The U.S. Federal Government yesterday issued final rules barring the tax-reduction technique known as earnings stripping from corporate tax inversions.
Earnings stripping happens when a U.S. subsidiary of an inverted company avoids taxes on domestic operations by sending them overseas as tax-deductible interest payments.
The new regulations seek to reclassify certain forms of debt as equity, which changes tax-exempt interest payments into dividends, which are taxed. The treasury also imposed a temporary rule in April to prevent foreign companies from engaging in serial inversions, which is expected to be be finalized later this year.
Tax inversions involve a U.S. company which is acquired by smaller foreign business in a low-tax country, which then adopts the new location to reduce the overall U.S. tax burden.
While inversions have happened since the 1980s, a recent wave of tax inversions, such as Medtronic‘s (NYSE:MDT) $50 billion merger with Covidien.
The U.S. Chamber of Commerce, along with other business groups, warned that the new regulations could harm cash management operations of U.S-based multinations and could have unintended consequences due to excessive red tape.
Treasury officials responded saying that those concerns were addressed by exemptions granted for regulated financial and insurance firms, cash pooling, short-term debt, transactions between the foreign units of U.S. companies, stock acquisitions for employee compensation plans and other operations.
“For years, this administration consistently has called for comprehensive business tax reform to fix our broken tax system. In the absence of congressional action, however, it is Treasury’s responsibility to use our authority to protect the tax base,” Treasury Secretary Jack Lew said.
The rules will likely be challenged in court, according to business lobbyists.
In April, Medtronic seemed unfazed by the U.S. Treasury Dept.’s push to rein in so-called “inversion” mergers, which allow American companies to re-organized under foreign jurisdictions, after the agency issued new rules on the deals this week.
Several U.S. presidential candidates, including Republican Donald Trump and Democrat Hillary Clinton, have seized on the issue in their campaigns. President Barack Obama, a Democrat, has called repeatedly for action by the Republican-controlled U.S. Congress on inversions, but lawmakers have done little.
The Treasury Dept. tightened the rules on inversions last November, limiting U.S. acquirers’ ability to set up new foreign parents and “stuff” assets into it to meet existing limits on post-inversion ownership levels. Medtronic, which shrugged off the implications back then, said today that a preliminary review of the newer regulations led it to conclude that they do not have a material financial impact on any transaction undertaken by the company.
The new rules have already scuppered 1 mega-deal, the proposed $160 billion combination of Pfizer (NYSE:PFE) and Allergan (NYSE: AGN), triggering a $150 million breakup fee to cover Allergan’s expenses in the deal.
Material from Reuters was used in this report.