The financial statement and cash tax savings thatderive from introducing substantial intercompanydebt into the U.S. group to strip the U.S. tax baseinto a jurisdiction where the interest income will besubject to much lower rates of tax are a major driverof corporate expatriations. In their report on therumored Walgreens inversion, Barclays Bank PLCresearch analysts estimated that Walgreens couldoffset just under half of its earnings before interest,taxes, depreciation, and amortization with inter-company interest and not run afoul of the interestdeduction limitation rules of section 163(j).
Theyestimated that the tax savings (for one year) would be $783 million. It is not surprising that Wall Streetinvestment bankers are pushing these deals andthat deal activity is reaching a frenzied level.Companies involved in expatriations from theearly 2000s have filed tax court petitions to protectthe fruits of their huge leveraging of U.S. opera-tions.
There is reason to suspect that the IRS willhave mixed success combating this stripping of theU.S.taxbase.In2012theIRSlostitsdebt-equitycaseagainst ScottishPower Ltd.’s hybrid instrument.
Ina 2009 Tax Court case, the IRS conceded 100 percentof a huge GlaxoSmithKline PLC deficiency relatingto a $13.5 billion intercompany obligation to Glaxo-SmithKline Investments (Switzerland) GmbH.
A second major incentive to invert is to lenduntaxed offshore controlled foreign subsidiary(CFC) earnings to non-U.S. affiliates (that are notdirect or indirect subsidiaries of the former U.S.parent), to repay debt (including debt incurred tomake the acquisition), to fund distributions in re-spect of stock and, indirectly, to make up forfunding of the U.S. group.
To achieve these taxsavings, it is necessary to avoid constructive divi-dend foot faults,
but the case law is quite favorablefor taxpayers. With diligence and planning, the taxrisks are manageable. The pressure to be able to useuntaxed foreign subsidiary earnings held in cashoffshore is evidenced by the lengths that Hewlett-Packard Co. went to in trying to circumvent theinvestment in U.S. property rules of section 956.
Cross-border, related-party debt equity issuesneed to be addressed in tax reform and, indeed,have been targeted by Camp’s tax reform plan andan administration budget proposal. There is clearregulatory authority, however, to address excessiverelated-party debt under current law. A secondmajor object of a corporate expatriation is to obtainaccess to offshore cash, earned while the foreignsubsidiary was subject to U.S. taxing jurisdiction,without U.S. taxation of the earnings that gave riseto the cash. Clever tax planners use corporateexpatriations to insert a foreign parent and useloans to try to hopscotch over or out of the U.S. tax base.
Treasury has both conventional regulatoryauthority and extraordinary multiparty financialregulatory authority to protect against this latestform of avoidance of these rules.
C. Reduce Expatriation Tax Incentives1. Related-party debt-to-equity limitation.
The ex-plicit language of section 385 gives the Treasurysecretary direct and powerful regulatory authorityto reclassify debt as equity and thereby transform adeductible interest payment into a nondeductible
discuss this possibility simply because those risks have not beensufficient to deter corporate expatriations.
Meredith Adler and Eric Percher, ‘‘Walgreen Co., Investorsin the Driver’s Seat; Upgrading to Overweight,’’ Barclays Re-search, at 36 (June 18, 2014) (‘‘Put another way, as much as 50percent or more of Walgreen’s annual adjusted taxable income(which would otherwise be paid as a taxable dividend to the[new foreign] parent) may be effectively exempted from U.S.income taxes by recapitalizing Walgreens with intercompanydebt’’).
Americans for Tax Fairness and Change to Win,‘‘Offshoring America’s Drugstore, Walgreens May Move ItsCorporate Address to a Tax Haven to Avoid Paying Billions inU.S. Taxes’’ (June 2014),
All of the former Tyco International Ltd. companies havefiled petitions contesting the disallowance of interest expense onintercompany debt.
Matthew Madara, ‘‘Tyco Petition Seeksto Avoid Billions in Adjustments,’’
, Sept. 2, 2013, p.976.
NA General Partnership v. Commissioner
, T.C. Memo. 2012-172.
GlaxoSmithKline-Kline Holdings (America) Inc. v. Commis-sioner
, Nos. 18940-08, 18941-08 (T.C. Nov. 18, 2009).
Jasper L.Cummings, Jr., ‘‘Income Stripping by Interest Deductions,’’
, Dec. 2, 2013, p. 971 (‘‘The IRS knows that the debt/equityargument is messy and hard to win against a taxpayer that hastried to plan around it. For example, in 2009 the IRS conceded100 percent of a huge deficiency assessment contested byGlaxoSmithKline Holdings in the Tax Court. The debt and theinterest paid on it to the foreign parent were pretty obviously asort of income stripping, which the IRS effectively blessed’’).
Credit Suisse European Pharma Team, Shire + AbbVie 1(June 24, 2014) (‘‘Reducing the US tax penalty on repatriation of ABBV’s overseas earnings is the key driver of the transaction, inour view’’).
Under the tax law, generally, a corporate action gives rise toa constructive dividend if it confers a specific economic benefiton its shareholder.
Bittker and Eustice,
FederalIncome Taxation of Corporations and Shareholders
, para. 8.06.
Senate Homeland Security and Governmental AffairsPermanent Subcommittee on Investigations Hearing on Off-shore Profit Shifting and the U.S. Tax Code, Exhibit 1, ‘‘Memo-randum From Chairman Carl Levin and Senator Tom Coburn toSubcommittee Members, Offshore Profit Shifting and the Inter-nal Revenue Code,’’ 24-27 (Sept. 20, 2012),
Edward D. Kleinbard, ‘‘Tax Inversions Must Be StoppedNow,’’
The Wall Street Journal
, July 21, 2014.
COMMENTARY / VIEWPOINTS474 TAX NOTES, July 28, 2014
( C ) T ax A n al y s t s 2 0 1 4 .A l l r i gh t s r e s er v e d .T ax A n al y s t s d o e s n o t c l ai m c o p y r i gh t i n an y p u b l i c d om ai n or t h i r d p ar t y c on t en t .