In an important first step to stem “inversions,” in which a larger U.S. multinational merges with a smaller foreign firm to avoid U.S. taxes, the Treasury announced new rules that not only effectively remove one way that taxpayers subsidize such deals, but also tighten existing limits on them. The President should (and likely will) look for further steps the Administration can take, and Congress should do its part to protect the corporate tax base from this brazen tax avoidance.
Here’s some background. Corporations do not pay taxes on foreign earnings until they bring them back to the United States. Many firms are looking for ways to access their foreign-held profits while avoiding U.S. taxes — the same taxes that domestic firms pay on their profits. A corporate inversion is one way to achieve this goal, which is why firms such as Medtronic, AbbVie, Pfizer, and Mylan have all sought or announced plans to invert.
The Treasury’s new rules aim to discourage firms from pursuing such tax avoidance inversions. One new rule prevents inverted firms from using so-called “hopscotch” loans to access a foreign subsidiary’s prior earnings and avoid U.S. tax. These loans, which a subsidiary in a foreign tax haven makes to the new foreign parent (thereby “hopscotching” over the former, U.S.-based parent in order to avoid U.S. tax), will now count as U.S. property and thus be taxable.
The Treasury is also closing some loopholes in existing anti-inversion regulations, such as tightening the rule that a U.S. firm combining with a foreign firm continue to be taxed as a U.S. firm if it owns 80 percent or more of the combined company. The Treasury rule aims to ensure that this 80 percent threshold is a real one.
The President and several key members of Congress have called for legislation to lower this threshold even further. They want to set the threshold at 50 percent, meaning that a U.S. firm could not invert without losing control of the new firm. That would act as a strong deterrent against inversions.
The President and Congress should also pursue how to crack down on “earnings stripping,” which allows companies to use debt to siphon profits out of the United States. A further option would be to require companies that invert to pay the taxes they owe before they “leave” the country. The President and Congress should take these next steps to combat the inversion epidemic.