That’s very good news, because these inversions are merely tax loopholes by which U.S. businesses “re-domicile” abroad, by which I mean they move their tax address, not their actual business.
Note that I said inversions “are” versus “were.” Without legislation, the Obama administration cannot completely close the loophole. But they can make it a lot smaller, as in less lucrative.
Doing so involves the following changes:
— Stopping “hopscotching”: Cute name, bad loophole. When inverted companies channel profits they’ve been holding overseas — money that’s been basking in the Cayman Islands or some other tax haven — back to what is now the U.S. subsidiary of the new, foreign firm, they are supposed to pay taxes on those “repatriated” earnings. But inverted companies avoid this by first moving the money through some other foreign affiliate to the new U.S. parent, thus skipping, or hopscotching, over the U.S. affiliate. The formerly deferred earnings can then be loaned, tax free, to the domestic affiliate of the new, inverted company. As Treasury notes, “this hopscotch loan is not currently considered U.S. property and is therefore not taxed as a dividend.”
The new rules block such fun and games.
— Raising the bar on inverting in the first place: Current law allows U.S. companies to invert as long as the new foreign parent company is valued at no less than 21 percent of total equity value of the new company. The problem is that tax avoiders have developed a number of tricks to artificially inflate the size of the foreign parent’s share of the value (again with the cute names: these techniques are called “cash boxes,” “skinny downs,” and my personal favorite: “spinversions”). The new rules go after these tricks, but what’s really needed is to significantly raise the bar on the equity share in the new company from 21 to 40 or 50 percent. But that would take legislation.
Somewhat to my surprise, the announcement stated that these actions only apply to deals closed today or after today, so no retroactivity. I expected they’d try to go after some recent inverters, but I suspect they viewed that as causing some legal exposure. Either way, you can be sure corporate tax lawyers are coming after these new rules in court.
And remember, this is just Treasury’s first step in terms of rule changes to reduce the tax benefits of inversions. They’re not yet dealing with the problem of “earnings stripping” either, where the new parent loads up the U.S.-based subsidiary with debt so it can deduct the interest payments from its U.S. tax bill.
So my sense is that the rule changes announced today are the ones they were most confident they could quickly and soundly get out the door. Under the safe assumption that Congress continues to do nothing to stop this type of tax avoidance, I’d consider this round one by the administration.
And I say again, good for them!
No question that our corporate tax code needs a major do-over. No question that it’s better to implement significant tax changes through legislation versus independent actions like this. But there’s also no question that congressional obstructionists were not about to work with the administration on closing this loophole. As long as the Obama folks could do something about it, for them to just sit on their hands and watch the tax base further erode would have been seriously negligent.
The Treasury pointed out that “genuine cross-border mergers make the U.S. economy stronger by enabling U.S. companies to invest overseas and encouraging foreign investment to flow into the United States.”
I agree. That’s not what we’re talking about here. What we’re talking about here is plain and simple tax avoidance. That fact that this just got a good bit harder is good news, indeed.