US Think Tank Says Earning Stripping Regs Should Be Retained

Contrary to calls from businesses from the regulation’s withdrawal, the Institute on Taxation and Economic Policy has called on the US Treasury to fully implement and strengthen its final Section 385 anti-earnings stripping debt-equity regulations, designed to reduce the benefits of corporate tax inversions.

The final regulations, released in October 2016, are intended to limit earnings stripping following inversions – a practice whereby US subsidiaries borrow from their new foreign parent company (or another foreign affiliate), increase their interest payments, and reduce their US taxable income by using the interest expense deduction. The Internal Revenue Service would be allowed to re-characterize certain debt instruments as equity under Section 385 of the Internal Revenue Code.

In an August 4 letter submitted to the US Treasury, Alan Essig, Executive Director, ITEP, said: “By inhibiting multinational corporations’ ability to artificially shift profits out of their US affiliates through the use of debt, this proposed action would take an important step toward putting an end to offshore tax avoidance. In fact, the Treasury estimates that this rule could recover USD7.4bn in tax revenue over ten years that companies would have otherwise avoided.”

Essig explained: “The part of the tax code known to tax lawyers simply as ‘Subpart F’ wisely ensures that interest income received by an American corporation and its offshore subsidiaries is subject to US tax. But ‘Subpart F’ does not apply to foreign corporations, which are thus able to use earnings stripping to obtain an advantage over US corporations. US corporations that want to engage in earnings stripping have sought to ‘invert,’ which involves using mergers to characterize themselves as foreign companies for tax purposes.”

Essig urged the Treasury to “reconsider a series of exceptions added into the draft regulations when they were made final,” adding that the Treasury “should reconsider its exceptions to the regulations for certain entities and so-called ordinary business course and business transactions. These exceptions substantially limit the scope of these regulations and should be eliminated.”

“In the absence of Congressional action to fix this problem, Treasury should take every possible step to prevent the base erosion and profit shifting created by corporate tax inversions and other corporate tax avoidance,” Essig concluded.