New anti-inversion measures from the US Treasury will have an impact on the corporate tax-avoidance strategies, but that impact may not last long. Certainly the day after the actions were announced by Treasury Secretary Jack Lew, the shares of takeover targets took a beating, and other uncertainties cloud the outlook. But it could be temporary. That’s because the positives from inversions could still end up outweighing the negatives.
While there are many reasons to do an inversion, there are two primary tax reasons, says a tax attorney who has been involved with the transactions. One is the ability to tap into untaxed offshore earnings and cash without paying current US taxes (e.g., by having the foreign subsidiaries of the US company lend to the new foreign parent). While this could definitely make companies pause before doing an inversion just for tax purposes, they may overlook it.
“The IRS notice is aimed at the first benefit and will subject the US company to US tax when, for example, its foreign subsidiaries lend to the new foreign parent,” the attorney says.
But the second benefit is one that could help a company move on after that pause. “A second benefit is to grow the offshore business underneath the new foreign parent rather than underneath the US company to minimize the extent to which future offshore earnings are subject someday to US corporate income tax,” says the attorney. That is, the future profits could nullify any negative impact of the hit the company would take at the time of the inversion. “The IRS notice does not address the second benefit from inversions, other than to generally make it more difficult for US companies to engage in inversion transactions, for example, by modifying the way the 80 percent test works,” the attorney adds.
The 80 percent rule refers to section 7874 of the US tax code whereby an inverted company is considered domestic if at least 80 percent of its stock is held continuously by owners of the former domestic business.
“I do not have a strong sense as to which was the more important benefit for US companies engaging in inversion transactions,” says the attorney. “I guess we will find out when we see what kind of continued inversion action there still is after the IRS notice.”