Coverage: Government tries to curb inversions

The U.S. government is tired of companies moving overseas to avoid paying corporate taxes. But can they actually do anything about it? The Treasury Department seems to think so.

Bloomberg’s Richard Rubin and Ian Katz had these details about the newly announced plan:

The Treasury Department announced steps that will make it harder for U.S. companies to move their addresses outside the country to reduce taxes, clamping down on the practice known as inversions.

The rules, which apply to deals that close starting today, include a prohibition on “hopscotch” loans that let companies access foreign cash without paying U.S. taxes, and impose new curbs on actions that companies can use to make such transactions qualify for favorable tax treatment.

The changes will have the biggest effect on eight U.S. companies with pending inversions, including Medtronic Inc. (MDT) and AbbVie Inc., which plan the two largest such deals in U.S. history. In its purchase of Covidien Plc (COV), Medtronic is loaning some of its untaxed profits outside the U.S. to its new Irish parent company, and that transaction could be penalized by the new anti-hopscotch rule.

Treasury stopped short of making the rules retroactive to deals that have been completed. Companies already reaping the benefits of a foreign tax address will face minimal changes except the risk of a second round of Treasury rules affecting maneuvers they use to reduce taxes on income earned in the U.S.

The Wall Street Journal’s John D. McKinnon and Damian Paletta had a pretty good primer at the top of their story in case you’ve forgotten the term “inversion.”

Treasury officials took action under five sections of the U.S. tax code to make inversions harder and less profitable, removing some of the appeal that has made the transactions more common in recent years, particularly in the pharmaceutical industry.

In an inversion, an American company reincorporates for tax purposes in a tax-friendlier country such as the U.K. or Ireland, typically while maintaining much of their operations in the U.S. Most recent inversions sprang from mergers of a U.S. firm with a smaller foreign firm after regulatory steps taken during President Barack Obama’s first term curbed other types of inversions.

The Treasury rules will make it harder for companies that invert to use cash accumulating abroad—a big draw in recent deals. In addition, the government has made it more difficult to complete these overseas mergers.

The USA Today story by Gregory Korte pointed out the rules were in preliminary stages:

The Treasury Department is still fleshing out the details on the new guidance, but it is putting companies on notice that deals that close on or after Monday’s announcement will be subject to the new tax rules.

“For some companies considering deals, today’s actions may mean that those transactions no longer make economic sense,” Lew said. He said more actions could be on the way.

Lew said the Treasury Department was also careful to target cases where the mergers were primarily for tax avoidance. “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,” he said.

Inversions aren’t a new problem, but a number of high-profile deals have rekindled interest in addressing the issue. Burger King is in talks to be acquired by Canadian company Tim Hortons, and an outcry over a similar plan by drugstore chain Walgreens caused that company to abandon its inversion plans.

Forbes offered even more details about the new proposal in a story by Jeremy Bogaisky:

Treasury closed a loophole that allowed a tax-free transfer of cash or property from a foreign subsidiary to the new foreign parent, and moved to stop companies from restructuring foreign units to access deferred earnings without paying taxes.

It also cracked down on techniques companies have used to meet a pre-existing requirement that a U.S. business can invert only if it does a deal that results in a new company in which the share of ownership of the foreign “acquirer” is above 20%. U.S. companies will no longer be able to “skinny down,” or reduce their size before completing a deal by issuing large dividends, and they will no longer be able to count passive assets to inflate the new foreign parent’s size.

The Financial Times reported in a story by Barney Jopson, Robin Harding, and Ed Hammond that many in the Republican party weren’t happy with the announcement.

Many on Wall Street believe the attack on inversions – and the rhetoric deployed – is a cynical attempt by Washington to avoid addressing the issue of reforming a US tax code that, they argue, makes it hard for its companies to compete globally.

“What we are watching here is tough rhetoric and a clear intention to change market behaviour in a place where they arguably lack legal authority,” said a senior Wall Street adviser.

The move provoked further disagreement with the Republican party over the issue of tax reform.

“Under President Obama, the United States has the highest corporate tax rate in the developed world,” said a spokesman for John Boehner, Republican speaker of the House of Representatives. “The answer is to simplify and reform our broken tax code to bring jobs home – and help grow our economy and create even more American jobs.”

There is still a lot of dissent about these rules. What is interesting is that they’re being enacted as of the moment they’re announced. No matter what you think of inversions – tax avoidance or brilliant business move – the timing leaves little room for companies to react or change plans. It also puts a damper on mergers, which could potentially harm innovation. Or it could increase U.S. tax revenue, lessen the burden on individual taxpayers and fund many new programs.