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US Treasury Presents Its Anti-Inversion Proposals

by Mike Godfrey, Tax-News.com, Washington

24 September 2014


On September 22, Treasury Secretary Jack Lew presented non-legislative measures put forward by the Obama Administration to deter US multinationals from using corporate inversions to move their tax residence abroad.

At a press conference to announce the measures, Lew said: "Treasury is announcing targeted action to meaningfully reduce the economic benefits of corporate inversions, and when possible, stop them altogether," he said. "This action will significantly diminish the ability of inverted companies to escape US taxation. For some companies considering deals, today's action will mean that inversions no longer make economic sense."

The proposed measures are contained in a formal notice from the Internal Revenue Service and Treasury, which are aimed at restricting or preventing the use of certain transactions to circumvent liability to US tax.

First, the Notice will prevent inverted companies from accessing a foreign subsidiary's earnings while deferring US tax through the use of "hopscotch" loans. Under current law, US multinationals owe US tax on the profits of their controlled foreign corporations (CFCs), although they do not usually have to pay this tax until those profits are repatriated. Profits that have not yet been repatriated are known as deferred earnings. Under current law, if a CFC tries to avoid this dividend tax by investing in certain US property – such as by making a loan to, or investing in the stock of its US parent or one of its domestic affiliates – the US parent is treated as if it received a taxable dividend from the CFC. However, some inverted companies get around this rule by having the CFC make the loan to the new foreign parent, instead of its US parent. This "hopscotch" loan is not currently considered US property and is therefore not taxed as a dividend.

The notice removes the benefits of these "hopscotch loans" by providing that such loans are considered to be "US property" for the purposes of applying the anti-avoidance rule. The same dividend rules will now apply as if the CFC had made a loan to the US parent prior to the inversion.

The next measure will prevent inverted companies from restructuring a foreign subsidiary in order to access the subsidiary's earnings tax-free.

After an inversion, some US multinationals avoid ever paying US tax on the deferred earnings of their CFC by having the new foreign parent buy enough stock to take control of the CFC away from the former US parent. This "de-controlling" strategy is used to allow the new foreign parent to access the deferred earnings of the CFC without ever paying US tax on them. Under the notice, the new foreign parent would be treated as owning stock in the former US parent, rather than the CFC, to remove the benefits of the "de-controlling" strategy. The CFC would remain a CFC and would continue to be subject to US tax on its profits and deferred earnings.

The final measure aims to close a loophole to prevent an inverted companies from transferring cash or property from a CFC to the new parent to completely avoid US tax.

These transactions involve the new foreign parent selling its stock in the former US parent to a CFC with deferred earnings in exchange for cash or property of the CFC, effectively resulting in a tax-free repatriation of cash or property bypassing the US parent. The action is said to prevent the use of this strategy by:

  • Making it more difficult for US entities to invert by strengthening the requirement that the former owners of the US entity own less than 80 percent of the new combined entity:
  • Limiting the ability of companies to count passive assets that are not part of the entity's daily business functions in order to inflate the new foreign parent's size and therefore evade the 80 percent rule – known as using a "cash box." Following the issuance of the Notice, US authorities will disregard the stock of the foreign parent that is attributable to passive assets in the context of this 80 percent requirement. This would apply if at least 50 percent of the foreign corporation's assets are passive. Banks and other financial services companies would be exempted.
  • Preventing US companies from reducing their size pre-inversion by making extraordinary dividends, also known as "skinny-down" dividends. These pre-inversion extraordinary dividends would be disregarded for purposes of the ownership requirement, thereby raising the US entity's ownership, possibly above the 80 percent threshold.
  • Preventing a US entity from inverting a portion of its operations by transferring assets to a newly formed foreign corporation that it spins off to its shareholders, thereby avoiding the associated US tax liabilities, a practice known as "spinversion." This strategy takes advantage of a rule that US authorities intended to permit purely internal restructurings by multinationals. Under the notice, the spun-off foreign corporation would not benefit from these internal restructuring rules with the result that the spun off company would be treated as a domestic corporation, eliminating the use of this technique for these transactions.

The measures will not have retroactive effect (contrary to previous suggestions), applying only to deals closed on or after September 22.

Lew explained that the Administration is "taking initial steps that we believe will make companies think twice before undertaking an inversion to try to avoid US taxes." He prefaced his remarks with the caveat that "comprehensive business tax reform that includes specific anti-inversion provisions is the best way to address these transactions," but he said, "it is now clear that Congress won't act before the lame duck session."

Lew concluded that: "these first, targeted steps make substantial progress in constraining the creative techniques used to avoid US taxes. Treasury will continue to review a broad range of authorities for further anti-inversion measures as part of our continued work to close loopholes that allow some taxpayers to avoid paying their fair share."

Following Lew's announcement, Senate Finance Committee Chairman Ron Wyden (D – Oregon) and its Ranking Member Orrin Hatch (R – Utah) confirmed that they are still actively examining a variety of legislative measures.

Wyden opined that what is needed from Congress is "a series of stopgap reforms to the tax code that siphon the economic juice out of inversions." Hatch's comments were more circumspect. He said: "America's tax system is broken to the point that it's putting our nation at a competitive disadvantage around the globe. That Treasury has opted to move forward with guidance to curb the recent uptick in corporate inversions only further underscores this monumental challenge."

Meanwhile, House of Representatives Ways and Means Chairman Dave Camp (R – Michigan) dismissed the package, stating: "Until the White House gets serious about tax reform, we are going to keep losing good companies and jobs to countries that have or are actively reforming their tax laws. A few campaign-style speeches and stop-gap measures from Treasury won't do it – it hasn't worked in the past, and even Secretary Lew admits the only real solution is tax reform."

TAGS: compliance | tax | business | tax compliance | law | corporation tax | multinationals | legislation | transfer pricing | United States | tax breaks | dividends | tax reform | regulation

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