Treasury Announces Rules To Help Curb Benefits Of Inversions

The Treasury Department is trying to stem the tide of deals that take U.S. companies overseas for tax purposes.

The Treasury Department announced new rules Monday afternoon seeking to make corporate inversions less economically attractive.

The announcement comes two weeks after Treasury Secretary Jack Lew said administrative action on slowing the tide of corporate inversions was coming soon. Corporate inversions, where a U.S. company buys a smaller foreign company and moves its headquarters for tax purposes to lower-tax countries, have skyrocketed in the last year, with hundreds of billions of dollars of either announced or completed deals. President Obama has pointedly criticized the deals, calling them unpatriotic, and Democrats in Congress have proposed bills that would make the deals less profitable or more difficult to do.

Lew said on a call with reporters that the rule changes will make it so that some inversions "will no longer make sense." Lew said the moves were only a first step and that it was "incumbent on Congress to pass anti-inversion legislation," but that the rule changes will "make inversions substantially less appealing."

The new rules will not ban inversions and do not deal with one of the main ways comapnies can reduce their tax bills following a move overseas: loading up U.S.-based subsidiaries with debt that can then be deducted from their taxes.

There are several large deals that have been announced but are yet to close that could be affected by the new rules, either by preventing the deals altogether or by limiting their tax effects. Such deals include the Minnesota medical device company Medtronic's $43 billion tie up with Ireland-based Covidien or Illinois-based pharmaceutical company AbbVie's $54 billion deal with Shire, which would take the new combined tax headquarters to Jersey, an island dependency of the U.K.

The outcry against such deals already helped scotch Walgreens' proposed acquisition of the rest of Alliance Boots, a Swiss-based pharmacy chain of which it owned a large piece. Burger King also has a deal to acquire Canadian doughnut-and-coffee chain Tim Hortons, which Burger King executives insisted was not done for tax purposes.

The Treasury official said the rule changes were directly aimed at companies pursuing deals and the investment bankers advising on them. "There's been a lot of activity in the investment banker part of the world where they're pitching deals and we're trying to take steps to make these less economically attractive."

They are likely to be met with opposition from those very bankers. Bob Steel, the head of the advisory firm Perella Weinberg, which advised on Medtronic's proposed acquisition of Covidien, said Monday at a conference before the rules were announced that the inversion wave was a "symptom, not a cause" and blamed the corporate tax code for encouraging companies to move their headquarters overseas.

JPMorgan Chase CEO Jamie Dimon, whose investment bankers have advised on several inversions, defended the deals on a call with reporters in July, saying, "You want the choice to be able to go to Walmart to get the lowest prices. Companies should be able to make that choice as well," referring to the tax benefits of being based overseas.

The regulatory actions, which will apply to any deal that hasn't closed today, mostly affect how companies that are already inverted can access the earnings of foreign subsidiaries of the U.S. company while avoiding the taxes that usually apply to overseas earnings. One rule change will make it so loans, called "hopscotch" loans, that go from a foreign subsidiary to a U.S.-based parent company after an inversion will be considered the same as a dividend for tax purposes.

"This is a way to prevent avoiding taxes," said a senior Treasury official on a call with reporters. "This would apply for 10 years after the inversion."

The rules could be challenged in court.

Other new rules will take away the economic benefits from transferring control or cash of their foreign subsidiaries after an inversion to avoid U.S. taxes. The final rule changes how a foreign company's assets are calculated.

This matters because the foreign company's shareholders need to own at least 20% of the new company for it to qualify for an inversion. By restricting how the size of the company is calculated, the Treasury's new rules put another barrier in front of inversion deals. The Obama administration supports raising the threshold to 50%, but that would require legislation.

The new rules will also prevent U.S. companies from paying out unscheduled dividends to shrink themselves right before the deal closes to meet the inversion threshold.

These rules fall short of what some tax experts have suggested the Treasury could do without congressional action, including former top international tax official Stephen Shay, who called for reducing the tax benefits that U.S. subsidiaries can get when they borrow money from their overseas parent company after an inversion.

Combined, the new rules "will prevent inverted firms from inappropriately making use of earnings and profits of controlled corporations," the Treasury official said.

The Treasury official said this is a first step, and even if Congress doesn't pass a deal to more comprehensively address inversions, the Treasury could enact more rule changes, including those that address how new inter-company debt leads to smaller tax bills.

When asked to estimate the specific effect inversions have on tax revenue, the Treasury official said that since "most transactions haven't closed, we don't know what the effect might be."