We’ll soon find out how good the Treasury is at Whac-A-Mole.
And we’ll also see if the written word — specifically, a recent article in Tax Notes, a hard-core tax-techie specialty publication — has the power to influence events. Which in this case, I hope it does.
Let me explain what’s going on. And why you should care about it.
Any day now, the Treasury is expected to unveil the final version of proposed regulations it issued in 2014 and 2015 to stop corporate inversions. “Inversion” is a euphemism for a transaction in which a corporation deserts our country by combining with a smaller foreign company, adopting its headquarters for tax purposes but keeping its operations based here to continue enjoying all the benefits — like strong capital markets, rule of law, military protection and great places for employees to live — it derives from being in the United States.
The question is whether the Treasury will try to extend its proposed regulations to cover deals involving Pfizer, Johnson Controls and IHS. Those three transactions would end-run the regulations unless the Treasury broadens them. It’s Whac-A-Mole, with billions of tax dollars at stake. As things stand now, the only transactions covered by Treasury’s proposed regulations are those in which shareholders of the deserting U.S. company own more than 60 percent but less than 80 percent of the shares in the combined company.
Pfizer and Johnson Controls are jumping through multibillion-dollar hoops to reduce their shareholders’ piece of the combined enterprise to less than 60 percent. Pfizer is doing this by putting a lot of cash into its deal with Irish-based Allergan PLC; Johnson by having Irish-based Tyco International PLC buy lots of Johnson stock for cash rather than stock.
I’ll spare you the gritty details. What matters is that Pfizer and Johnson are clearly worried enough about the impact of the Treasury’s proposed regulations to spend billions to avoid them. This tells me it would be a good thing for our country to expand the regs, which make it far more difficult for deserters to access cash they have stashed offshore to avoid U.S. taxes. Who knows? Maybe that would knock out one or both of these desertions. It would certainly complicate life for future would-be deserters.
In the case of IHS, a Colorado data provider that is combining with London-based Markit, there’s no hoop-jumping. It’s a straight up stock-for-stock deal in which the numbers work without extraordinary effort. It’s distasteful to me, but not convoluted.
Having holders of the U.S. company own less than 60 percent of the combined enterprise is crucial, because the anti-inversion section of the tax code covers only transactions in which holders of the U.S. firm own between 60 and 80 percent of the combined company.
The Treasury’s proposed regulations affect only the deals subject covered by this section, 7874, which Congress passed in 2004.
Enter Tax Notes. To give you a greatly simplified version, the influential Feb. 22 article, “Treasury’s Unfinished Work on Corporate Expatriations,” argues that the Treasury has authority under various rules, including Section 956 of the tax code, to broaden its proposal beyond transactions subject to Section 7874.
“My concern was that Treasury had not gone big enough in its notices to date and risked losing credibility,” said Stephen Shay of Harvard Law School, the article’s lead author. (The other authors are J. Clifton Fleming Jr. and Robert Peroni, of the Brigham Young and University of Texas law schools, respectively.)
The article also argues that the Treasury should go further in barring “earnings stripping” maneuvers that strip profits from the United States and its 35 percent corporate tax rate and shift them to places such as Ireland, with a 12.5 percent rate.
There’s some dispute about whether Shay and his colleagues have it right. “He’s putting too much weight on that regulation [Section 956], it can’t bear the load,” says tax expert Robert Willens, whose letter published in Tax Notes opposes Shay’s thesis.
The Treasury declined to comment, but referred me to what Treasury Secretary Jack Lew said last November, when the second batch of proposed regulations was unveiled:
“We continue to explore additional ways to address inversions — including potential guidance on earnings stripping — and we intend to take further action in the coming months.”
That was more than four months ago.
All of us have a huge stake in how this plays out. Why? Because unless something is done soon, more and more companies will move their tax domiciles out of America and our corporate tax base will continue to bleed out, leaving the rest of us to make up the shortfall.
In an ideal world, Congress would fix the corporate tax code to make desertions less attractive and more painful, the way it did before “bipartisan” became a dirty word. But Congress seems totally gridlocked and dysfunctional. That leaves it up to the Treasury.
I don’t know if Shay and his co-authors are right about the Treasury’s powers, or whether my longtime source and friend Bob Willens is. There’s no way to tell without years of litigation.
I hope the Treasury swings for the fences. Deserting companies operate on the principle of, “If it’s not illegal, it’s not wrong.” So I’m fine if the Treasury decides, “If it’s not demonstrably wrong, it’s right.”
Whac-A-Mole, anyone? Or given what I’ve written about these deals since Pfizer tried to desert two years ago by combining with British-based AstraZeneca, I’d like to give the game a new name: Whac-A-Troll.