US tax rules would curb inversions through earnings stripping limits, stopping serial inversions

The US Treasury today announced a package of tax rules designed to discourage corporate inversions, including measures that restrict earnings stripping following an inversion and that thwart “serial inversions.”

“For years, companies have been taking advantage of a system that allows them to move their tax residences overseas to avoid US taxes without making significant changes in their business operations,” Treasury Secretary Jacob J. Lew told reporters during a conference call announcing the new rules.

Lew said Treasury will continue to explore additional ways to limit inversions but said that only Congress has the power to stop inversions altogether.

Under proposed regulations to be issued under section 385, following an inversion or foreign takeover, debt issued by a US subsidiary to its foreign parent in a dividend or an economically similar transaction will be reclassified as equity if the debt does not finance new US investment.

The provision would reduce the incentive to invert because groups would no longer be able to load a US subsidiary with related-party debt to strip income out of the US through tax deductions, and, at the same time, arrange for the related interest income to be recognized in a low or no-tax jurisdiction.

Treasury said it intends to move swiftly to finalize the rules, which apply to instruments issued after April 4.

Another set of rules applicable to “serial inverters” appears designed to kill transactions similar to Pfizer’s pending merger with Allergan, scheduled to close later this year.

Under the rules, foreign parent stock attributable to assets acquired from a US company within three years would be disregarded for purposes of calculating the 60 percent threshold of section 7874 .

“It is not consistent with the purposes of section 7874 to permit a foreign company (including a recent inverter) to increase in its size in order to avoid the inversion threshold under current law for a subsequent acquisition of an American company,” Treasury said.

Also, proposed regulations under section 385 would allow the IRS on audit to divide a purported debt instrument into part debt and part stock.

The current law’s “all-or-nothing approach creates distortions when the facts support treating debt as part debt and part stock,” Treasury said.

Regulations would also require members of large groups to to provide information so the IRS can conduct a debt-equity analysis of related-party instruments. This will help the IRS determine if intent to create a genuine debtor-creditor relationship exists.

Temporary regulations implementing two previous inversion actions released in 2014 and 2015 will also be issued, Treasury said.

The Administration also today released an updated framework on business tax reform, which includes the government’s legislative proposal to stop inversions.

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