The Corporate Inversion Debate Intensifies
July 2014During July the debate in Washington over whether and how to address the growing number of “inversions” of U.S. corporations intensified. The impetus was a letter sent by the Secretary of the Treasury, Jacob Lew, to Representative Dave Camp, the Chairman of the House Ways and Means Committee, Senator Ron Wyden, the chairman of the Senate Finance Committee, Representative Sander Levin, ranking member, House Ways and Means Committee and Senator Orrin Hatch, ranking member, Senate Finance Committee. The letter triggered various responses discussed below.
Secretary Lew’s Letter
Secretary Lew’s letter, dated July 15, sets out the Obama’s administration’s concern that U.S. companies that complete a corporate inversion will lower their U.S. tax bill while continuing to enjoy certain benefits from locating their business in the United States, including the protection of U.S. intellectual property law, research and development tax incentives, a favorable investment climate and utilization of U.S. infrastructure. The letter refers to retroactive tax legislation proposed by Democrats in Congress that would tighten U.S. the anti-inversion rules and urges Congress to “enact legislation immediately – and make it retroactive to May 2014 – to shut down this abuse of our tax system.” The letter concludes with a call for “a new sense of economic patriotism” and urges Congress not to provide support for “corporations that seek to shift their profits overseas to avoid paying their fair share of taxes.”
Senator Hatch’s Response
Senator Hatch did not delay in responding to Secretary Lew. In his letter of July 17 to Secretary Lew, Senator Hatch states “I must disagree with the administration’s position that we should, in the short term, enact punitive, retroactive policies designed to force companies to remain domiciled in the United States.” Senator Hatch also notes the risk that the proposed tightening of the U.S. anti-inversion rules would not deter outright takeovers of U.S. companies by foreign competitors, which also would erode the U.S. tax base.
Senator Hatch also stated that he was surprised by the tone of Secretary Lew’s letter, including the reference to a “new sense of economic patriotism.” He characterized that language as rhetoric “almost always [used] in the context of a political campaign” and states that he finds it “odd that you would use it in an official communication between branches of government.”
During the month of July there were several other developments related to corporate inversions.
- Senator Carl Levin (Democrat Michigan) and others proposed legislation that would not allow U.S. corporations that inverted to enter into contracts with the U.S. federal government. The legislation is known as the No Federal Contracts for Corporate Deserters Act. A press release from Senator Levin cites an estimate that inverted companies have received $1 billion in federal contracts during the past five years.
- On July 24 President Obama spoke in Los Angeles and referred to U.S. companies seeking to invert as “corporate deserters who renounce their citizenship to shield profits.” Echoing the language of Secretary Lew’s letter President Obama also called for a new sense of economic patriotism.
- In an interview with the U.S. tax publication, Tax Notes, Steve Shay of Harvard Law School has suggested that the Obama administration could reduce the incentive for U.S. companies to invert by writing regulations that would limit their interest deduction. An inverted U.S. company has a foreign parent. Typically, subsequent to the inversion, the U.S. company issues debt to its parent (or another foreign member of the group) creating an interest deduction that reduces the U.S. tax base.
- Secretary Lew responded to Professor Shay’s proposal stating that the Treasury Department had investigated that option and concluded that approach was not feasible.
Congressional elections will be later this year, and it is a commonplace that tax legislation is not enacted during an election year. Developments during July only reinforce that conclusion. Typically, if the executive and legislative branches wish to cooperate to craft tax legislation, they will do so privately. Secretary Lew’s public letter, followed by President Obama’s speech in Los Angeles, demonstrates that for the time being at least, corporate inversions will be a topic that Democrats will use primarily to mobilize their constituents.
Senator Hatch’s letter to Secretary Lew states that “there may be steps Congress can take short of comprehensive tax reform, to address corporate inversions and related issues.” Although Senator Hatch does not offer details, he probably is referring to legislation that would make it more difficult to restructure a U.S. corporate group after it has inverted. Simply creating a foreign holding company through an inversion transaction does not reduce the inverted company’s U.S. tax liability. Additional steps are necessary. These steps typically include moving foreign subsidiaries of the former U.S. parent company “out from under” that company and locating it beneath the new foreign parent company, leveraging U.S. subsidiaries with debt owned in a low-tax jurisdiction and moving intellectual property (“IP”) into low-tax jurisdictions. Accomplishing these transactions in a manner that attracts little U.S. tax often requires skillful tax planning and the right set of facts.
Secretary Lew’s stated rationale for strengthening current anti-inversion rules does not directly address the “out from under” movement of foreign subsidiaries. Foreign subsidiaries, the income of which avoids U.S. corporate level tax after the inversion, typically do not operate in the United States and so do not avail themselves of the benefits enumerated in the Secretary’s letter. Those benefits are enjoyed by the U.S. companies in the group. Perhaps Secretary Lew is focusing on erosion of the tax base of the U.S. group through excess leverage and IP migration. If so, that concern could be addressed through strengthened thin capitalization rules and IP migration rules, rather than tougher anti-inversion rules.
 Very generally, a U.S. corporate group “inverts” when it undertakes a transaction in which the U.S. parent corporation becomes the subsidiary of a foreign corporation and there is some continuity of shareholder interest, i.e., shareholders of the U.S. parent corporation become shareholders of the foreign corporation and own at least 60 percent of the new parent. Recently, these inversion transactions have been accomplished by the merger of a U.S. public corporation with a smaller foreign corporate group in a transaction in which the smaller foreign parent corporation becomes the parent of the combined groups. http://www.levin.senate.gov/newsroom/press/release/summary-of-the-levin-durbin-no-federal-contracts-for-corporate-deserters-act 143 DTR G-3 http://www.bloomberg.com/news/2014-07-28/lew-can-use-tax-rule-to-slow-inversions-ex-official-says.html Id. Foreign subsidiaries usually are relocated under foreign parent companies so that the foreign subsidiaries’ income is not subject to U.S. corporate income tax of 35 percent (less the foreign tax credit) when repatriated. Foreign parent companies are usually resident in a jurisdiction that offers a participation exemption and weak or no anti-deferral (CFC) rules so there is no tax imposed at the level of the foreign parent.KEYWORD: Corporate Inversions
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