Finance

Senate Democrats Push For IRS to Expand Reach of the Anti-Inversion Rules

Prior to the Christmas recess, five leading Democrat Senators, Reed (D-R.I.), Hirono (D-Hawaii), Baldwin (D-Wis.) Durbin (D-Ill.) and retiring Carl Levin (D-Mich) delivered a letter to the IRS asking the National Office to address several types of transactions that companies have used in connection with an inversion in.

By Jerald David August  
on

Ed note: This post originally appeared on Fox Rothschild’s Federal Taxation Developments Blog.

Prior to the Christmas recess, five leading Democrat Senators, Reed (D-R.I.), Hirono (D-Hawaii), Baldwin (D-Wis.) Durbin (D-Ill.) and retiring Carl Levin (D-Mich) delivered a letter to the IRS asking the National Office to address several types of transactions that companies have used in connection with an inversion in. The Senators want the Treasury and IRS to issue new rules to further prevent or reduce earnings stripping, the use of so-called “hopscotch” loans and the avoidance of gain recognition through use of inverted corporations.

The Service had issued guidance to prevent further exploitation of the inversion rules last September, including use of spin-offs and “hopscotch” loans. Another strategy that is on the Treasury’s anti-inversion “hit list” is the so-called skinnying down” device in which companies pay special dividends prior to a merger to avoid or soften the application of the inversion provisions.

What is clear to members of Congress is that U.S. based companies have not reduced their desire to re-incorporate off-shore despite the inversion provisions. Indeed, there are new ways to exploit the policing rules. Thus, according to certain members of Congress and certainly the Obama Administration, Treasury and IRS, there must be new impediments to going off-shore. Well, that’s one way at looking at the continued migration to outside of the United States by our biggest U.S. multi-nationals. But it is not the only way. Indeed, a better, much better solution should be to enact into law new incentives to U.S. based corporations to remain in the U.S., most notably by lowering the corporate tax rate to 25% or even lower to more than offset the advantages of having engaged in a corporate expatriation. With the highest corporate tax rate in the world, Democrats and the President delude themselves that corporate inversions have no rationale other than tax avoidance on a massive scale. What they need to understand is a simple economic fact of life, the U.S. corporate tax rates must be reduced in order to keep capital and labor engaged in the United States and for corporations to be persuaded not to reinvent themselves elsewhere.

The Anti-Inversion Rule on the “Books”

An “inversion” is described in Section 7874 as a series of transactions whereby a U.S. corporation becomes a foreign corporation that is not subject to the general taxing jurisdiction of the United States, or similar transactions whereby the U.S. corporation’s shares or assets are placed under a new foreign holding company. The anti-inversion rules contained in Section 7874 are designed to restrict inversion transactions by treating inverted foreign corporations as domestic corporations. If three requirements are met under Section 7874, a foreign corporation will be treated as a “surrogate foreign corporation” that will be classified as a domestic corporation for all U.S. income tax purposes: (i) the foreign corporation acquires substantially all of the properties of a U.S. corporation after March 4, 2003; (ii) the former shareholders of the U.S. corporation hold 80% or more (by vote or value) of stock of the foreign corporation after the transaction by reason of having held equity interests in the U.S. corporation (disregarding stock owned by members of the expanded affiliated group and stock sold in a public offering related to the acquisition) (the “shareholder continuity” test); and (iii) the foreign corporation and its expanded affiliated group do not have substantial business activities in its country of incorporation (compared to the business activities of the expanded affiliated group outside such country).

An “expanded affiliated group” will meet the “substantial business activities” test if at least 25% of its employees, 25% of its assets, and 25% of its income are located in, or in the case of income, derived from, that foreign country. Treas. Reg. Section 1.7874-3T(b).

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In addition, where the above three requirements would be satisfied if “60%” was substituted for “80%” in the shareholder continuity test, the foreign corporation will remain a “foreign” corporation for U.S. tax purposes, but special rules are triggered, including that the expatriating domestic corporation (or any U.S. person who is or was related within the meaning of Section 267(b) to such expatriating domestic corporation) will not be permitted to use its tax attributes (e.g., net operating losses or available foreign tax credits) to reduce its U.S. income tax liability attributable to certain “inversion gains” (essentially income and gains from shifting assets outside of the U.S. taxing jurisdiction to the foreign acquirer or to related persons).

Stay tuned for sure. Congress may end up doing the “right” thing and reduce the corporate income tax rate to 25% (or less).

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