creating broader circumstances where that debt could be converted to equity (66 DTR G-7, 4/6/16)

For example, Edward Kleinbard, law and business professor at the University of Southern California Gould School of Law, said the rules don't reach a decision by a foreign parent to fund a new acquisition through a U.S. subsidiary using a high amount of debt.

He told Bloomberg BNA April 6 that it would be better for Congress to fix the issues Treasury took on, with easier technical fixes and “no possible controversy about the ultimate legitimacy of the new rules.”

‘Better Off.’

However, “Congress has shown itself to be unwilling to honor its obligation to invest in the routine maintenance of the tax code to yield the revenues on which we rely and to run a system that we all can regard as fair,” he said, and the administration had to act.

“While I think Treasury took an ambitious view of its authority to do so, and while I think that the regulations are mind-numbingly complex, I ultimately conclude that we are better off for Treasury's actions,” he told Bloomberg BNA.

Bret Wells, an associate law professor at the University of Houston Law Center, said “The earning stripping regulations are an important milestone because they finally recognize that inversions are not the problem but a symptom of a larger inbound base erosion problem.” The rules deal with all inbound foreign related-party transactions that arise from a common fact pattern.

Some Related-Party Debt Escapes

However, because they don't deal with all related-party debt, he said, “they create a definitional game that will be played out over time.”

According to Wells, the rules do nothing to address other forms of base erosion and profit shifting, such as intellectual property migration strategies, related-party leasing, supply chain restructuring and related-party services, among others. “Thus, the guidance does not holistically address the problem,” he said.

However, he said, the guidance is welcome because it “finally shows that the IRS is not dealing with inverted companies as a standalone problem,” he said.

Not Far Enough?

One attorney told Bloomberg BNA April 6 that he thinks Treasury could have gone further using the authority it has. Charles Kolstad, counsel at Venable LLP, said it is tough to understand why the government didn't go after the same deals for privately held companies that it is trying to stop in publicly traded corporations.

“I understand what they're trying to accomplish,” he said. “It's clear the rules were aimed at a selected group of transactions. But why there should be a difference in the theoretical treatment of the same transaction isn't clear. I don't think there's anything that says there should be a different set of rules for publicly traded companies than for privately held companies. They do the same thing.”

Authority Questioned

Paul Schmidt, chair of tax at Baker Hostetler, said the authority question is tough because the Internal Revenue Service crafted the earnings stripping provisions under tax code Section 385—where the grant of power is broad.
However, that code section calls for a balancing of factors in determining what is debt and what is equity, he said. Treasury's approach in this area, particularly as it applies to related-party debt, “seems to go beyond what the statute has in mind,” Schmidt said in an April 6 interview.

The guidance “departs in large measure from standards that have been relied on for decades,” he said. “You have to wonder whether Treasury has gone too far, beyond interpretation and into actual law-making. There's a question of whether it is an appropriate exercise of authority to make such broad changes.”

The rules specifically targeting inversions were issued as proposed rules (REG-135734-15) that cross-reference final and temporary regulations (T.D. 9761). The regulations on earnings stripping came in proposed form (REG-108060-15).

With assistance from Aaron Lorenzo in Washington.

To contact the reporter on this story: Alison Bennett in Washington at and Kaustuv Basu in Washington at
To contact the editor responsible for this story: Brett Ferguson at