United States: Opposition To Corporate Inversions Growing On Capitol Hill

Yesterday, July 22, 2014, the Senate Finance Committee held a hearing at which the so-called corporate inversions of U.S. multinationals were a key topic. The hearing followed U.S. Treasury Secretary Jacob Lew's July 15 letter to congressional tax writers urging immediate legislative action to stop corporate inversions of U.S. companies.

Generally, a corporate inversion is a transaction in which a U.S. multinational group with a U.S. parent corporation restructures so that the U.S. parent is replaced by a foreign corporation, typically domiciled in a low-tax jurisdiction. Inversions, in connection with other tax planning strategies, have the result of shifting certain tax liabilities to the foreign domicile of the new foreign parent corporation. Because of the relatively higher (often much higher) corporate tax rate in the United States compared to the country of domicile of the foreign parent, inversion transactions have the effect reducing the multi-national group's effective tax rate. In his letter, Secretary Lew charged U.S. inverted corporations as having renounced their U.S. citizenship to avoid paying taxes, despite taking advantage of U.S. protection of their intellectual property rights, U.S. support of research and investment, the favorable U.S. investment climate and U.S. infrastructure funded by U.S. taxes.

Senator Orrin Hatch (R-Utah) ranking minority member of the Senate Finance Committee, responded quickly with a letter to Treasury Secretary Lew indicating that he would be willing to consider proposals to stop corporate inversions outside of comprehensive tax reform, but that he disagreed with the approach of adopting "punitive, retroactive policies designed to force companies to remain domiciled in the United States."  Senator Hatch repeated this position at yesterday's hearing.

Corporate inversions were popularized in the 1990s, prompting the IRS to issue "anti-inversion" regulations under Section 367 of the Internal Revenue Code of 1986, as amended (the "Code") taxing the shareholders of a U.S. corporation that transferred stock of a U.S. corporation to a foreign corporation if the U.S. transferors received more than 50% of the voting power or value of the stock of the foreign corporation in the inversion transaction. Following the stock market correction in the early 2000s, many U.S. corporations took advantage of low stock prices and inverted because their shareholders had little or no gain to recognize in the inversion. Companies that inverted during this period include Accenture, Cooper Industries, Everest Re Group, Foster Wheeler, Fruit of the Loom, Global Crossing, Ingersoll Rand, Leucadia National Group, Nabors Industries, Noble Drilling, Seagate Technologies, Trenwick Group, Triton Energy Corp and Tyco International.

In response to this wave of inversions, Congress enacted Code Section 7874 in the Jobs Creation Act of 2004 specifically to target and discourage corporate inversions. Under Code Section 7874, an "expatriated entity:"

  • is subject to U.S. tax on "inversion gain" for the 10-year period commencing with the conversion,
  • cannot use net operating losses and other tax attributes to offset the inversion gain, and
  • is subject to an excise tax on certain equity-based executive compensation.

An "expatriated entity" is generally a U.S. corporation that has been inverted in a transaction where the former shareholders of the U.S. corporation own 60% or more of the foreign corporation following the inversion and the foreign corporation (or its affiliated group) does not have substantial business activities in the foreign corporation's country of incorporation. The substantial business activities test is difficult for inverted U.S. corporations to satisfy. If the former shareholders of the inverted U.S. corporation own 80% or more of the foreign parent following the inversion and the substantial business activities test is not satisfied, then Code Section 7874 deems the foreign parent to be a domestic corporation.

Despite the limitations of Code Section 7874, the number of inversion transactions that have been proposed or completed have escalated in recent months. Some of these transactions have been completed with former shareholders of the inverted U.S. corporation owning greater than 50% but less than 60%, avoiding Code Section 7874 altogether. Others have been completed with former U.S. shareholders owning 60% or more but less than 80%, incurring the tax penalty of inversion gain but avoiding being cast as a U.S. corporation. Examples of recent inversion transactions (announced or completed) include Endo International's acquisition of Paladin Labs, Perigo's acquisition of Elan, Liberty Global's acquisition of Virgin Media and Pfizer's now abandoned acquisition of AstraZeneca. It has even been recently reported that Walgreens may be considering an inversion transaction. Testifying at yesterday's hearing, Allan Sloan, Fortune magazine senior editor at large and the author of Fortune's recent "Positively Un-American" cover story about inversions, characterized the Joint Committee on Taxation's $19.5 billion 10-year estimated revenue loss as "way, way low" if inversions are not stopped.

While Secretary Lew did not specifically propose a legislative fix, he referred in his letter to President Obama's Fiscal Year 2015 Budget Proposal. The 2015 Budget proposal noted that the adverse tax consequences associated with inversions that failed the 60% test but met the 80% test had not been sufficient to prevent inversion transactions from occurring. The proposal would reduce the threshold under Section 7874 for the foreign parent being deemed a U.S. corporation from 80% to greater than 50%, would eliminate the 60% test, and would apply the anti-inversion provision regardless of former shareholder continuity if the multinational group maintains substantial business activities in the United States and is primarily managed and controlled in the United States. Secretary Lew submitted that such a law should be applied retroactively to May 8, 2014. This law change would make it practically impossible for a U.S. corporation to invert without undergoing a change of control and moving management outside of the United States in the process.

Senator Carl Levin (D-Mich.) and Representative Sander M. Levin (D-Mich.) previously introduced the Stop Corporate Inversions Act, which closely tracks the President's 2015 Budget proposal. The Stop Corporate Inversions Act was met with resistance from both sides of the aisle, including from Senate Finance Committee Chair Ron Wyden (D-Ore.) who is working on different legislation that he hopes will be bi-partisan. It appears increasingly likely that comprehensive tax reform is a long way off but that some form of anti-inversion legislation may be forthcoming, though it may differ from the President's 2015 Budget proposal.

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Authors
J. Leigh Griffith
Donald B. Stuart
 
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