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Corporate Tax Inversions Targeted by New Federal Actions

Friday, September 26, 2014
Sandler, Travis & Rosenberg Trade Report

The Treasury Department announced Sept. 22 actions designed to reduce or halt the use of corporate tax inversions, which Treasury Secretary Jacob Lew said are used by some companies “to avoid paying their fair share.” Lew said the Obama administration will also continue to pursue comprehensive business tax reform legislation that includes specific anti-inversion provisions and review other options for further anti-inversion measures, including through additional regulatory guidance and reviewing U.S. tax treaties and other international commitments.

A corporate inversion is a transaction in which a U.S.-based multinational corporation restructures so that the U.S. parent is replaced by a foreign parent. Whereas “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 U.S., Lew said, inversions are structured to “shift the tax residence of the parent entity to a low-tax jurisdiction simply to avoid U.S. taxes,” which erodes the U.S. tax base and places a larger burden on small businesses and individuals.

There are already measures in place to discourage inversions based primarily on tax considerations, according to a Treasury fact sheet, but “it has become clear by the growing pace of these transactions that for many corporations these consequences are acceptable in light of the potential benefits.” Specifically, an inverted company is subject to potential adverse tax consequences if, after the transaction, (1) less than 25 percent of the new multinational entity’s business activity is in the home country of the new foreign parent and (2) the shareholders of the old U.S. parent end up owning at least 60 percent of the shares of the new foreign parent. If these criteria are met and the continuing ownership stake is 80 percent or more, the new foreign parent is treated as a U.S. corporation. If the continuing ownership stake is at least 60 percent but less than 80 percent, U.S. tax law respects the foreign status of the new foreign parent but other potentially adverse tax consequences may follow. Treasury notes that “the current wave” of inversions involves transactions in this latter category.

To further combat this practice, Treasury has acted to prevent inverted companies from (a) accessing a foreign subsidiary’s earnings while deferring U.S. tax through the use of “hopscotch” loans, (b) restructuring a foreign subsidiary to access its earnings tax-free, and (c) transferring cash or property from a controlled foreign corporation to the new parent to completely avoid U.S. tax. Treasury has also made it more difficult for U.S. entities to invert by strengthening the requirement that the former owners of the U.S. company own less than 80 percent of the new combined entity. These actions apply to deals closed on or after Sept. 22.

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