There’s a harmful flipside to the U.S. anti-inversion push. The Treasury Department’s latest plan to rein in tax-motivated overseas M&A takes aim at intercompany loans. It’s a good idea to curb this so-called earnings stripping. The proposed rule is broad, however, and could hurt normal funding practices.
The Obama administration developed the rule amid a wave of corporate emigration by way of acquisition, including Pfizer’s $150 billion attempt last year to buy Allergan. Treasury’s proposal, for which public comments are due on Thursday, specifically targets the practice of U.S. companies borrowing from their foreign parent in a lower tax region, leaving interest payments to be deducted when calculating its annual tab to Uncle Sam.
It’s called earnings stripping because it essentially ships the profit overseas. Often, a U.S. company doesn’t even actually borrow the money and just makes interest payments to its corporate overlord. Sometimes subsidiaries are created exclusively for this purpose. Treasury is long overdue in targeting such schemes.
The trouble is that, as written, the new rule also might capture legitimate cash-management activities. Companies often take a surplus from one division to finance activities at another carrying a deficit. This might be prohibited under the proposal and force companies to borrow more from banks.
In other cases, companies could in a way wind up facing a double tax bill. Consider the example of a German company that has its UK financing arm lend money to a U.S. operation to, say, build a new plant. The interest expense would no longer be deductible in the United States while the interest income would be taxed in Britain.
While Treasury has asked whether exceptions should be made for such activities, it is also eager to proceed with inversion-blocking measures. Its Internal Revenue Service division has said it hopes to finalize a plan by September. The plan was only just put forward in April, there will be thousands of pages of suggestions to review and a hearing on the matter next week. It’s rare for such a complex tax proposal to be finished in a year, much less six months.
The government is to be applauded for trying to advance swiftly a sharp piece of useful policy. It just would be wise to pause, however briefly, to avoid any detrimental unintended consequences.
(This item has been updated to add specific reference to Treasury’s Internal Revenue Service division in paragraph six.)