The Treasury Department and the Internal Revenue Service (IRS) announced late on Monday evening that they are taking action to try and stem the flow of companies moving overseas to dodge taxes, moves specifically known as tax “inversion” deals. The announcement comes after American fast food chain Burger King moved to buy Canadian company Tim Horton’s and move its headquarters into Canada.
Here’s what you need to know about what the Obama administration is doing and why it matters:
What are tax inversions?
A tax inversion is when a U.S.-based company buys another one located abroad and moves its headquarters to that country in an effort to exploit the other country’s lower corporate tax rate. The U.S. has one of the higher on-paper corporate tax rates at 35 percent, even though American companies pay an average 12.6 percent effective rate thanks to various ways to lower the bill (something that may actually make them more competitive). A swarm of these deals have cropped up lately, from Burger King to Chiquita Banana to drug company Pfizer. In fact, more than half of the 76 deals over the last three decades were completed since the beginning of the recession and about a dozen have wrapped up this year. They cost the country between $30 billion and $90 billion a year in revenue.
This trend caught the attention of both politicians and the public — outcry was part of what led Walgreens to ditch its own inversion plans in August. But the rest are moving forward. So the administration has taken action meant to make them less attractive.
What is the White House doing about them?
The new rules won’t ban inversions. But they are aimed at “meaningfully reducing the economic benefits of inversions,” Treasury Secretary Jack Lew said in a press release. “For some companies considering mergers, today’s action will mean that inversions no longer make economic sense.”
The agencies want to make some of the tax benefits of inversion deals disappear by taking aim at a complex set of techniques that inverted companies have used to bring some money earned abroad back to the United States without paying U.S. taxes. Previously, a type of loan known as a “hopscotch loan” was not considered to be taxable as U.S. property. The new rules would prevent companies from using these loans without paying American taxes. Companies will also be prevented from avoiding taxes by having the foreign company take control of subsidiaries, allowing it to access earnings without paying U.S. taxes — moving forward, the subsidiaries will still be considered to be controlled by the American-based company and earnings will be subject to American taxes. The rules will also close a loophole that allowed inverted companies to transfer cash or property from a foreign subsidiary to the American headquarters tax-free.
Treasury and the IRS are also looking to make these deals more difficult to pull off in the first place. Former owners of the American company will face stricter enforcement of the requirement that they own less than 80 percent of the new, foreign-headquartered company in order for a deal to go through.
Who will be impacted?
The new rules only apply to tax inversion deals that happen after Monday, so past deals won’t feel the effect. But the dozens that are in the works, like the Burger King — Tim Horton deal, could end up derailed. Signs of the impact were already evident on Tuesday morning, as stock shares for the companies that have been targeted for acquisitions by American firms were trading lower, a potential sign that traders think the rules will upend the deals.
What else might happen in the future?
Monday’s announcement amounts to action that the administration can take without Congress, and more rules from the Treasury Department may follow. But there have been legislative moves to go further. A group of House Democrats introduced a bill in May that would block an inversion deal if shareholders still own 50 percent or more of the American company, rather than the current threshold of 80 percent, thus keeping U.S. companies from inverting by buying smaller companies abroad. Earlier this month, Sen. Chuck Schumer (D-NY) put forward a proposal to limit future tax deductions for inverted companies to reduce the attractiveness of these deals.
Lawmakers have also promised more aggressive action against inversions in comprehensive tax code reform, which may be introduced in the lame-duck session coming up in November.