New US Inversion Rules To Have Impact Abroad

The US Treasury’s latest measure to keep US companies from reincorporating in lower-tax countries is its strongest effort yet to halt so-called “inversions,” and could have far-reaching consequences for multinationals.

The proposed rules have already upended the $150 billion merger of Pfizer with Ireland-based Allergan (formerly of California) and could have broad implications for the large number of healthcare companies that have used inversions to re-domicile in tax-advantaged countries in the past few years, Fitch Ratings says.

“Although the Pfizer-Allergan combination offered some interesting strategic benefits, the cancellation of the merger indicates that tax synergies were the overwhelming factor supporting the transaction,” Fitch said in a release. The US taxes corporate profits at 35%, one of the highest rates in the world, whereas Ireland has a corporate tax rate of 12.5%, and even as low as 6.25% in some cases.

The new rules, which include hundreds of pages of regulations, would exclude recent acquisitions from helping a company meet the foreign ownership hurdle for an inversion. US companies that acquire 60% or more of a foreign company cannot access their deferred earnings abroad without paying the US tax.

By excluding Allergan’s recent string of acquisitions, the new rules would, in effect, shrink the Irish company’s size, making it impossible for Pfizer to pass the 60% test to access its $74 billion of deferred foreign earnings tax-free. The US Treasury and the Internal Revenue Service are targeting “serial inverters,” such as Allergan, which has been involved in multiple deals with US companies.

“We know companies will continue to seek new and creative ways to relocate their tax residence to avoid paying taxes here at home,” Treasury secretary Jacob Lew says. “This [new effort] will have an important effect, but we cannot stop these transactions without new legislation.” The odds are long, however, for a major tax overhaul to pass Congress in the foreseeable future. Congress shouldn’t wait, Lew says, because inversions are continuing to erode the US tax base.

The new rules also propose to curb “earnings stripping” by limiting the amount of money that foreign parent companies can lend to US subsidiaries in order to deduct the interest payments from US taxes. Any note issued to a related foreign company could potentially be considered to be stock, and the “dividends” would not be deductible.

The Treasury says the proposed regulations generally do not apply to related-party debt that is incurred to fund actual business investment, such as building or equipping a factory. To the extent that the proposed rules make it more difficult for multinational companies to reduce US taxable profits, however, there could be a negative effect on foreign direct investment as an unintended consequence.

Nancy McLernon, president and CEO of the Organization for International Investment in Washington, DC, says: “The administration’s sweeping proposal will increase the cost of investing and expanding across the US for all foreign companies. This is a misguided approach that will damage US competitiveness.”

Meanwhile, US multinationals have stockpiled $2.4 trillion of earnings overseas, according to Citizens for Tax Justice, allowing these companies to avoid nearly $700 billion in taxes.