In a desperate attempt to stop companies from moving their headquarters out of the U.S. to avoid taxes, the Obama administration is advancing a rule that businesses warn could have far-reaching consequences for many kinds of firms.
The rule, proposed by the Treasury Department in April, sounds arcane: It would require businesses to demonstrate that any borrowing they did was for legitimate business purposes, rather than for shifting income into tax havens. If the businesses couldn't provide such a justification, the Treasury would reclassify the debt as equity and tax the interest payments, which would have been tax-deductible, as dividends.
But the move, while technical and complex, is the Treasury's workaround for a major problem it hasn't been able to solve otherwise, namely the surge of corporate inversions.
Over the past several years, dozens of corporations, such as Wisconsin-based Johnson Controls and Minnesota-based Medtronic, have sought to lower their tax bills by combining with companies located in low-tax countries and then placing the headquarters of the combined businesses there.
Treasury Secretary Jack Lew and congressional Republicans agree on the factors pushing companies out, especially the high 35 percent U.S. corporate tax rate and the unusual practice of applying that rate to all worldwide income. Business executives are desperate to bring back some of the $2 trillion in deferred earnings they have overseas without paying the full 35 percent.
For political reasons, however, the two sides were unable to agree on corporate tax reform during Obama's tenure. And Republicans weren't interested in Democratic bills to impose short-term punitive measures on companies that seek inversions.
That left the administration, worried about possible erosion of the corporate tax base, to try to stop, or at least slow, further inversions through regulation. The Treasury has tried to do so through a series of rules.
The latest one, however, goes much further than businesses expected and far enough to draw stern objections from both Republicans and Democrats on the tax-writing committees.
It was meant to prevent "earnings stripping," a practice by which a company issues excessive debt to a parent or related company in a country with lower taxes. Because interest payments are deductible in the U.S., such a maneuver has the potential to cut U.S. taxes.
By granting itself the ability to reclassify debt as equity, the Treasury can stop such profit-shifting.
Businesses have a range of complaints about the rule. For instance, the Business Roundtable, a group of CEOs of major corporations, estimated that the tax increase alone would cost at least $10 billion over 10 years and possibly much more. But the major problem that businesses see is that the rules would apply to not just inverted companies but to all multinationals and would harm their ability to manage their own finances.
"This goes far beyond inversions, and we can't imagine that any of this extra stuff is really what Treasury intended, because it'd be so devastating to the companies," said Anthony Carfang, partner at Treasury Strategies Inc. Carfang's firm consults with companies to help them manage their cash flows to maximize profits, a daunting task for complex multinationals with many subsidiaries.
Most corporations are highly efficient with their cash management, Carfang said, collecting funds from subsidiaries in a centralized pool each day and shifting them around as needed.
Under the Treasury's proposed rule, that cash management process, effectively short-term loans from one subsidiary to another, would be at risk of suddenly becoming a taxable transaction.
Carfang's clients "are not going to take even the slightest risk of accidentally falling over a tripwire" and incurring large tax bills, he said. Instead, they would overhaul their cash management practices, losing efficiency.
Caroline Harris, the chief tax policy counsel at the U.S. Chamber of Commerce, warned that the rules would impact "really almost every facet of the business being in business, essentially."
It would cause corporations to have to overhaul their finance management, the way they repatriate earnings from overseas, corporate restructurings, and even equity payments to employees. Those are all the "ordinary course of business and competing globally," Harris said. The Chamber has called for the Treasury to withdraw the rule or to delay its implementation until 2019. The public comment period for the proposed rule ended last week.
Yet, for some advocates of the rule, its sweeping impact is an advantage, not a problem.
After all, in their view, it is not just inverted companies that are engaging in profit-shifting to avoid U.S. taxes. A wide range of multinationals are.
One recent study, a very rough estimate, put the total cost to the Treasury of profit-shifting at about $100 billion in 2012, a number that likely has grown since then and would represent more than a quarter of total corporate tax receipts today.
"It doesn't matter what the vehicle is for the tax dodge, if they're able to game the system because there's loopholes in the system that haven't been closed and Treasury is able to close those ... then Treasury should do those," said Frank Clemente, the executive director of Americans for Tax Fairness, a group that advocates against corporate tax dodging.
Gary Hufbauer, a scholar at the Peterson Institute for International Economics and former Treasury tax official, said "this Treasury, under this president, has really wanted to go after the earnings of U.S. companies doing business abroad and foreign companies doing business in the United States.
"It's been, in tax terms, an anti-business presidency."