US Treasury Makes 'Inversion' Proposals To Congress

by Mike Godfrey, Tax-News.com, Washington

07 June 2002

The US House of Representatives Ways and Means Committee held a hearing yesterday on the subject of 'corporate inversion', the process by which a US company removes its base to an offshore jurisdiction, often Bermuda, in order to improve its international tax profile.

Pamela Olsen, Acting Assistant Secretary to the Treasury (Tax Policy) addressed the meeting, emphasising that companies often feel obliged to move out of the US tax system in order to compete effectively against other, foreign-based companies. Ms Olsen spoke against any 'knee-jerk' legislation which might boomerang against US interests:

"A narrow policy response to the inversion phenomenon may inadvertently result in a tax code favoring the acquisition of US operations by foreign corporations and the expansion of foreign controlled operations in the United States at the expense of domestically managed corporations. In turn, other decisions affecting the location of new investment, choice of suppliers, and employment opportunities may be adversely affected. While the openness of the US economy has always made -- and will continue to make -- the United States one of the most attractive and hospitable locations for foreign investment in the world, there is no merit in policies biased against domestic control and domestic management of US operations.

Ms Olsen proposed some specific directions for action to be targeted:

"We believe there are several specific areas in which changes are urgently needed. The statutory rules regarding the deductibility of interest payments to related parties must be tightened to prevent the inappropriate use of related-party debt to generate deductions against income from US operations that otherwise would be subject to US tax. We must undertake a comprehensive review of the rules governing the transfer of assets among related parties and establish a revitalized compliance program to ensure adherence with the arm’s-length standard for related party transfers. We must undertake a comprehensive review of our income tax treaties and make the modifications to particular treaties necessary to ensure that they do not provide inappropriate opportunities to reduce US taxes. We must promulgate reporting requirements to provide the IRS with information to ensure that shareholders are paying the tax owed on the gain recognized in an inversion transaction. We also are working on other areas where further study is needed.

"In addition, we must continue to work to address the US tax disadvantages faced by US-based companies that do business abroad relative to their counterparts in our major trading partners. We look forward to working closely with the Committee on this important issue."

Ms Olsen set out a number of proposals for changing current rules on the tax treatment of inter-company debt, one of the main mechanisms used by companies to ensure that profits are made in low-taxed areas:

"The prevalent and increasing use of foreign related-party debt in inversion transactions demonstrates the importance to these transactions of the tax reductions achieved through interest deductions and the need to act now to eliminate this benefit. Accordingly, we propose statutory changes to tighten the interest disallowance rules of section 163(j) in several respects. Moreover, the opportunities for generating interest deductions that reduce US taxable income are not limited to inversion transactions. These U.S. taxable income minimization strategies, which are not available to U.S.-based companies, are possible as well in cases where a U.S. business is structured from the outset with a foreign parent and in cases where a foreign corporation acquires a U.S. operating group. Therefore, we believe these revisions to section 163(j) should not be limited to companies that have inverted but should apply across the board. There is no reason to allow companies to reduce income that would otherwise be subject to U.S. tax through deductions generated simply by putting in place debt owed to related parties."

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