·

New York Times Editorial: A Corporate Tax Dodge Gets Harder

Any pretense to a motivation other than dodging taxes has now been wiped away. On Wednesday, just two days after the Obama administration introduced new rules to narrow the loopholes that the drug companies were exploiting, Pfizer announced that the deal with Allergan was off.

This editorial appeared in the New York Times.


Pfizer never tried to hide the fact that its proposed $152 billion merger with Allergan, based in Ireland, would cut its tax bill in the United States. But even as it rushed to complete the biggest tax-avoidance deal in the history of corporate America, it continued to promote the strategic and economic benefits of the merger.

Any pretense to a motivation other than dodging taxes has now been wiped away. On Wednesday, just two days after the Obama administration introduced new rules to narrow the loopholes that the drug companies were exploiting, Pfizer announced that the deal with Allergan was off.

The new Treasury Department rules take aim at “inversions,” in which an American company merges with a foreign company in a low-tax nation to pass itself off as foreign and in that way cut its American taxes. Inverted companies are often described as having “moved abroad” or “renounced their citizenship.” But the only tie that an inverted company really cuts with the United States is the one that binds it to the Internal Revenue Service.

Such companies almost invariably keep their headquarters, officers and much of their business in the United States. Some 40 American companies have become inverted over the past five years, while tax laws have failed to keep pace with tax-avoidance strategies made possible by a complex mix of corporate offshore accounts and global capital flows.

The Treasury had to act to stop inversions because Congress, still in the grip of an anti-tax Republican majority, won’t. One of the new rules effectively denies tax benefits in new mergers that involve companies that have recently inverted. That scotches the Pfizer and Allergan deal because Allergan, when it was still known as Actavis, an American company, inverted to Ireland in 2013.

The new rules will also clamp down on a practice known as earnings stripping, in which a multinational reduces its American tax bill by having its American subsidiary borrow money from a foreign parent company and then deduct the interest on that loan against its earnings, which cuts its tax bill.

Worse, cash can also be lent to a foreign parent from American profits stashed abroad that are supposed to be taxed when they are repatriated to the United States. Such loans essentially allow foreign-held profits to be used tax-free. American companies could avoid tax on as much as $1 trillion in foreign-held profits by this strategy.

The new rules will fight earnings stripping by treating the loan in the transaction as equity, which removes the debt-based tax benefit. But this regulation could very likely provoke legal challenges. It would be better simply to outlaw tax-motivated inversions and related stripping techniques.

Of course, instead of that straightforward approach, lawmakers, chiefly Republicans, have seized upon the wave of inversions as proof that corporate taxes are too high and must be cut. They say that the only real fix for inversions is a complete overhaul of the corporate tax code. But broad tax reform is pie-in-the-sky in today’s hyper-partisan Congress, and they know it. Their argument does nothing but avoid dealing with these gigantic tax-avoidance schemes.

The Treasury Department deserves credit for tackling the problem. But its regulatory powers, though powerful, are limited. Only Congress can fully stop inversions and the looting of the American corporate taxes.