U.S. Treasury Department Moves to Limit Inversion Deals

For U.S.-based companies looking to buy foreign firms and relocate abroad to avoid higher U.S. taxes—a practice called inversion—the window of easy opportunity may haven just shut a little. Most often, though a firm “relocates” to a foreign country, executives and major operations remain in the United States.

On Monday, Sept. 22, the U.S. Department of the Treasury implemented new rules—effective immediately on deals that had not closed as of Sept. 22—to make inversion tougher. This puts deals such as Minneapolis, Minn.-based Medtronic Inc.’s proposed $43 billion deal to acquire Ireland-based Covidien plc in limbo.

Medtronic officials released the same statement to multiple news outlets late on Sept. 22: “We are studying Treasury’s actions. We will release our perspective on any potential impact on our pending acquisition of Covidien following our complete review.”

Corporate income tax in the United States is 35 percent, and among industrialized nations the United States is one of the few that imposes its corporate tax on the foreign income of companies based in the country. This, along with the ability of inverted companies to reduce U.S. taxes on their future income, have made inversions attractive to companies.

The congressional Joint Committee on Taxation has estimated that legislation to curb inversions would raise about $20 billion in the next 10 years.

The new rules, announced by Treasury Secretary Jacob Lew include a prohibition on “hopscotch” loans that allow firms companies access to foreign cash without paying U.S. taxes, and impose limits on actions that companies can use to make such transactions qualify for favorable tax treatment.

Companies that already have completed inversion deals will face minimal changes except the risk of a second round of Treasury Department rules affecting maneuvers used to reduce taxes on income earned in the United States.

This year has been, by far, the busiest year for cooperate inversions. And, along with Medtronic’s deal, there are still quite a few in the works. AbbVie Inc., the pharmaceutical spinoff of Abbott Laboratories Inc., has plans to purchase United Kingdom-based drug maker Shire for $54 billion—which, if completed, would be the largest inversion deal ever.

Despite this recent move by the Obama administration to slow the pace of inversions, the president and Lew continue to urge Congress to pass a bill that would curtail inversions.

“We’ve recently seen a few large corporations announce plans to exploit this loophole, undercutting businesses that act responsibly and leaving the middle class to pay the bill,” the president said in a statement. “I’m glad that Secretary Lew is exploring additional actions to help reverse this trend. “While there’s no substitute for congressional action, my administration will act wherever we can to protect the progress the American people have worked so hard to bring about.”

Lew told reporters on a conference call that he wanted to make companies think twice before considering inversions. “This action will significantly diminish the ability of inverted companies to escape U.S. taxation,” Lew said. “For some companies considering deals, today’s action will mean that inversions no longer make economic sense.”

Lew told the New York Times:“For some companies considering deals, today’s actions will mean that inversions no longer make economic sense. These transactions may be legal, but they’re wrong.”

Under current U.S. law, companies that invert through a merger are still treated as domestic for tax purposes if the former U.S. company’s shareholders own more than 80 percent of the combined firm. The administration wants to reduce that 80 percent to 50 percent. That move, however, would require legislation.

Instead, the Treasury looked for other ways to make it difficult for companies to get around the 80 percent limit. The new rules try to limit “spin-versions,” in which U.S. companies spin off units into a foreign company.

It also would restrict a move called “skinning down,” in which companies make special dividends to reduce their size before a merger to meet the current law’s requirements. 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 give up control of their foreign subsidiaries to free them from the U.S. tax code. U.S. companies must pay taxes when they repatriate foreign profits. The changes to those control provisions and the hopscotch rules would apply to inversion deals where the former U.S. company’s shareholders own 60 percent to 80 percent of the combined business.

According to the Bloomberg news service, Terry Haines, a policy analyst with ISI Group LLC, said Treasury risks exceeding its authority and may face a legal challenge from companies with pending inversions that are made invalid by the changes.

While many Democrats favor an individual legislative solution with regard to inversions, most Republicans—and even an unlikely ally, former President Bill Clinton—say the issue should be addressed as part of a broader change of the U.S. tax code.

“We’ve been down this rabbit hole before, and until the White House gets 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,” said Rep. Dave Camp (R-Mich.), chairman of the House Ways and Means Committee, said in a statement. “A few campaign-style speeches and stopgap measures from Treasury won’t do it. It hasn’t worked in the past, and even Secretary Lew admits the only real solution is tax reform. I fear this administration is only interested in doing the bare minimum—just enough to say they care. The American people see right through that – they see it in their paychecks, which have been flat; they see it when their kids cannot find a job after college; and, they see it when our high tax rates push our companies overseas. It is time for the administration to put forward a serious, detailed, credible plan to reform our tax code.”

On the other side of the capitol building, the chairman and ranking member of the Senate’s Finance Committee also weighed in.

“As more companies use inversions as a strategy to avoid paying U.S. taxes, it is clear that Congress must act to protect remaining U.S. businesses, workers and families from having to pay higher taxes,” said Senate Finance Committee Chairman Ron Wyden (D-Ore.). “Today’s action by the Treasury Department reinforces the urgency for action before this growing wave of inversions erodes our nation’s tax base. 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. This will require a series of stop-gap reforms to the tax code that siphon the economic juice out of inversions, including limiting abusive interest stripping, preventing hopscotch loans to foreign parent companies, cracking down on decontrol transactions that shift U.S. companies’ income overseas, and relieving competitive pressures that drive these transactions. Such actions can and should be done consistent with comprehensive tax reform. Congress should move a bipartisan bill in the lame duck session as an immediate action to address inversions, to create incentives so businesses will remain in or move to the U.S., and to use that legislation as a springboard to comprehensive tax reform.”

Finance Committee ranking member, Orrin Hatch (R-Utah) agreed with Camp, saying that the U.S. tax system is “broken to the point that it’s putting our nation at a competitive disadvantage around the globe,” and advocated extensive tax code change.

“[Inversion] a very real problem that would best be resolved through a comprehensive overhaul of the tax code that includes dropping the corporate tax rate to 25 percent, shifting the U.S. to a territorial tax system, and implementing smart safeguards to prevent further corporate income tax base erosion. American job creators understand this. Members of Congress understand this. And, even this administration understands we need to make it easier for companies to invest and create jobs here at home. In the end, any solution that permanently addresses inversions must be legislated by Congress. As we work to achieve this bipartisan goal, I will thoroughly examine the administration’s new approach to this issue and continue my efforts with Chairman Wyden to create a stop-gap measure that fully meets the four principles I have laid out.”