Treasury issues rules cracking down on offshore tax deals

The Treasury Department on Thursday announced final regulations aimed at curbing offshore tax deals.

The final rules, which would treat certain related-party debt as equity, come after business groups and lawmakers from both sides of the aisle expressed concerns about the rules initially proposed in April.

{mosads}The rules take aim at a tax-avoidance strategy known as “earnings stripping.” This is a technique that multinational companies often use after they engage in “inversions,” in which U.S. companies reincorporate overseas after merging with foreign companies. 

“Earnings stripping can reduce a company’s tax bill by generating large interest deductions when that company simply increases its debt to an affiliated foreign firm, without financing new investment in the United States,” Treasury Secretary Jack Lew said in a press call Thursday.

The Obama administration has made stopping inversions a top priority. President Obama himself gave a speech the day after the proposed rules and a separate anti-inversion guidance were released in April. In that speech, he called on Congress to take action to fully stop inversions.

Business groups and lawmakers complained that the rules as they were proposed would hurt routine business practices that have nothing to do with tax avoidance. 

Some business groups had pushed for the rules to be withdrawn, or at least narrowed in scope. Some GOP lawmakers had asked the Treasury to issue another round of proposed rules so that stakeholders could comment. 

Lew said that “after carefully considering this feedback, we have addressed stakeholder concerns by more narrowly focusing the final regulations on aggressive tax avoidance tactics and providing certain limited exemptions.”

For example, Treasury said the final rules include a “broad exemption” for cash pools and other short-term loans used for cash management.

There are also limited exceptions for transactions between foreign subsidiaries of U.S. multinational companies and transactions between S-corporations.

Treasury also said it has eased the documentation requirements in the regulations, and it delayed the effective date of the documentation rules to Jan. 1, 2018.

“Coupled with our previous actions to address corporate inversions, these changes balance the operational needs of companies while preventing the erosion of our U.S. corporate tax base,” Lew said.

Treasury estimated that the rules would lead to additional tax revenue of between $461 million per year and $600 million per year over 10 years, in 2016 dollars. The revenues generated as a result of the rules would be at least six to seven times as large as the compliance costs. 

Republican lawmakers were critical of Treasury for finalizing the rules when it did.

“By rushing the review process—despite the extensive comments received—and finalizing these regulations so quickly, it appears that the Obama Administration has ignored the real concerns of people who will be most impacted by these far-reaching rules,” House Ways and Means Committee Chairman Kevin Brady (R-Texas) said.

Senate Finance Committee Chairman Orrin Hatch (R-Utah) said the “issuance of final regulations continues the administration’s pattern of creating rules unilaterally, forgoing views from Congress, large and small businesses alike, and in this case, ignoring input from members of its own party.”

While Hatch noted that Treasury tried to address some of the proposed rules’ concerns, he said “the devil’s in the details.”

But the top Democrats on the congressional tax-writing committees spoke favorably of the rules.

“The final regulations rightly made sensible changes to the proposed regulations, ensuring it does not unintentionally interfere with ordinary business transactions, such as transactions related to cash management, transactions where there is a low risk of earnings stripping (e.g., between highly regulated companies), and other issues Democratic Ways and Means Members raised in a June letter to Secretary Lew,” said House Ways and Means ranking member Sandy Levin (D-Mich.)

Levin, who has introduced legislation targeting inversions and earnings stripping, also urged congressional Republicans to work with Democrats to pass measures to stop corporate tax avoidance.

Sen. Ron Wyden of Oregon, the top Democrat on the Senate Finance Committee, said the rules “clearly reflect a lot of input and careful study, and in my view they will go a long way to protecting our corporate tax base.”

Both Wyden and Hatch stressed the need for tax reform.

Business groups said they were reviewing the final rules and said Treasury appears to have tried to address some of their concerns.

Caroline Harris, vice president of tax policy at the U.S. Chamber of Commerce, said that regardless of the efforts to address issues with the proposed rules, the Chamber believes that “punitive, one-off changes to the tax law do nothing to address the root of the purported ‘inversion problem’: our antiquated and anticompetitive tax code.”

“If we are seeking to make the United States a competitive place to do business, we need to focus on achieving comprehensive tax reform,” she said.

Updated at 6:41 p.m.