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Treasury finalizes an important rule to block tax avoidance

Congress wouldn't budge, so the Treasury is doing its part to push back on multinational corporate tax avoidance.

Treasury Secretary Jack Lew. (Andrew Harrer/Bloomberg)

Remember tax inversions? You know, that tax avoidance scheme where a U.S. multinational seeking to reduce its tax bill acquires a smaller foreign company and then locates the merged company in some low-tax haven outside the United States? Think of it less as moving a company abroad and more like moving its tax mailbox.

As our Treasury Department puts it, “the primary purpose of an inversion is not to grow the underlying business, maximize synergies, or pursue other commercial benefits. Rather, the primary purpose of the transaction is to reduce taxes, often substantially.”

A flurry of corporate inversions a little while back got the attention of some (a precious few) policymakers who quite reasonably wanted to block this play. After all, the more such shenanigans are permitted to erode our tax base, the more the rest of us — the peeps without bevies of tax lawyers finding loopholes for us to exploit — must pony up, or the more we must cut spending, or the more we must borrow and raise the deficit.

The Obama administration went to Congress to implement some common-sense ideas to block inversions but were met with — surprise! — gridlock. The majority over there likes to talk about tax reform, but it’s all just talk. They don’t really want to take anything that you or I would recognize as constructive action.

So the administration undertook to do what they could themselves, and on Thursday, they released the final version of an important new rule to block the mother’s milk of corporate inverters: earnings stripping. Like most of this sort of thing, it’s a bit of a tricky move, but it falls right out of the basic playbook of multinational tax avoiders: Book your income in low-tax countries and your expenses in high-tax ones.

In this case, the new foreign parent company makes a “loan” (I’ll explain the scare quotes in a sec) to its U.S. affiliate. The latter then makes interest payments on the loan back to the parent (or some other foreign affiliate in a low-tax haven) which can be deducted against earnings. The U.S. firm uses the interest payments to strip off its taxable earnings from the liability side of its ledger.

If you hunger for a deeper dive into these weeds, here’s a fact sheet with the details. To close the loophole, Treasury changed the tax rules to prohibit the relabeling of what’s really an equity transfer as a loan. One important “tell” here is that the IRS can see that the alleged loan generates big, fat interest deductions but no new investment.

I can’t say for sure, but my impression is that this rule, which was announced in April and finalized this week, has already dampened the zeal to invert (earlier anti-inversion rules are probably helping as well, but this one is the most potent). If so, it’s already making an important contribution to pushing back on tax base erosion.

And it will continue to do so, unless … the next president gets rid of it.

You see, we’re talking about rule changes, which, like executive orders, do not require congressional approval. That doesn’t mean presidents can do whatever they want, of course. The power of the purse lies with Congress, and any rules or executive orders have to pass legal muster. But trust me when I tell you — I’ve been there for this — when a new administration from the other party comes into power, the first thing they do is whack a bunch of the previous team’s administrative actions.

And this means that along with all the other reasons you hopefully view this election as a uniquely high-stakes affair, you must consider this change as well, along with dozens of others.

In fact, to remind you what’s at stake, along with the anti-inversion rules, here’s a list of some from the econ space:

Then there are the executive orders extending some degree of legal status to certain undocumented people (deadlocked at 4-4 in the understaffed Supreme Court), barring employers from retaliating against those who discuss their compensation, enhancing work/life balance at federal agencies, and barring federal contractors from discrimination on the basis of sexual orientation or gender identity. Not to mention environmental initiatives, such as higher emission standards and the Clean Power Plan targeted at reducing states’ carbon emissions.

It’s a remarkable record, given the aforementioned gridlock, one that doesn’t get nearly enough attention, IMHO. But all of these hard-fought accomplishments could be unwound. And that would be a terrible shame.