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Nov. 20 — The provision in new IRS anti-inversions guidance making it more difficult for companies to restructure their operations through lower-tax third countries carries a big wallop and shows the government is broadly interpreting its legal authority to close down these deals, practitioners told Bloomberg BNA.
“There was never before a limitation on where the target corporation was located,” Paul Schmidt, managing partner and chair of tax at Baker & Hostetler LLP, told Bloomberg BNA Nov. 20. “Until now, the jurisdiction of the target corporation has never been a problem.”
The third-country provision was among a host of changes in Notice 2015-79, released by the Internal Revenue Service and the Treasury Department Nov. 19, that are intended to make it less attractive to engage in transactions allowing U.S. companies to move to lower-tax domiciles through mergers. The measure is designed to stop companies from cherry-picking a tax-friendly country for their tax residence, though it wouldn't apply to recent high-profile deals, such as the proposed merger of Ireland-based Allergan Plc and New York's Pfizer Inc. (224 DTR GG-1, 11/20/15).
Third-Country Provision a Surprise
Schmidt and other practitioners said this provision is eye-opening and likely to have a broad, immediate effect on the ability of U.S. companies to combine with foreign entities when the new parent is located in a third, lower-tax country.
“I think it could be very, very impactful,” Schmidt said. “I do think that there has been an appetite” for cross-border mergers and activities “where inversions have made a deal attractive,” he said. “I think that will slow down because of the potential target company not being in the right jurisdiction.”
John Harrington, a partner with Dentons US LLP, told Bloomberg BNA Nov. 20 that the third-country rule was “surprising.” While existing regulatory authority gives the government a lot of leeway, “this change seems to be the kind more appropriately made by legislation rather than regulation,” he said, with the administration on “shaky ground” because Congress has subjected some structures to the inversion rules and not others.
Joseph Calianno, partner and international technical tax practice leader at BDO USA LLP, said the government may have gone too far in assuming all of these transactions are done to avoid taxes. “I think they're interpreting their authority very broadly,” he said. “There can be non-tax reasons for choosing a third country.”
Both Calianno and Philip West, chairman of Steptoe & Johnson LLP, said this and other provisions in Notice 2015-79 seem to be very carefully targeted.
“Obviously Treasury and the Service were looking very specifically at situations that gave them pause, things that they believe are either untenable or should be untenable,” West said in a Nov. 20 interview. “The detail of the notice suggests they had in front of them the positions that were being taken.”
Impact Still Unclear
While the guidance was issued amid plans for Allergan and Pfizer to merge, which would create the largest inversion in U.S. history, West said it is his understanding that the ownership percentage involved in that deal is less than 60 percent—while the new third-country measure “only bites” in deals involving more than 60 percent ownership.
However, he said, it's clear that the provision is aimed, at least in part, at inversions structured through Ireland. Taken as a whole, it's unclear exactly what impact the notice will have on the world of inverted companies, given that the majority of the notice is prospective, he told Bloomberg BNA.
Still, “there are any number of inversions on the board that have not closed yet, and all of them could be affected,” West said. “Every transaction is going to stand on its own. The history of inversions is the history of a cat and mouse game.”
Earnings Stripping ‘Up in the Air.'
Mitch Thompson and Don Moorehead, both tax partners with Squire Patton Boggs US LLP, said Nov. 20 that the fact that earnings stripping wasn't addressed in the notice leaves taxpayers up in the air. Even though Treasury Secretary Jacob J. Lew vowed Nov. 19 that it remains high on the government's agenda, “We really need a lot of certainty,” Thompson said.
West said despite the fact that earnings stripping is “actually the easiest thing to do,” and much less complex than other things in the notice, there's still a question of how much Treasury will be able to accomplish with the authority it currently has.
He noted that several proposals in Congress to address earnings stripping have been much broader than proposals the administration has made in its annual budget.
Capitol Hill Action Needed
Nearly all the practitioners interviewed by Bloomberg BNA said it remains clear that there are changes Treasury can't make without legislation—a point emphasized by Lew in issuing Notice 2015-79.
Jeffrey Paravano, managing partner at Baker & Hostetler, said the best hope is for Congress to undertake a tax overhaul that would lower the corporate tax rate, put a territorial system in place and otherwise reduce the economic incentives for companies to leave the U.S. However, that will take time, and in the interim, “I'd be surprised if the Hill was willing to do much.”
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