Yesterday, following a summer during which a number of major American companies announced plans to invert (i.e., shift their tax domiciles overseas following cross-border mergers), the US Treasury Department issued a notice of proposed rulemaking with a number of measures designed to reduce the tax advantages of inversion.
The regulatory actions taken by Treasury to curb inversions include:
- preventing inverted companies from accessing a foreign subsidiary’s earnings while deferring US tax through the use of loans from a controlled foreign corporation to its new foreign parent, known as “hopscotch” loans
- preventing inverted companies from restructuring a foreign subsidiary in order to access the subsidiary’s earnings tax free
- preventing inverted companies from transferring cash or property from a CFC to the new foreign parent to avoid US tax and
- altering the computation of the current law requirement that shareholders of the pre-inverted entity own less than 80 percent of the new combined entity by, among others, disregarding certain passive assets of the combined entity that have the effect of reducing the ownership percentage held by the former shareholders.
Treasury also announced that this new guidance would be effective immediately. It is possible an additional set of proposed regulations will be issued dealing with debt/equity issues in inverted companies.
The uptick in inversion activity over the summer has altered the debate on Capitol Hill on tax reform. Until recently, much of the discussion was academic, with numerous law professors and economists testifying at hearings as to the likely damage to the US economy and potential erosion of the US tax base as a result of the US having the highest corporate tax rate among OECD members and keeping a worldwide system of taxation when most of its trading partners have shifted to some form of a territorial system. The announcement that some major and very familiar US brands had decided to invert, and not to traditional tax havens but to US trading partners including the United Kingdom and Canada, has changed the debate from an academic one to a very real-world debate in which a number of US policymakers now fear that the US corporate tax system faces serious erosion that could threaten Congress’ ability to enact tax reform and respect for the US tax system in general.
Treasury’s actions were designed to slow down the pace of inversions to give Congress time to act legislatively. Senate Finance Committee Chairman Ron Wyden (D-OR) and his ranking member, Senator Orrin Hatch (R-UT) have been working intensively over the past two months on bipartisan temporary measures, to be enacted before this Congress adjourns in December, to stem the tide of inversions pending tax reform.
Senator Hatch has insisted that those measures must meet the following criteria:
- the measures must be prospective
- they cannot be punitive and
- the measures must help move the US towards tax reform that would result in a lower corporate tax rate and a territorial system.
Senator Wyden had hoped to consider these measures in September and now expects to bring them up in the lame duck session that will begin on November 12.
Regardless of what Congress is able to accomplish on a temporary basis, there is a renewed interest in tax reform, which is viewed by tax writers in Congress, the Administration and most commentators as the best approach to deal with the underlying problems that have motivated the recent inversion activity. While Congress is unlikely to enact tax reform this year, Senators Wyden and Hatch and the expected incoming chairman of the House Ways and Means Committee in the next Congress, Representative Paul Ryan (R-WI), reportedly are in discussions already on the substance and timing of efforts to achieve tax reform in 2015.
Republican tax writers on the Hill have been critical of the Administration for not taking a more forceful role in tax reform. In his remarks over the past several days on the inversions issue, Treasury Secretary Jack Lew has emphasized the Administration’s view that corporate tax reform is urgent, and some legislators, most notably Senate Finance Committee Member Rob Portman (R-OH) have recently suggested that the inversion activity is a crisis that may necessitate that Congress act first on corporate and international reform and leave the individual reform to another time.
At the start of the summer when the first new inversion announcements were made by a number of major companies, the Administration appeared reluctant to act on its own, and efforts to enact tax reform in Congress were stalled. Concern over the erosion of the US tax system motivated the Administration to act, and key tax writers in Congress believe may have given tax reform a boost;reform certainly will be the top priority for the Ways and Means and Finance Committees in 2015.