In recent years, a process known as “inversion” has received increased scrutiny by the public and by the government. It’s a way for businesses to avoid certain taxes by claiming to be a foreign company. These tax dodges are costing the United States millions a year in revenue, and the Treasury Department has been taking steps to make the less effective.
Some of the rules implemented in the past make the process harder, and, according to The New York Times, the US Treasury has just added some more restrictive rules that should slow down the rate of inversions (although it isn’t likely to stop them altogether).
What is an Inversion?
An inversion happens when a US company decides to buy a foreign company and make it a subsidiary. Once that transaction is completed, the American company can then relocate its operations abroad, as the foreign company, to enjoy a lower tax bill. One example is the recent hope of Pfizer to buy Allergan, a drug maker based in Ireland. Pfizer hopes to buy Allergen, make it a subsidiary, and then move to Ireland to avoid some of its US tax burden. The new rules, according to The New York Times article, might thwart this move.
In addition to this tactic, another strategy is one called “profit stripping.” Basically, after an inversion transaction takes place, the American subsidiary borrows money from its “parent.” The loans are complicated and internal, and it’s a cost that doesn’t affect a company’s financial statements. However, the interest paid on the loan comes with a tax benefit in allowing the company to deduct the interest payments against its earnings, effectively lowering taxable income.
US Treasury Department Works to Reduce These Practices
New rules from the Treasury Department are designed to reduce the effectiveness of these tax dodging strategies. One of the rules takes the practice of internal loans and reclassifies them. Instead of treating the transaction like debt, the new rules treat it as stock-based, which means there is no longer a deduction for interest.
Adding new rules to these types of transactions might slow the tide of inversions, and even change some of the profit stripping. However, it isn’t like to stop the practices altogether. There have been different rule changes in the past, and they haven’t stopped these sorts of tactics. The past changes did help slow the number of inversions, though, and there are hopes that fewer companies will move forward with these types of tax avoidance strategies in the future.
In combination with increased FACTA enforcement and other moves in recent years, it appears that the US government is getting more serious about reclaiming revenue lost to offshore tax shelters.
There is no perfect way to stop these types of tax dodges, but stepping up enforcement and making it harder can weigh on businesses and individuals in a way that means that there are diminishing returns for those who have to spend more time and money in increasingly creative methods of tax avoidance.