Treasury Targets Inversions, Earnings Stripping in New Rules

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By Alison Bennett

April 4 — The Treasury Department took another major step to put more limits on corporate inversions, where U.S. companies change their tax residence to cut or avoid U.S. taxes, issuing long-awaited guidance that also targets earnings stripping.

The proposed, final and temporary rules—which could take away the benefits of some recent deals—come as the U.S. has struggled to stop massive inversions where companies have structured their transactions around existing laws.

In an April 4 conference call with reporters, Treasury Secretary Jacob J. Lew said among other things, the government is seeking to stop companies from undertaking serial inversions and getting big tax benefits from certain recent transactions.

Treasury issued the rules as Pfizer Inc. and Allergan Plc are working on a $160 billion inversion, the biggest in U.S. history.

Recent Inversions Targeted?

A senior Treasury official, also on the media call, declined to comment on whether the guidance is designed to take aim at specific deals. Pfizer and Allergan issued a statement April 4 that they won't speculate on any potential impact of the guidance until they finish a review of the rules.

Lew stressed on the call that Treasury can't fully solve the issue of inversions without action by Congress. He said the best way to curb these deals is to overhaul the nation's business tax system, releasing “The President's Framework for Business Tax Reform: An Update.”

While lawmakers are working on that, however, the Treasury official said Congress shouldn't wait to stop companies from transactions that reduce the U.S. tax base.

The White House April 4 said President Obama is pleased by the Treasury action. The statement urged support for the administration's budget proposal “to fully close the loophole that allows for corporate inversions.”

Rules Intended to Implement Notices

The proposed rules (REG-135714-15, RIN 1545-BM45) cross referencing final and temporary regulations (T.D. 9761, RIN 1545-BM88) put into more formal guidance two previous notices to curb inversions.

Among several actions, the guidance would disregard stock of foreign parent companies that can be attributed to some recent inversions or acquisitions of U.S. companies.

The agency said in a fact sheet that this provision is intended to stop foreign companies—including recent inverters—from increasing their size in order to avoid the inversion threshold for a subsequent acquisition of a U.S. company.

Bigger Steps

This provision goes beyond Treasury's previous guidance to stop inversions, including Notice 2014-52 and Notice 2015-79

In another major step under tax code Section 385 (REG-108060-15, RIN 1545-BN40), the guidance takes aim at transactions designed by companies to “strip” income out of the U.S. by:

  • curbing transactions that increase related-party debt if it doesn't finance new investment in the U.S.;
  • allowing the IRS to take action during audits to divide a purported debt instrument into part debt and part stock; and
  • requiring members of large corporate groups to document their actions, including key information for analyzing how debt and equity is handled for tax purposes.
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    Action Under Section 385 `Surprising.'

    One member of the private sector said the rules were highly significant, but the government's decision to crack down on earnings stripping via Section 385 was surprising.

    This is “mainly because the IRS and Treasury had refrained using authority under Section 385 in its first three rounds of anti-inversion guidance,” John Harrington, a partner at Dentons USA LLP, told Bloomberg BNA April 4.

    He said the fact that the administration released its updated plan for overhauling the business tax system along with inversions guidance “shows the extent to which the administration views its anti-inversion and other guidance as part of its view of a reformed tax code.”

    Party-Line Reaction

    The Treasury action got resounding praise from congressional Democrats, who also stressed the need for action by lawmakers and called on Republicans to move legislation forward.

    “It’s past time for Republicans in Congress to show the same commitment” as the administration, Rep. Sander Levin (D-Mich.), ranking member of the House Ways and Means Committee, said in an April 4 statement. He urged action on the Stop Corporate Earnings Stripping Act, which he sponsored with Rep. Chris Van Hollen (D-Md.).

    Senate Finance Committee member Sen. Charles E. Schumer (D-N.Y.), called the Treasury action “a great step forward.” He said it will make potential inverters and foreign acquirers “think twice before making the leap, and those bad actors should be on notice that we intend to clamp down even further” with legislation.

    Sen. Richard J. Durbin (D-Ill.) added his voice, urging that “now it’s time for Congress to permanently close these loopholes in law.”

    At the other end, Republicans said the rules would only hurt businesses and make the economy less competitive.

    “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,” House Ways and Means Committee Chairman Kevin Brady (R-Texas) said in a statement.

    Meanwhile, Senate Finance Committee Chairman Orrin G. Hatch (R-Utah) said he will “carefully scrutinize” the administration's business tax overhaul proposal included in the announcement, but the new rules aimed at inversions amount to tinkering “along the regulatory edges.”

    “Proposed regulations aimed at curbing earnings stripping may limit some incentives of inverting, but it will not prevent companies from restructuring for tax purposes,” Hatch warned.

    Nancy McLernon, president and chief executive officer of the Organization for International Investment (OFII), sharply criticized the rules April 4.

    She said the guidance “has the potential to make historic foreign companies that are invested in the United States the collateral damage.”

    McLernon said the action is “a misguided approach that will result in damaging U.S. competitiveness, which may very well be measured in lost jobs, wages and GDP,” with the possibility of hurting 12 million U.S. workers who are supported by foreign direct investment.

    To contact the reporter on this story: Alison Bennett in Washington at abennett@bna.com

    To contact the editor responsible for this story: Brett Ferguson at bferguson@bna.com

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