Obama Can't Really Do Anything To Crush Inversions

Brett LoGiurato

The Treasury Department earlier this week outlined new executive steps aimed at curbing companies' so-called practice of "inversions" — steps it said would have bit in accomplishing that goal.

But the reality, according to multiple analysts and experts, could be far from the stated goal. They say it's likely there's nothing the Obama administration can do to stem the recent trend of inversions absent congressional action.

"The Treasury alone cannot realistically stop inversions all together," said Dick Harvey, a professor at Villanova University.

Inversions are the practice by which companies slash their tax bills by moving their companies' tax bases overseas. They have been on the rise over the past year, as companies have either acquired rivals or merged with them to relocate their headquarters to a foreign country with lower corporate tax rates.

The actions unveiled on Monday eliminate certain techniques inverted companies currently use to gain tax-free access to the deferred earnings of a foreign subsidiary, which officials said would "significantly diminish" the ability of inverted companies to avoid US taxation. The moves also erect more barriers to inversion by strengthening a requirement in the tax code that former owners of a US company own less than 80% of the combined entity.

In a research note Friday, Goldman Sachs analyst Alec Phillips said the Treasury's changes would make inversions "incrementally more difficult" — but they are unlikely to even reverse the trend, let alone stop it. 

The problem for the administration is that, though inverted companies will lose some access to foreign earnings under the changes, they will also retain some of the most attractive benefits that incentivize them to invert in the first place. 

For example, Goldman said, the Treasury's rule change focuses more on the companies' access to pre-inversion foreign earnings, while saying little about post-inversion foreign earnings. 

"While it is possible that some inverted companies could face incremental tax liabilities associated with post-inversion restructuring that is often done to avoid tax on future foreign earnings, it appears unlikely that use of those future foreign earnings would be otherwise constrained," Phillips wrote.

"This is a critical distinction, in our view, because if the inverted companies retain flexibility to use post-inversion foreign profits that have not been taxed by the US, the motivation to pursue these transactions will remain."

Moreover, the rule changes only make it "slightly" harder for companies to invert.

For example, one of the changes Treasury announced strengthens the requirement that former owners of the US entity own less than 80% of the new, combined entity.Under current law, companies can engage in an inversion as long as the US company has a 79% stake in the new entity and the foreign acquirer has at least a 21% stake in the new, combined entity. 

The change, under Section 7874 of the tax code, would limit the ability of companies to count so-called "passive assets" toward the 80% rule; prevent US companies from reducing their size through dividends; and block so-called "spinversions," a method by which companies transfer a portion of its assets to a newly formed corporation and then spinning off that corporation to shareholders. Under current law, it allows the companies to avoid US taxes.

"Some of the announced changes raise the bar regarding which transactions qualify, but probably won't be a significant deterrent," Phillips wrote.

" Under current law, ownership of the newly formed post-inversion company must overlap no more than 80% with ownership of the pre-inversion US company. The Treasury notice retains that threshold, which is set in law, but restricts some strategies companies use to make it easier to meet this test. Those changes on their own are unlikely to significantly reduce the number of inversion transactions."

The administration has said that any actions it takes can't match congressional action — and the chances of some move by Congress has risen slightly, according to Goldman. If Democrats keep control of the Senate after November's elections, it's more likely they will keep a narrow focus on inversions-related legislation. If Republicans win control of the Senate, the chances of broader tax reform — including provisions on inversions — would rise.

"That said, the election result is hardly decisive in how Congress will address these issues. Corporate reform will be an uphill climb under any electoral scenario and, if the number of inversion deals begins to climb again in coming months, Congress could come under pressure to act regardless of who controls the majority," Phillips wrote.

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