Congress and the administration are under increasing pressure to stem the flow of recent inversion transactions, whereby a U.S. company merges with a foreign company and uses the transaction to reorganize as a foreign company, while retaining substantial U.S. business operations.
Treasury Secretary Jacob Lew said last week that the department is very near a decision on whether to issue guidance to make inversions less "economically appealing" for U.S. companies. Treasury appears to be working not on strengthening the actual anti-inversion rules under Section 7874, but instead on curbing the benefits of the "earnings stripping" that inverted companies use after a transaction. Interim guidance that is immediately effective could come in the form of a notice as early as the week of Sept. 15. Treasury may have the authority to issue guidance under Section 385 to limit deductions for related-party debt after an inversion or to reclassify debt as equity under Section 956.
Lew acknowledged that Treasury's ability to curb inversions is limited and called for Congress to take legislative action. Senate Majority Leader Harry Reid, D-Nev., said he doubted the Senate would vote on inversion legislation in September before Congress adjourns for the elections, but Senate Finance Committee Chair Ron Wyden, D-Ore., said he remains optimistic he can reach a bipartisan agreement in a lame duck session.
Orrin Hatch, R-Utah, Senate Finance Committee ranking minority member, is one of the few Republicans who have expressed a willingness to address inversions outside of tax reform, and Wyden said he has been encouraged by the negotiations with Hatch. Wyden initially expressed support for retroactively strengthening the anti-inversion rules under Section 7874, but like Treasury's focus, negotiations currently appear focused on changing the economics of earnings stripping.
Sens. Chuck Schumer, D-N.Y., and Richard Durbin, D-Ill., introduced legislation last week that would target earnings stripping by repealing the debt-to-equity safe harbor in Section 163(j) and reduce the maximum amount of deductible interest expense for 50% of a subsidiary's taxable income to 25%.
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