US Democrat Bill Takes Further Aim At Inversions
On February 23, US House of Representatives Ways and Means Committee Ranking Member Sander Levin (D – Michigan) and Budget Committee Ranking Member Chris Van Hollen (D – Maryland) introduced legislation aimed at reducing the number of corporate tax inversions by limiting the use of “earnings stripping.”
Tax inversion techniques are being used by some US multinationals to move their tax residences abroad – away from the high 35 percent US headline federal corporate tax rate – even if management and operations remain in the United States.
The intention of Levin and Van Hollen’s bill is to curb the practice of earnings stripping, under which US subsidiaries borrow from their new foreign parent company (or another foreign affiliate) to increase their interest payments, reduce their taxable income, and lower their US taxes. The foreign lender then typically pays a reduced or zero tax rate on the interest income under an existing tax treaty.
The present law disallows a deduction for excess interest paid by a US entity to a related party (where the interest payment is exempt from US withholding tax) when the entity’s debt-to-equity ratio exceeds 1.5 and net interest expense exceeds 50 percent of its adjusted taxable income.
Disallowed interest expense may be carried forward indefinitely for deduction in a subsequent year, and the entity’s excess limitation for a tax year (i.e. the amount by which 50 percent of adjusted taxable income exceeds net interest expense) may be carried forward to three subsequent tax years.
However, the lawmakers pointed out that foreign-controlled groups have been able to work around the limitations on interest deductions, because the present law requires a group to exceed both thresholds before excess interest deductions are disallowed. So long as the borrowing entity is able to maintain a debt-to-equity ratio of less than 1.5, it is not limited by the 50 percent net interest expense threshold.
“After inverting, many of these companies engage in earnings stripping, a practice that enables them to significantly lower the amount of taxes they pay in the US, while taking advantage of our country’s resources and strong workforce,” said Levin, while Van Hollen added that “putting an end to earnings stripping by inverted companies is an important step toward ensuring these companies aren’t reaping taxpayer-funded benefits while failing to pay their fair share.”
Their new bill, the Stop Corporate Earnings Stripping Act, would apply to any US corporation that has inverted (or will invert) on or after May 8, 2014. It would limit the foreign-controlled inverted group’s ability to reduce its US tax by repealing the debt-to-equity ratio threshold; reducing the permitted net interest expense threshold to no more than 25 percent of the entity’s adjusted taxable income; eliminating the excess limitation carryforward; and permitting disallowed interest expense to be carried forward only for five years (rather than indefinitely under present law).
The foregoing limitations would apply if historical shareholders of the US entity own more than 50 percent (but less than 80 percent) of the new foreign parent entity following an inversion.
The proposed bill is meant to work in tandem with the Stop Corporate Inversions Act, which was reintroduced by Democrat lawmakers last year and would also apply to any inversion on or after May 8, 2014. The bill would change the current law, under which a company that merges with an offshore counterpart can move its residence abroad so long as at least 20 percent of its shares are held by the foreign company’s shareholders after the merger. It would restrict corporate inversions by putting the minimum foreign shareholding cap at 50 percent.
