Treasury Secretary Jack Lew called again in a speech Monday for Congress to revamp the corporate tax code to stem the tide of corporate inversions — when U.S. companies acquire smaller, overseas companies and move their corporate headquarters abroad in order to pay lower taxes — and said that executive action could be forthcoming in the absence of a legislative overhaul.
"The best way to address inversions is through comprehensive business tax reform that includes specific anti-inversion provisions," Lew will say in prepared remarks for a speech at the Urban Institute, a left-leaning Washington, D.C. think tank. "At the same time, we cannot wait to complete business tax reform before taking action to fix this problem."
Lew has said before that the Treasury Department was looking at options to slow down or halt inversions without a bill passing Congress, but his speech today gave the most specific timeline.
"The administration is clear-eyed about the possibility that Congress may not move as quickly as necessary to respond to the growing wave of inversions," Lew said. "The Treasury Department is completing an evaluation of what we can do to make these deals less economically appealing, and we plan to make a decision in the very near future."
Corporations can pay a substantially lower corporate tax rate, get tax-free access to their overseas cash, and use other maneuvers to lower their overall tax bill by locating outside of the U.S. by pursuing a type of merger known as an "inversion." Typically, a U.S.-based company buys a smaller overseas company that pays taxes in a country with lower corporate tax rates, like Ireland, the Netherlands, the United Kingdom, or Canada.
The larger, U.S.-based company then moves its headquarters overseas, while much of the operations and the company's executives remain in the U.S. "The problem is, with many inversions, the change in residence is done primarily for tax purposes, and the new entity is, for all intents and purposes, effectively just changing its address," Lew said.
Spurred on by eager investment bankers and lawyers, such deals have taken off this year, with over $120 billion worth of proposed inversions, nearly 6% of all merger and acquisition activity globally, according to Credit Suisse. The deals have been bashed as "unpatriotic" by President Obama, and Treasury Secretary Lew has implored Congress to pass legislation limiting them.
Lew's speech also reiterated the administration's support for a more comprehensive legislative fix to the inversion wave, including measures that would work retroactively. "To prevent a rush of corporate inversions to get in under the wire before a change in the law, legislation should work retroactively, applying to any deal after early May of this year," Lew said. "Only a change in the law can shut the door, and only tax reform can solve the problems in our tax code that leads to inversions."
The administration's proposal, which would need to be passed by Congress, would change tax rules so a company still "managed and controlled" in the U.S. would not be able to move its tax residence overseas if it does not "do a significant amount of business" in the country where it moves (such as Ireland or Jersey).
Also, the proposal would change tax rules so that the acquiring U.S.-based company would have to own at least half of the newly formed company, as opposed to 20% as it does today.
Any legislation on inversions, if retroactive, could affect over $100 billion of agreed-to deals. The Minnesota-based medical device company Medtronic agreed in June to acquire Covidien, whose headquarters for tax purposes is in Ireland, for $43 billion. Illinois-based pharmaceutical company AbbVie agreed to buy the English drugmaker Shire in July for $54 billion and incorporate the new company in Jersey, an island dependency of the UK.
In both cases, the companies advertised the tax advantages but also said there were operational and business reasons for the combinations. Neither deal has closed and are two of the most likely targets for any inversion legislation. The Medtronic deal allows for the company to cancel the merger if tax laws change and don't allow it to move, for tax purposes, out of the U.S.
The administration has long taken a stance against inversions, and Lew's previous public remarks and President Obama calling such deals "unpatriotic" were followed by a slowdown of inversion announcements. "We expect the potential for administrative action to remain an overhang on inversions for the foreseeable future," wrote Compass Point analyst Isaac Boltansky in a note Monday morning.
When Burger King and Tim Hortons agreed to an $11 billion merger that would be followed by setting up a third company that would own both brands and be based in Canada — despite being majority-owned by Burger King's current owners — Burger King executives insisted that it was not a tax-driven deal. That did not stop several Democratic lawmakers from harshly criticizing the proposed takeover.
The outcry against inversions helped to successfully scuttle a deal for the pharmaceutical chain Walgreen to buy out the rest of its stake of the drugstore chain Alliance Boots and move its tax domicile to Switzerland.
While Lew did not share any details about what the Treasury Department — which oversees the Internal Revenue Service — could do, one of the panelists who will speak after Lew has put forward a proposal.
Harvard Law School Professor Stephen Shay, a former top international tax official in the Treasury Department, wrote a much-cited article in the trade journal Tax Notes outlining how the administration could greatly limit the tax benefits of inversions without Congressional action.
The Treasury Department, through the IRS, could restrict how much U.S.-based subsidiaries deduct from their corporate taxes interest payments they make on debt to their overseas-based parent companies. Shay also said the Treasury Department could limit how companies use overseas money. "The obvious advantage of taking regulatory action is the ability to act quickly," Shay wrote.