Banks are among the winners in the final version of long-anticipated new rules announced by the Treasury Department Thursday meant to prevent businesses from shifting profits out of the U.S. and crack down on corporate inversions.
The administration finalized the rules, proposed in April, amid intense pushback from businesses and members of Congress, and just ahead of the timeline required to have them go into effect before President Obama leaves office.
Treasury Secretary Jack Lew said on a press call Thursday that the administrative action was justified to “protect the tax base” from the erosion of companies shifting profits offshore, and added that the final version of the rule addresses business concerns by “narrowly focusing the regulations on aggressive tax avoidance tactics.”
The rules finalized Thursday would prohibit U.S. companies from a practice known as “earnings stripping,” thought to be a means of cutting U.S. tax bills and a major motivation for major motivation for companies to move their headquarters out of the U.S. through inversions. Earnings stripping involves issuing lots of debt to a parent company in a tax haven. The interest payments on that debt are tax-deductible in the U.S., while the parent company would pay a lower corporate tax rate on the incoming payments, meaning that taxable income has been shifted from a high-tax jurisdiction to a low-tax one.
The rules would require businesses to justifiy inter-company loans, and allow the IRS to reclassify debt as equity if they suspected earnings stripping, making the transactions taxable.
Among the changes to the final rule meant to make them easier on businesses, a senior Treasury official said, is that regulated banks and other financial institutions will get exemptions. Debt plays a much larger and different role at banks than at other businesses, and bank transactions are already regulated by bank regulators, the Treasury noted.
The final rule also creates an exemption for corporate cash pools, meaning accounts shared among subsidiaries of a company. Corporate treasurers have warned that such accounts are critical to modern cash management, and that subjecting them to the rules would be costly.
Transactions between foreign subsidiaries of a company also will be excluded, as will be partnerships and sole proprietorships.
Also, the Treasury will delay by a year the deadline for companies to begin issuing documentation for inter-company loans. That won’t be effective until 2018.
Businesses have warned that the rules go too far and would affect companies of all kinds that haven’t undertaken inversions while crimping normal business transactions.
The early reaction to the finalization of the rules from congressional Republicans, who had not yet had a chance to review them in full, was skeptical. Kevin Brady, the Texan who heads the House Ways and Means Committee, claimed that the administration “rushed” the rules, and commented that “it appears that the Obama Administration has ignored the real concerns of people who will be most impacted by these far-reaching rules.”
Republicans have consistently said that, rather than impose rules meant to keep companies in the U.S., Congress should pass tax reform that would eliminate the incentives for executives to move headquarters overseas. Those include the 35 percent statutory corporate tax rate, the highest among advanced nations, and the U.S. practice of taxing all overseas profits, an unusual tax code feature among rich countries.
