New Rules from Obama Administration on Inversions Ignore Corporate Tax Reform

Michi Iljazi

October 1, 2014

Last week the Obama Administration acted unilaterally, again, proposing new restrictions through the Treasury Department aimed at halting the growing trend of tax inversions by U.S.-based companies. President Obama has been one of the loudest critics of the practice of inversions, but he is one of the main reasons why we have seen such an uptick in inversions over the last few years.

Inversions occur when “an American company reincorporates for tax purposes in a tax-friendlier country such as the U.K. or Ireland, typically while maintaining much of their operations in the U.S.A.” Just a little over a week ago, the Treasury Department announced new rules and regulations regarding tax inversions by companies headquartered in the United States. Actions taken by the Treasury Department to change the current inversion rules include:

  • Changing the loan classification so as to make it possible for Treasury to classify value of loans taxable as U.S. property, which allows the value to be taxed under current dividend rules pre-inversion.
  • Taxing the foreign companies involved in inversions based on profits and deferred earnings.
  • Making it more difficult for a foreign entity to own enough of a US entity, thus not forced to pay high US corporate tax rates.
  • Limiting assets that can be used toward claiming the current ’>20 percent’ control figure that is required for foreign entities after an inversion.

There are other changes, but as noted the major ones are aimed at punishing any ongoing inversions, and making future inversions more difficult.

The real issue here is the Obama Administration continues to ignore the very real reason we see inversions, and job loss, and companies outright leaving America behind: our broken tax code, and more specifically the inflated corporate tax rate in the United States. It has been nearly two and half years since the US overtook Japan for the highest effective corporate tax rate in the world, it should be no surprise to anyone that companies are looking for ways to better serve their interests, their shareholders, and their bottom line. Unfortunately, these ways have led to American jobs moving overseas, American companies relocating internationally, and now the increased practice of inversions in order to benefit from a friendly business climate when it comes to taxation. Can anyone blame corporations for their behavior since the US achieved the dubious distinction of having the world’s highest corporate tax? In Forbes, Yevgeniy Feyman identifies the high corporate tax rate as one major part of the predicament that American companies are facing with today’s tax structure; he also clearly defines another problem with our tax code and how it impacts the decisions those companies are making today:

But there is another factor at play here as well. Most developed economies use what’s known as a “territorial” tax system. Under such an approach, income is only taxed when it’s earned domestically. So a U.K.-headquartered company will only pay U.K. taxes on its British income. The United States, however, employs a hybrid between a territorial and worldwide system. U.S. citizens and corporations are required to pay U.S. taxes on all income – even if that income is earned outside of the country. (The tax system provides credits for foreign taxes paid, which reduce or eliminate double taxation of income.) But foreign income is only taxed upon repatriation – when it is brought back to American shores. At this point the incentives should be fairly clear – companies have every reason to avoid bringing their earnings back to the U.S. if they were earned in a lower corporate tax rate country. So it’s not hard to see why firms hold somewhere around $2 trillion abroad in unremitted earnings, according to the Center for Budget and Policy Priorities.

Companies can’t afford to do business in America because of the current tax structure in the United States. The only solution to making sure that business can continue for shareholders, employees, and consumers is to engage in practices (including inversions) that are not only legal, but economically beneficial to the sustainability of corporations. The real villain here isn’t any company or companies who are doing their job to protect the interests of the stakeholders involved in their businesses. The real villain is Washington, and specifically the Obama Administration and their allies in the Senate who continue to demonize business while ignoring the most obvious remedy to this problem: reforming our Corporate Tax structure.

As elected officials continue their dereliction in reforming our tax code, businesses will continue to do what they must in order to survive in a challenging and changing global economy. Even with the new rules announced and the clear goal of discouraging future inversions, there’s little guarantee that companies will stop trying to ensure the best outcomes for their shareholders, employees, and consumers. The Wall Street Journal recognized the obvious; as the business climate continues to evolve, companies will learn to adapt:

Any chilling effect on inversions might not last long, experts said, adding that companies could find ways to do the deals despite the new rules. Some predicted privately that deal making could resume in coming weeks. Others said some of the new restrictions might be challenged, or could be avoided.

The Taxpayers Protection Alliance (TPA) recognizes that the inability to do corporate tax reform will continue to cause problems economically. The business community needs certainty and incentive in order to be a part of expanding the American economy. TPA continues to call for comprehensive tax reform, and specifically lowering of the corporate tax rate. The key to keeping companies in the United States and keeping them successful starts with a reduction in corporate tax rates that will allow American companies to stay, hire, and compete around the globe.

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