Representative Levin Releases Discussion Draft of Legislation to Limit Benefits of Corporate Inversions
On July 31, 2014, Representative Sander Levin (Democrat, Michigan) released a discussion draft of legislation that, if enacted into law, would limit certain tax benefits that often flow from corporate inversions. The legislation is known as the “Stop Corporate Earnings Stripping Act of 2014.” The discussion draft focuses on three areas: (i) tightening the “earnings stripping” rules of section 163(j), (ii) expanding the scope of section 956, and (iii) taxing the “decontrol” of a controlled foreign corporation.
Proposed changes to section 163(j)
After an inversion, the leverage of the U.S. group is usually increased in order to reduce U.S. taxable income. Thus, tightening the rules of section 163(j), which limits the deduction for interest paid to, inter alia, a related person, would hamper the ability of the multinational group to reduce its U.S. tax exposure. The discussion draft would tighten the rules of section 163(j) in several ways.
Under current law, section 163(j) does not apply if the debt-equity ratio of the borrower is not greater than 1.5:1. The discussion draft would repeal this debt-equity safe harbor. Also, under current law, only “excess interest expense” is subject to the limitation of section 163(j). Excess interest expense is calculated as the amount by which net interest expense exceeds 50 percent of the borrower’s adjusted taxable income plus any excess limitation carry-forward. The discussion draft would lower this percentage to 25 percent. The discussion draft also would shorten the relevant carry-forward periods for excess interest expense and any unused excess limitation.
Proposed changes to section 956
The purpose of section 956 is to tax earnings of a controlled foreign corporation that are effectively repatriated to the United States by means of an investment in “United States property.” Such investments include a loan by the controlled foreign corporation to a U.S. person. After an inversion, the foreign parented-group may include not only controlled foreign corporations but foreign subsidiaries that are not controlled foreign corporations and that are in need of funding. The discussion draft would expand section 956 to include investments in “foreign group property.” That term is defined to be, subject to certain exceptions, “any stock or obligation of any foreign person which is not a controlled foreign corporation.” Thus, a loan by a controlled foreign corporation to any member of the group could be treated as a repatriation of earnings to the controlled foreign corporation’s U.S. parent.
This proposed change to section 956 is not limited to U.S. multinational groups that have recently inverted. There are many foreign multinational groups that have, over the years and for sound business reasons, acquired smaller U.S. multinational groups having controlled foreign corporations. Loans by those controlled foreign corporations to other foreign corporations in the group would trigger a section 956 inclusion should the discussion draft become law. While this would be a surprising expansion of subpart F and perhaps annoying to U.S. treaty partners, anti-deferral rules such as subpart F generally are not considered to be a violation of U.S. treaty obligations.
Decontrolling controlled foreign corporations
A summary released with the discussion draft includes the following statement: “it is intended that the Act also would address the ability of foreign-controlled U.S. multinational groups to ‘decontrol’ CFCs in order to avoid subpart F rules, including the proposed changes to section 956.” There is no further indication as to what Representative Levin has in mind.
Unlike most recent anti-inversion measures, which have retroactive effective dates, the discussion draft has a prospective effective date.
During August there was speculation in Washington that the Treasury Department would issue regulations (or more likely a notice) that would, in some respects, limit the benefits a U.S. multinational group could realize from entering into a corporate inversion. The Treasury, however, has not made an announcement that such regulations are under development nor has it indicated the subject matter of such regulations or notice.
The discussion draft focuses on areas of the tax law in which the Treasury also might wish to exercise its regulatory authority. To the extent Congress believes such changes should be made by legislation (as evidenced by the discussion draft) the Treasury’s authority to write similar regulations is implicitly proscribed. In general, the changes to the law that would be made by the discussion draft appear to be more appropriately achieved by legislation, than by regulation.
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