Ways and Means Democrats Summarize Anti-Inversion Proposal

It is clear that a swift response is needed by Congress to limit the tax benefits associated with corporate inversions. There have been more than 40 corporate inversions in the last decade, costing the U.S. tax base billions of dollars. The press reports that there have been 14 acquisitions announced this year that will lead to corporate inversions. These 14 acquisitions appear to be the tip of the iceberg as more companies currently are evaluating similar inversion deals.

This wave of corporate inversions threatens to undermine the U.S. tax base and our economy, to the long-term detriment of all the companies that do business here, as described by veteran business reporter Allan Sloan in a recent cover story for Fortune magazine. Sloan wrote: "The spectacle of American corporations deserting our country to dodge taxes while expecting to get the same benefits that good corporate citizens get makes me deeply angry." These companies will no doubt continue to benefit from being headquartered in the United States, with our robust financial markets, protection of intellectual property rights, and our support of research and development, along with our stable communities and wealth of educated workers.

Although comprehensive business tax reform may stem the corporate inversion wave, it is not at all clear when that reform will materialize. As we work diligently toward comprehensive tax reform, we need to enact legislation now to prevent companies from simply changing their tax domicile to avoid paying U.S. taxes.

On May 20, 2014, Congressman Levin and nearly a dozen House Democrats introduced legislation, the "Stop Corporate Inversions Act of 2014" (H.R. 4679), to tighten restrictions on corporate tax inversions The bill would effectively require U.S. companies to merge with foreign companies that are roughly equal or larger in size in order to move their location for tax purposes outside the United States and, thereby, escape U.S. taxes. The legislation would apply to inversions completed after May 8, 2014.

The discussion draft released today complements H.R. 4679 and takes another step toward curbing corporate inversions by closing two loopholes that provide significant tax incentives to companies that have moved offshore. First, under current law, once a U.S. multinational company inverts, the new foreign combined company and other foreign affiliates in the group gain access to the untaxed foreign earnings of the former U.S. parent company's controlled foreign corporations (e.g., through loans) without triggering a current U.S. tax. The borrowing foreign affiliate could deploy such untaxed earnings to repay debt (including debt incurred to finance the inversion transaction) or to make investments in the United States. Such untaxed foreign earnings would likely escape the U.S. tax base all together. By contrast, if these loans were made to the former U.S. parent company, the current law would treat the loan as a deemed dividend subject to current U.S. income tax. The bill would close the foregoing loophole.

Second, under current law, once a corporate inversion has taken place, the new foreign-controlled U.S. multinational group effectively can strip the U.S. tax base through large interest deductions on intercompany loans. The bill would close this loophole by tightening the existing anti-earnings stripping rules. Limits on earnings stripping have been a bipartisan approach to deterring inversions, and such proposals have been included in both Republican and Democratic Administration budgets.

The discussion draft is designed to give stakeholders the opportunity to comment on the approach to closing the above-described corporate loopholes. Congressman Levin invites public comments on the discussion draft through September 5, 2014.

Current Law. Section 956 of the Internal Revenue Code (the "Code") was intended to prevent the use of a CFC's untaxed earnings for direct investments in the United States without incurring U.S. tax. It prevents circumvention of the rule that would otherwise tax earnings repatriated to the U.S. parent. This section requires U.S. shareholders of CFCs to include in gross income a pro rata share of any increase in the CFCs' investment of earnings in "United States Property." For purposes of this rule, "United States Property" includes, among others, stock and debt obligations of related domestic corporations. The provision currently does not require a similar pro rata inclusion of the CFCs' investment of earnings in stock and debt obligations of non-CFC foreign affiliates. As a result, a CFC can lend its untaxed earnings to a non-CFC foreign affiliate, which in turn could, among other possibilities, make investments in United States Property, without triggering U.S. income tax at the shareholder level (assuming this series of transactions did not run afoul of substance-over-form arguments or other doctrines).

Proposed Change. The Act would require that stock and debt obligations of non-CFC foreign affiliates held by CFCs trigger current U.S. income tax to U.S. shareholders. The Act would broaden the scope of Section 956 of the Code to provide that a U.S. shareholder's gross income includes a pro rata share of the "foreign group property" in addition to a pro rata share of any increase in the CFC's investment of earnings in United States Property. For purposes of this expanded rule, "foreign group property" means any stock or obligation of any non-CFC foreign affiliate.

Current Law. Section 163(j) of the Code limits excessive deductible interest payments. Specifically, the provision denies a deduction for excess interest paid by a U.S. entity to a related party (where the interest payment is exempt from or subject to a reduced rate of U.S. withholding tax) when the entity's (1) debt-to-equity ratio exceeds 1.5, and (2) net interest expense exceeds 50% of the entity's adjusted taxable income. Disallowed interest expense may be carried forward indefinitely for deduction in a subsequent year. In addition, the entity's excess limitation for a tax year (i.e., the amount by which 50% of adjusted taxable income exceeds net interest expense) may be carried forward to the three subsequent tax years.

Proposed Change. The Act would further limit a foreign-controlled U.S. multinational group's ability to strip its U.S. tax base by repealing the debt-to-equity safe harbor under 163(j) and reducing the permitted net interest expense to no more than 25% of the entity's adjusted taxable income. In addition, the Act would repeal the excess limitation carryforward, but permit any disallowed interest expense to be carried forward for five years.