Anti-inversion noise grows but power to act is limited

The US Congress was never likely to act this year to ban corporate expatriation as executed by AbbVie and Medtronic, but the issue has caught fire among President Barack Obama’s fellow Democrats. The result of this is new efforts to tinker with existing laws and pending legislation to put pressure on inverted US companies and those who are considering an exit from US tax laws.

Mr Obama’s administration is proposing executive action to limit the ability of companies to seek tax relief by acquiring overseas businesses; meanwhile, in the Senate, legislation to cut inverted companies from government contracts has advanced as far as committee approval. The issue will not go away, but time will limit US lawmakers’ ability to address it.

Executive power

Treasury Secretary Jacob Lew last week proposed using the power contained in existing law to reduce the ability of inverted US corporations to shield overseas income from US taxation. Mr Lew was not specific about what action the US could take – the Treasury Department almost certainly lacks the authority to follow through on the broad-brush approaches contained in the 2015 White House budget plan that would limit the ability of US corporations to buy foreign companies and domicile overseas.

The most significant proposal in that budget plan is changing the ownership mix to escape US tax law. Today an inversion is allowed if at least 20% of the shareholders in the newly merged company were former equity owners of the target company domiciled overseas. Mr Obama’s budget proposed raising this threshold to 50%, a requirement that would have limited the tax rate cut AbbVie would achieve by acquiring Shire (Watch out AbbVie and Medtronic: That tax shelter could melt away, July 16, 2014).

Some actions the White House could take unilaterally are suggested in an article written by a Harvard Law School professor, Stephen Shay, in the prestigious publication Tax Notes, such as the ability to re-define debt as equity. This would convert loans from parent corporations to foreign subsidiaries into shareholdings and thus change non-taxable interest into taxable dividends.

Mr Shay also wrote that the Internal Revenue Service has the authority under four sections of current tax law to prevent inverted companies from making tax-free use of overseas cash held by foreign subsidiaries.

No government contracts

Aside from executive action and broad limits on inversions, several Congressional proposals have arisen that would cut government backing from expatriated companies.

The most significant of these has been a Department of Defense spending bill approved by the Senate Appropriations Committee that would bar inverted companies from receiving Pentagon contracts. In the healthcare sphere this could, for example, limit funding for biodefence research.

Beyond that, Senator Richard Durbin has introduced legislation that would bar inverted companies from receiving any government contracts. Mr Durbin has emerged as a pivotal figure in this battle, as he is chairman of the Appropriations Committee panel overseeing defence spending as well as a senator representing Illinois, the state in which AbbVie and the drugstore chain Walgreen Company are headquartered.

Pressure from Mr Durbin has been given partial credit for Walgreen dropping its plans to invert when it acquired Switzerland-based Alliance Boots, a decision that hammered its shares last week.

Get out the vote

Aside from hometown politics, it should not be too surprising to find Mr Durbin in the front lines of this battle. He is the Senate’s chief majority whip, its second-ranking member, and a mid-term election is approaching in which his fellow Democrats are forecast to lose their five-vote edge in that chamber.

This activity is a renewal of the “economic patriotism” message from Mr Obama’s successful 2012 re-election campaign, and one that appeals strongly to his party’s liberal wing. If Democrats are to retain the Senate, they will need strong turnout in November, and corporate inversions including those by AbbVie, Mylan, Medtronic and The Cooper Companies have handed them a useful tactical weapon.

Short-term campaign politics do not make for long-term solutions, however. An overhaul of US corporate taxes will not be achieved until next year at the earliest, and could take until after the next presidential election in 2016. Even then, broad restrictions on inversions cannot stop corporate migration as long as earnings can be propped up by tax rate cuts and nations are willing to race to the bottom in the name of economic development.

To contact the writer of this story email Jonathan Gardner in London at [email protected] or follow @JonEPVantage on Twitter

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