New Treasury Department rules aimed at discouraging corporate mergers called inversions have constraints, according to a Congressional Research Service report.
As a result, legislative options remain a possibility, said the report, which discussed a number of bills to address inversions as well as the recently issued regulatory changes and other potential regulations.
Treasury has proposed rules to curb tax-free access to U.S. companies' earnings held overseas and maneuvers to skirt ownership requirements by altering a company's size to receive tax benefits from an inversion. The department explained the scope of the changes in a fact sheet and Notice 2014-52 issued Sept. 22.
“Administrative remedies recently promulgated and under consideration may contribute to policymaking but are limited in their scope, thus legislative measures continue to be under consideration,” the CRS said in the report, released Sept. 29, which largely reprised material from an earlier report.
Treasury Sept. 22 said new rules applying to future deals include a prohibition on “hopscotch” loans that let companies access foreign cash without paying U.S. taxes, as well as language to stop inverted companies from restructuring a foreign subsidiary in order to access its earnings tax-free under §7701(l).
Treasury Secretary Jacob J. Lew said in a conference call announcing the action that because Congress didn't act to stop inversions before the lame-duck session, an administrative solution was needed. Still, the new rules will not outlaw the cross-border merger deals, and Lew called on lawmakers to deliver an anti-inversion bill.
“There are limits to what we can do administratively,” Lew said. Still, Lew said, the rules will diminish the ability of inverted companies to escape U.S. taxation. “For some companies considering deals, today's action will mean that inversions no longer make economic sense,” he said.
To reduce an inverted company's use of earnings held by a U.S. foreign subsidiary, the new rules would make taxable any loans from the subsidiary to the new foreign parent company, treat the acquisition of stock in a foreign subsidiary as acquisition of stock in the U.S. parent company and prevent the new foreign parent from selling stock from the U.S. parent to its foreign subsidiary.
Regarding ownership, other new rules would prevent original U.S. shareholders from reducing their stake to less than 80% as required, by inflating the foreign merger partner's size, shrinking the size of the U.S. company by issuing extraordinary dividends before a merger and spinning off part of the original U.S. company.
Other potential administrative options listed in the report would treat already accumulated offshore earnings as taxable and increase restrictions on interest deductions under thin capitalization rules, though the report said the interest deduction idea could capture all corporations in general, not just those that have inverted.
Given a range of opinions on the various executive steps, there is disagreement over the feasibility or desirability of such additional regulatory changes, said the report.
Treasury can't explicitly change the 80% ownership rule—that's where Capitol Hill must step in, the senior Treasury official said.
Several pieces of legislation, such as a pair of bills (S. 2360 and H.R. 4679) introduced by Sen. Carl Levin (D-Mich.) and Rep. Sander M. Levin (D-Mich.), would require that the foreign subsidiary own at least 50% of the combined company. Those bills would be retroactive to May 8.
Both Rep. Levin and Sen. Levin in a joint statement released Sept. 22 welcomed Treasury's actions.
Anti-inversion bills, however, failed to advance as Senate Finance Committee Chairman Ron Wyden (D-Ore.) and ranking member Orrin Hatch (R-Utah) continued negotiations in the brief legislative period between the August recess and when Congress left to campaign for midterm elections. Both camps said they were making progress.
Treasury also said it will stop U.S. entities from inverting a portion of their operations by transferring assets to newly formed foreign corporations that are spun off to shareholders, a practice known as “spinversions.”
Spinversions take advantage of a rule that was intended to permit purely internal restructurings by multinationals, Treasury said. The rule change aims to block the spun-off foreign corporation from being able to benefit from such internal restructuring rules with the result that the spun-off company would be treated as a domestic corporation, Treasury said.
Treasury's rules also restrict the use of a technique known as “skinnying down,” in which companies make special dividends to reduce their size before a merger to meet the current law's requirements.
In addition, U.S. companies would be less able to seek out so-called old and cold foreign companies with cash and other passive assets as merger partners to meet the rules. Other changes announced in the rules would make it harder for inverted companies to relinquish control of their foreign subsidiaries to get them out of the U.S. tax code's orbit.
Reaction from congressional taxwriters was nearly unanimous in calling for a broader overhaul of the tax code to ultimately solve the inversions issue.
House Ways and Means Committee Chairman Dave Camp (R-Mich.) called Treasury's actions a “stopgap measure,” saying that the only real solution will come though revamping the tax code to lower the corporate rate and eliminate the incentive for companies to invert.
“We've been down this rabbit hole before, and until the White House get serious about tax reform, we are going to keep losing good companies and jobs to countries that have or are actively reforming their tax laws,” Camp said.
Wyden called for a tax code rewrite as well, but also advocated for legislation in the lame-duck to “siphon the economic juice out of inversions,” including provisions similar to the Treasury action, such as limiting interest stripping, hopscotch loans and decontrol transactions.
“Today's action by the Treasury Department reinforces the urgency for action before this growing wave of inversions erodes our nation's tax base,” Wyden said. “But only Congress has the full range of tools to address both the immediate problem and ensure U.S. businesses continue to be competitive in the global economy.”
The changes could cause complications for companies including Medtronic Inc. that are counting on the benefits of tax-free access to foreign cash. Eight inversions are pending, including Burger King Worldwide Inc.'s planned merger with Tim Hortons Inc., which would put the combined company's headquarters in Canada.
Another inversion involving Horizon Pharma Inc. closed on Sept. 19.
Investors have been watching for signs of what Treasury would do because the changes could penalize or unravel some of the pending inversion deals.
Scott Bonikowsky, a spokesman for Tim Hortons, didn't immediately respond to messages seeking comment. Burger King, based in Miami, didn't respond to a request for comment.
Billionaire investor Warren Buffett, Berkshire Hathaway Inc. chairman and CEO who is helping finance the Burger King deal, called Sen. Hatch to gauge Congress's direction on inversions, the senator said.
“He called me and he said you've got to do something about tax inversions,” Hatch said Sept. 11, deviating from his prepared remarks in a speech at the U.S. Chamber of Commerce in Washington. “I think he wanted to know where we were going and he knows I'll tell him the truth, which I did.”
E-mails and calls to spokesmen at Medtronic, Mylan Inc., AbbVie Inc. and Pfizer Inc. after business hours weren't immediately returned. Medtronic, Mylan, and AbbVie all have inversion deals pending. Pfizer's bid for London-based AstraZeneca Plc failed in May, but chief executive officer Ian Read has said he is still looking for an inversion opportunity.
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