New crackdown on corporate tax avoidance

Avoiding U.S. corporate taxes

The U.S. goverment is taking more steps to clamp down on companies that try to reduce their tax bills by merging with foreign firms.

On Monday, the Treasury announced new regulations intended to further discourage so-called inversions, which have been on the rise in recent years.

After a U.S. company inverts, it may change the address of its headquarters to a foreign country but still operate in the United States.

“Many of these companies continue to take advantage of the benefits of being based in the United States — including our rule of law, skilled workforce, infrastructure, and research and development capabilities — all while shifting a greater tax burden to other businesses and American families,” said Treasury Secretary Jack Lew.

The new set of rules aim to do a few things:

Prevent so-called “earnings stripping.” Until now, U.S. companies that invert have been able to cut their tax bills on future earnings through “earnings stripping.”

It can work like this: The foreign parent makes a large and unnecessary loan to the U.S. subsidiary strictly for tax purposes. The interest on that loan is deductible, and those deductions can largely offset — or even wipe out — the taxes that the U.S. subsidiary owes Uncle Sam on its earnings, according to Steven Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center.

The new rules will discourage foreign-parent companies from loading up their U.S. branches with unnecessary debt because the interest paid by subsidiaries will no longer be deductible.

Stop companies from flouting existing curbs on inversions. Existing rules state that any shareholders of an acquired U.S. firm must own a certain percentage of the merged company. But some foreign companies have grown by acquiring multiple, small U.S. firms in a short period of time. That then makes it easier for them to buy a much larger U.S. company without violating the ownership thresholds.

The new rules will make such “serial inversions” less attractive because Treasury will calculate the ownership percentage of the foreign company by excluding stock attributable to smaller purchases made within the past three years.

These rules may help curb tax-driven inversions, but Lew has stressed repeatedly that no amount of Treasury regulations will put a stop to the activity.

For that, lawmakers need to act. “Only new anti-inversion legislation can stop these transactions,” he said.

While lawmakers have introduced anti-inversion bills, none have been passed. And the chance that Congress will embark on business tax reform this year are very slim.

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