The U.S. government is cracking down on corporate inversions. Treasury Secretary Jacob J Lew announced new rules regarding U.S. corporations that merge with foreign firms and move abroad in trying to reduce their U.S. tax obligations.
Unable to get the current Congress to act on much of anything, the Obama administration has taken action, labelling the process of inversions as unpatriotic.
The new rules will govern future inversions and impose one new rule on corporations already inverted.
While inverted companies could previously get around paying U.S. taxes on foreign earnings (which are only taxable when brought back to the United States) by having a foreign subsidiary make a “hopscotch” loan to the parent company instead of repatriating the money, the Treasury will now consider such loans as taxable dividend in many cases.
Furthermore, two new rules for completing the process of inversion were brought into effect. Now U.S. companies cannot payout premerger dividends in an attempt to cut their size and make it easier to be under the ownership-percentage threshold to successfully invert. For a U.S. company to invert, it must own less than 80% of the newly merged company. The pre-deal dividends are no longer recognized when assessing the ownership-percentage requirement.
Alternatively, the foreign company’s size prior to inversion will also be scrutinized. Passive assets (money not used in business operations, such as securities), when they make up at least half of the company’s total assets, are no longer considered when assessing the ownership-percentage requirement, except for banks and financial service companies.
It is estimated by the Joint Committee on Taxation that inversions keep about US$20 billion in federal revenue each year.
Corporate inversions are under the spotlight recently after the US$12.5 billion merger of fast-food company Burger King with the Canadian coffee and donut company Tim Horton’s. Federal corporate tax rates are lower in Canada (11% to 15%) than they are in the United States (15% to 39%).