Obama’s Inversion Rules on the Cusp of the House and Senate Elections can be Devastating to the Bigger Problem of Corporate Tax Reform

Barack Obama has been proposing corporate tax reform for a few years now.1 Democrats and Republicans agree that corporate tax reform is needed, but Democrats are reluctant to lower the rate without removing tax breaks and Republicans do not want the tax breaks to end. Washington is not moving quickly, if at all. The House and a portion of the Senate will be decided next week on November 4th. Polls suggest that both The House and The Senate will remain Republican.2 However, whether our government remains divided or not Washington needs to keep corporate tax reform high on the things to do list.

The US corporate tax rate of 35% is the highest in the world among developed countries. America is also unique in that US corporations are taxed on worldwide earnings. Inversions – relocation of US corporations overseas by way of merger with a foreign company thereby securing the new country’s lower tax rate on overseas income – have become more popular than ever. Transfer pricing and aggressive tax planning are increasingly becoming the norm. While Obama has called these inversions unpatriotic,3 in reality, it is the US tax code failures and not unpatriotic motives causing this new business trend.

On September 22, in an attempt to stop these inversions, the Obama administration released a much-anticipated executive action designed to make inversions more difficult.4 The new plan prevents inverted companies from deferring taxes via “hopscotch” loans from the foreign subsidiary to the new foreign parent company under section 956(e) of the code, prevents restructuring foreign subsidiaries in a way that gives the foreign parent tax-free access to the subsidiary’s earnings under section 7701(l) of the tax code, and beefs up the current requirement that the original US company own less than 80% of the new inverted one under section 7874 of the code.

These new rules have already had some of their desired effect. AbbVie, a Chicago drug company, called off a $54 billion deal takeover of Shire, a British pharmaceutical. On October 15, AbbVie announced that the changes to tax rules have caused the directors to recommend that shareholders vote against the deal.5 The directors explained that the new rules targeting the ability to use overseas cash tax-free was a significant factor in the board’s decision.

Inversions have kept tax reform in the news headlines. These new rules will likely slow inversions down, but in the process they may also further the ultimate goal, corporate tax reform. Without headline-worthy “unpatriotic” business actions, the need for a more competitive US corporate tax system may lose some the recent momentum it has gained.

In reality, business on the world stage is not the only tax issue facing the US. Deciding on where internet sales can be taxed is another problem that needs to be resolved. The Internet Tax Freedom Act6 prohibits state taxation on online retailers within their borders. The Marketplace Fairness Act7) proposed in February 2013, would enable state collection of internet sales tax from out-of-state online retailers without any physical in-state presence. We are not in the pre-internet days anymore; US corporate tax needs to adapt as we move toward a globalized internet-driven economy.

US treasury secretary Jack Lew admitted that the new inversion plan is only a temporary fix designed to cure one of the many problems in the current tax code. But recognizing that the tax code needs to be changed is not good enough. The post-election government should take a page out of the Organization for Economic Co-operation and Development’s (OECD) book and clearly define current tax problems and create an action plan to deal with them.8 Republican or Democrat, the legislative branch needs to get corporate tax reform rolling! Pray that the lack of inversion headlines does not cause Washington to stagnate.

  1. Treasury.gov, http://www.treasury.gov/resource-center/tax-policy/Documents/The-Presidents-Framework-for-Business-Tax-Reform-02-22-2012.pdf (last visited Oct. 29, 2014). 

  2. Real Clear Politics, http://www.realclearpolitics.com/epolls/latest_polls/ (last visited Oct. 29, 2014). 

  3. Associated Press, Overseas ‘Tax Inversions’ are Unpatriotic: Obama, New York Post (July 26, 2014, 6:30 AM), http://nypost.com/2014/07/26/overseas-tax-inversions-are-unpatriotic-obama/ 

  4. irs.gov, http://www.irs.gov/uac/Newsroom/Notice-2014-52-Rules-Regarding-Inversions-and-Related-Transactions (last visited Oct. 29, 2014). 

  5. New York Times, http://dealbook.nytimes.com/2014/10/16/abbvie-board-recommends-shareholders-vote-against-shire-acquisition/ (last visited Oct. 29, 2014). 

  6. 47 U.S.C. § 151. 

  7. S. 336, 113th Cong. (2013), and H.R. 684, 113th Cong. (2013 

  8. OECD.Org, Action Plan on Base Erosion and Profit Shifting, http://www.oecd.org/ctp/BEPSActionPlan.pdf (last visited Oct. 29, 2014).