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The Daily

Treasury Releases New Rules Meant to Curb Inversions

Chris Gaetano
Published Date:
Apr 6, 2016

BigFishSmallFishThe U.S. Treasury Department has released new rules intended to make corporate inversions—the act of reincorporating a company overseas—less attractive as a tax planning option.  The new rules follow previous actions taken to curb the practice in 2014 and 2015.

“Genuine cross-border mergers make the U.S. economy stronger by enabling U.S. companies to invest overseas and encouraging foreign investment to flow into the United States. But these transactions should be driven by genuine business strategies and economic efficiencies, not a desire to shift the tax residence of a parent entity to a low-tax jurisdiction simply to avoid U.S. taxes,” said the Treasury Department press release.  

Under current tax rules, if shareholders in a former U.S. company own at least 80 percent of the combined firm after the inversion, it is still considered subject to U.S. taxes, even if it’s now based in another country, according to The Wall Street Journal. In order to be completely exempt from U.S. tax, that share must be lower than 60 percent.

The Treasury Department said that some companies try to stay below the 60 percent threshold by acquiring multiple U.S. companies in a short period of time. This increases the value of the foreign company through issuing stock in connection with the acquisition, thereby increasing its value in relation to the U.S. companies it acquired.  The regulations are meant to curb this practice.

“For the purposes of  computing the ownership percentage when determining if an acquisition is treated as an inversion under current law, today’s action excludes stock of the foreign company attributable to assets acquired from an American company within three years prior to the signing date of the latest acquisition,” said the Treasury fact sheet.

This measure, however, is not permanent: it is set to expire in 2019, according to the rules document.

The Treasury Department also aims to address earnings stripping in corporate inversions, a practice where, following an inversion, the U.S. subsidiary issues its own debt to its foreign parent as a dividend distribution, which in turn then transfers the debt to another foreign affiliate in a lower-tax jurisdiction. The U.S. subsidiary then deducts the resulting interest expense on its U.S. income tax return

“In fact, the related foreign affiliate may use various strategies to avoid paying any tax at all on the associated interest income.  When available, these tax savings incentivize foreign-parented firms to load up their U.S. subsidiaries with related-party debt,” said the Treasury Department face sheet.

In order to prevent this, the Treasury Department is proposing to: 

  • Treat as stock an instrument that might otherwise be considered debt if it is issued by a subsidiary to its foreign parent in a shareholder dividend distribution; 
  • Address a similar “two-step” version of a dividend distribution of debt in which a U.S. subsidiary (1) borrows cash from a related company and (2) pays a cash dividend distribution to its foreign parent; and 
  • Treat as stock an instrument that might otherwise be considered debt if it is issued in connection with certain acquisitions of stock or assets from related corporations in transactions that are economically similar to a dividend distribution.

It is also proposing to allow the IRS, when on an audit, to divide a purported debt instrument into part debt and part stock, as well as requiring documentation for members of large groups to include key information for debt-equity tax analysis.

The temporary rules could cause companies currently planning to undergo an inversion to reconsider, according to Reuters. One example is a merger between Pfizer and Allergan, which has now been cancelled amid the new rules, according to Bloomberg. Allergan is, itself, the result of another inversion, as it is technically based in Ireland but operates primarily from New Jersey. With the new rules in place, Allergan's recent acquisitions do not count towards the inversion threshold, meaning that the tax incentives to merge were largely eliminated The Wall Street Journal