The U.S. Treasury finally acted Monday to slow down, if not halt, the rising number of inversion transactions that has had politicians, the public, and the press in a frenzy over U.S. corporate tax dysfunction.
While often legitimate non-tax reasons drive cross-border mergers and acquisitions beyond tax calculations, the current economic climate, which combines relatively cheap financing for mergers with a growing chasm between U.S. corporate tax rates and the prevailing rates in most other countries, has produced an appetite in U.S. companies to achieve tax efficiencies through inversions at the expense of the U.S. fisc. Set against a backdrop of political standstill in the U.S. Congress, companies seeking to take advantage of the potential tax benefits of an inversion have taken a calculated risk that the threat of retroactive rules substantially limiting or eliminating these benefits or any reform at all is unlikely.
In a perhaps surprisingly definitive move, the U.S. Treasury took affirmative steps Monday to address techniques used to avoid application of the anti-inversion rules and to substantially curb certain of the U.S. tax avoidance measures utilized by companies following an inversion transaction, making the rules effective immediately, but not retroactively. In particular, the new rules—
- prevent artificial inflating and deflating of the U.S. acquirer and foreign target through increasing passive assets or by dividend distributions and asset spin offs, tactics used to properly “size” the two parties in order to meet the inversion requirement that the original U.S. company shareholders comprise less than 80% of the ownership of the new foreign parent;
- remove the benefit of so-called hopscotch loans made from controlled foreign subsidiaries to the new foreign parent, which bypass the former U.S. parent company thereby facilitating the withdrawal of previously untaxed profits without paying the expected repatriation tax in the U.S.; and
- prevent the “de-controlling” of the former U.S. parent’s controlled foreign subsidiaries in which control of the foreign subsidiary is transferred to the new foreign parent for the purpose of avoiding repatriation tax on the deferred earnings held in that controlled foreign subsidiary.
In a sure sign that the inversion debate will rage on, Burger King’s forthcoming merger with Canada’s Tim Hortons, one of the largest inversion transactions currently announced, appears to be proceeding in spite of the new rules, testament perhaps to the strength of its non-tax driven reasons for pursuing the inversion. The Treasury’s promise of forthcoming additional measures, including addressing so-called “earnings stripping” transactions to limit U.S. tax, also means the stage is by no means set for what the near future of inversions will look like.
While the Treasury’s action may make it less appealing for certain companies to pursue an inversion strategy, viable planning opportunities remain. If you are interested in discussing the merits of pursuing an inversion or other reorganization strategy for your company, please do not hesitate to contact the attorneys listed on this alert.