Why New U.S. Rules Won’t Completely Halt Tax Inversions

Shell game
The U.S. Treasury department’s announcement on Monday of new rules to discourage U.S. companies from resorting to “inversion deals” to relocate to lower-tax countries has shaken the corporate world by its unprecedented force and reach. The proposed $150 billion merger between Pfizer and Allergan took a direct hit, and the two companies have called off the deal.
Essentially, the rules sought to curtail tax inversions by addressing two controversial themes: One is the rise of the “serial acquirer,” a phenomenon where foreign companies grow too big through M&A deals, ostensibly to make inversion deals with a U.S. company compliant with U.S. law. Two, the rules target a practice called “earnings stripping,” where U.S. companies borrow money from their overseas subsidiaries and thereby generate large interest deductions without financing new investment in the U.S.
While the Treasury Department’s new rules would prevent many such inversion deals, they merely treat the symptoms of the problem, said experts at Wharton and Washington University Law School. A complete overhaul and of the U.S. tax regime is badly needed, and those efforts must go much beyond lowering tax rates, they added.
The Treasury Department says its main objective is to ensure that these companies pay their fair share of taxes. “After an inversion, many of these companies continue to take advantage of the benefits of being based in the United States, while shifting a greater tax burden to other businesses and American families,” it said in a press note. Companies like Pfizer have said the relocation to the U.S. would help them compete better with foreign companies that pay lower taxes, among other advantages.
“When you are fighting the last battle, you are not necessarily prepared to win the next one.”–Adam Rosenzweig
The new rules are unlikely to put a stop to inversion deals, although they may significantly dampen enthusiasm for them. Washington University Law School professor Adam Rosenzweig said that while the lawyers at the Treasury Department are “incredibly good” at what they do, “they are always chasing the last deal, and always fighting the last battle.” That captures the essence of the challenges the U.S. tax system faces, he added.
“When you are fighting the last battle, you are not necessarily prepared to win the next one,” said Rosenzweig. “The real problem here is they are chasing the symptoms of the problem and not [the underlying causes].” He acknowledged that the Treasury Department is constrained by time pressures and the limited scope of its powers without the necessary supporting legislation. “So we never resolve the underlying source of these problems.”
Even so, the Treasury Department has taken an extra-long stride with its latest move. Wharton accounting professor Jennifer Blouin said she was “stunned at the approach the government had taken with this announcement.” Earlier attempts to check inversion deals in 2014 and 2015 broadened the interpretations of existing laws, she added. But with its actions on earnings stripping and serial acquirers, the government has begun talking tougher, she noted.
Blouin and Rosenzweig weighed the potential benefits and shortcomings of the Treasury Department’s new rules on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

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