Fleischer: Treasury Department Drops The Gloves On Inversions

Following up on this morning's post, Treasury Department Issues Third Batch Of Anti-Inversion Rules, Updated Framework For Business Tax Reform:  New York Times Deal Book, On Inversions, the Treasury Department Drops the Gloves, by Victor Fleischer (San Diego):

Tax lawyers at the Treasury Department have grappled in recent years with the many corporations finding ways to merge with overseas “inversion” partners and, as a result of the merger or acquisition, move their legal residence offshore to reduce tax payments.

Each of the last two years, the agency took sensible and mostly modest steps to slow the trend of tax inversions. The efforts have only partly succeeded. Some giant deals, including the proposed $150 billion merger between Pfizer and Allergan, continue to dodge the Treasury’s new guidance and demonstrate the continuing allure of expatriation.

Tired of waiting for Congress to step in, lawyers at the Treasury Department have dropped the gloves.

The Treasury’s new administrative guidance that was released on Monday tackles a wide range of tax issues related to inversions, including new approaches to multistep acquisitions and earnings-stripping. The new guidance also revises and completes the rules proposed in 2014 and 2015.

The guidance cuts some companies narrow and deep, throwing the tax consequences of Pfizer’s proposed merger with Allergan, among other proposed deals, into question.

I’ve looked at the proposed rules, which run over 300 pages. It’s an admirable and professional accomplishment, thorough and, if not exhaustive, exhausting. ... It will take weeks for tax lawyers to fully digest the implications of the rules. It may take the stock market just as long to accurately price in the tax risk. ...

In the guidance issued in 2014 and 2015, the Treasury nibbled around the edges, shutting down the ability of companies to “skinny down” the United States entity or “fatten up” the foreign acquirer to clear the statutory hurdles.

The guidance issued Monday goes further, effectively counting domestic acquisitions by an inverted acquirer within the last three years as an impermissible fattening-up. If the value of those previous acquisitions is disregarded, the foreign acquirer becomes smaller and subject to more stringent inversion rules. ...

I’m not sure if the new guidance will survive a legal challenge. It is hardly unusual for tax rules to disregard the form of a transaction in favor of its economic substance. Multistep transactions are often “stepped together” and treated as a single transaction for tax purposes.

But it would be unusual to step together transactions that occur over a period of years, each of which had independent legal and economic substance and significance, in the absence of evidence of a plan to complete the series of transactions. The Treasury’s legal authority is broad, and the policy defensible, but it’s not a layup.

A second area of controversy relates to earnings-stripping, a common technique where multinational corporations use interest payments or other transfers to shift income out of the high-tax United States into a low-tax jurisdiction like Ireland or the Cayman Islands.

The guidance takes a broad swipe at earnings-stripping, employing legal authority that has lain dormant for nearly 50 years. In 1969, Congress authorized the Treasury to issue regulations distinguishing between debt and equity. The Treasury tried to use its authority under this section of the code, Section 385, in 1980, only to delay putting the proposal into effect and ultimately withdrawing it.

Some tax experts consider Section 385 to be dead letter, superseded by more recent, specific limits on interest deductions. ...

It could be years before a court decides whether the Treasury has the legal authority it claims. In the meantime, thousands of large corporations will have to review complex multinational structures to sort out how the rules apply to them.

Tax lawyers can expect a busy summer.

• Bloomberg, Obama Calls Inversions ‘Insidious,’ Praising New Treasury Rules
• New York Times, Obama Hails Rules to Thwart Companies Moving Abroad to Cut Tax Bills
• Wall Street Journal, Obama Renews Call for Congress to Limit Tax Inversions