U.S. plans to curb tax ‘inversions’ could hit foreign companies

Obama says that planned changes that are aimed at ensuring American companies do not avoid tax by shifting their headquarters overseas could also force foreign companies to adopt more conservative U.S. tax-planning strategies. One of the measures restricts the ability of U.S. subsidiaries of foreign companies to deduct the interest they pay on loans from their parent firms from their taxable income.

The plan also aims to stop a redomiciled American firm from reducing its U.S. tax bill by piling inter-group debt on its U.S. operations, and effectively shifting profits overseas. But it could also affect European companies that use similar strategies to reduce their tax bills in the United States after buying U.S. firms.

The new rules announced by the Treasury department this week aim to curb so-called ‘inversions’ – where a U.S. group acquires a smaller overseas company and shifts its domicile to a lower-tax jurisdiction.

Under the new rule regarding debt, if a U.S. subsidiary transfers money to its overseas parent within three years before or after borrowing money from it, by paying a dividend or buying shares in the parent, then U.S. tax authorities could potentially treat the loan as if it was equity.

This means the interest on the debt would not be deductible for U.S. income tax purposes.

Experts said that European companies would still be able to shift profits via inter-group debt, but may have to do so gradually over a longer period of time.

“It, without doubt, significantly changes the rules of the game,” said Stephen Shay, professor of law at Harvard University.

“In the old days you bought and then you levered up as much as you can and that is not going to happen in the same way, but how much of a constraint that becomes is unclear,” he added.

Netscape

BILLIONS AT STAKE

The Treasury says it is targeting situations where large debts are incurred to fund dividends shortly after an inversion or foreign acquisition, rather than the most common way U.S. subsidiaries accumulate inter-group debt. That is by having the subsidiary gradually pay all its profit to its parent as dividends and then borrow money from its parent for new investment.

“The proposed regulations generally do not apply to related-party debt that is incurred to fund actual business investment, such as building or equipping a factory,” a Treasury factsheet released last week said.

Netscape

Companies don’t usually publish details of their inter-group financing so it’s impossible to put a figure on how much profit foreign companies shelter from U.S. tax through inter-group loans. Richard Murphy, professor of practice in international political economy at City University London, estimates the IRS could lose tens of billions of dollars in taxes each year in this way.

Companies that have reduced their U.S. tax bills via inter-group lending include drugmaker GlaxoSmithKline, education group Pearson, utility Scottish Power and telecoms group Vodafone.

All said their lending to U.S. subsidiaries had been unwound and that they complied with all tax rules. Details of their lending arrangements came to public attention following data leaks or legal action with tax authorities.

A 2013 Reuters examination of tax planning by Europe’s largest software group, SAP AG, showed how the German company shifted profits from the United States, which has a corporate tax rate of at least 35 percent, to Ireland whose headline rate is 12.5 percent.

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