U.S. Unveils Rules to Make Corporate Inversions More Difficult

The Treasury Department on Thursday released new rules to restrain U.S. companies from putting their addresses in foreign countries to reduce their tax bills.

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The changes will make it harder for U.S. companies to buy a company in one foreign country and locate the combined entity's address in a different country. They also would limit companies' maneuvers before a merger to make a foreign company look bigger and thus escape existing U.S. tax restrictions.

The new rules could have immediate implications for Pfizer Inc.'s attempt to merge with Allergan PLC.

One aspect of the rules, which limit companies' ability to transfer foreign operations to a new foreign parent company, will apply to future transactions by all companies that completed inversions since Sept. 22, 2014, potentially causing problems for those such as Medtronic PLC and Mylan NV that have already completed their inversions.

The Treasury's actions mark the government's latest attempt to deter companies from considering corporate inversions, deals in which U.S. businesses typically put their tax addresses in a foreign country but continue U.S. operations and management with few or any changes.

Inversions have helped drive mergers-and-acquisitions activity to record highs as companies, particularly those in health care, have looked to foreign deal making for tax savings.

"It's Treasury's responsibility to protect the U.S. tax base," said Treasury Secretary Jack Lew. "These actions further reduce the benefits of inversion and make these transactions even more difficult to achieve."

The new rules build on existing tax laws that prevent companies from escaping the U.S. tax system unless they merge with a foreign firm. Current law allows inversions to proceed as long as the U.S. company's shareholders own less than 80% of the combined company.

The rules announced on Thursday go after a technique known as "stuffing, " in which the non-U. S. company is artificially made bigger before a merger to comply with that 80% threshold.

They also make it harder for companies to do what the Treasury calls "cherry-picking," which is finding an address in a country with a favorable tax treaty. They will instead be more limited to taking new addresses in the country where the merger partner is organized.

Democrats favor immediate curbs on inversions that would prevent U.S. companies from changing addresses through mergers with a smaller foreign company, a step that would raise $41 billion in revenue over the next decade. That change, Democrats say, would be a stopgap measure that could stem the tide while Congress works on broader changes.

"We welcome efforts from Treasury to curb overseas tax inversions," said Sen. Ron Wyden of Oregon, the top Democrat on the Senate Finance Committee. "Inversions are a red flag on the urgent need for tax reform. If we want to protect the economic strength of the U.S. and create jobs, this must be a top priority for all lawmakers in the year ahead."

Republicans say the real problem is the entire U.S. tax system, and they have resisted quick action in favor of an overhaul that has stalled in Congress.

Most GOP presidential candidates want to lower the corporate tax rate, give U.S. companies a discounted rate on repatriating offshore profits and remove or lower taxes on U.S. companies' foreign income. That combination, they say, would virtually eliminate the incentive for companies to invert.

"A lot of money's going to come back in, we're going to get rid of the bureaucratic problems and roadblocks because that's also a problem," presidential candidate Donald Trump, who would cut the corporate tax rate to 15% and impose a 10% one-time tax on offshore profits, said during the Nov. 10 Republican debate. "And, we're going to have all of this money pour back into the United States. It's going to be used to build businesses, for jobs, and everything else."

House Speaker Paul Ryan (R., Wis.) has tried to reach an agreement with the administration and Senate Democrats on international taxes, but the two sides so far been unable to turn a broad consensus for lower rates, fewer tax breaks and lighter taxes on U.S. companies' foreign income into a coherent proposal. They have struggled with the complex details of tax policy and the difficult politics of separating international corporate taxation from small businesses, domestic companies and individuals, all of which have strong pull in Congress.

The Treasury Department said it is still working on future rules and warned it may take aim at a practice known as earnings stripping. That is the way companies based outside the U.S. load up their U.S. subsidiaries with deductions and push profits to low-tax countries. For example, an inverted company with a tax address in Ireland loans money to its U.S. subsidiary from the new parent company, reaping deductions at the 35% U.S. rate and income at the 12.5% Irish tax rate.

Indeed, companies that started in the U.S. and then inverted are particularly active at earnings stripping, according to a 2007 Treasury Department study. The data "strongly suggest that these corporations are stripping substantially all of their income out of the United States, primarily through interest payments," the report said. "Consequently, these corporations' U.S. operations are very unprofitable."

For example, Aon PLC inverted in 2012 and now has its address in Britain. The U.K. company's intercompany receivables increased from $166 million to $7.2 billion from 2012 to 2013, according to filings with the Securities and Exchange Commission. In 2011, its final full year in the U.S., the company reported an effective tax rate of 27.3%; it was 18.9% in 2014. A company spokeswoman didn't return a call for comment on Thursday.

That study didn't find much evidence of earnings stripping by other foreign-based companies. Still, foreign-based companies have structural advantages under U.S. law, said Bret Wells, a tax-law professor at the University of Houston.

"This is another chapter in Whac-A-Mole tax policy where we are simply killing the inversion messenger," said Mr. Wells. "The inverted companies are telling us a basic truth that we do not want to hear, and we are shouting for them to shut up."

Beyond the occasional speech urging congressional action, the Treasury Department has been relatively quiet on inversions since September 2014, when it detailed a series of regulations designed to curb inversions. Those changes included new limits on using offshore profits to finance deals and provisions to prevent companies from doing "skinny-down" transactions that made them just the right size to skirt rules that would keep them inside the U.S. tax net.

The 2014 Treasury actions caused Medtronic to alter its deal financing and led AbbVie Inc. to abandon its plans to merge with Shire PLC. They may also have helped prevent other deals from occurring. But inversions have continued, just not with household names. For example, pending inversion deals include CF Industries Holdings Inc.'s purchase of Dutch fertilizer rival OCI NV and the merger of Coca-Cola Co.'s global bottling operations.

The government hasn't yet released the formal rules that were supposed to follow the 2014 announcement and Treasury said on Thursday that the rules would be released in the coming months.

Republicans, in particular, say focusing on inversions obscures the fact that U.S. companies can achieve many of the same tax results if they are taken over by larger foreign corporations.

Liz Hoffman contributed to this article

By Richard Rubin