A bill that Sen. Carl Levin, D-Mich., plans to introduce this week to restrict companies from inverting for tax purposes could include a sunset provision as an incentive for lawmakers who think tax reform is the only real solution to inversions.
"The question is [how] to stop the bleeding, to stop this rush of some companies to just change addresses and avoid paying taxes, stiffing the treasury of the United States in the process," Levin told reporters on May 14. "That needs to be stopped now in an effective way while the tax reform debate takes place. The question is what should be in place during the debate on tax reform, which apparently now is going to be next year."
Senate Finance Committee Chair Ron Wyden, D-Ore., has vowed to work on tax reform with the goal of moving legislation through Congress by July 2015, before the presidential election season interferes. Like Levin, Wyden has said he believes a stopgap measure is needed to prevent domestic companies from merging with foreign subsidiaries simply to avoid paying U.S. taxes. In a May 9 op-ed in The Wall Street Journal, Wyden called for changing the requirement under section 7874 that an inverted company have at least 20 percent of its stock held by foreign investors by increasing that threshold to 50 percent. (Prior coverage: Tax Notes, May 12, 2014, p. 656.)
Levin said he is looking to change the rule "to some higher number than 20 percent -- maybe 50 percent, which is the [Obama] administration's approach." The 20 percent stock ownership requirement is a big loophole and is not working, as shown by Pfizer Inc.'s attempt to take over U.K.-based AstraZeneca PLC, Levin said.
The bill Levin is working on will closely follow a proposal that the administration included in its fiscal 2015 budget plan. "Our language may be somewhat different from what theirs is because I want to try to keep it simple," Levin said. He said Wyden is expected to either support his bill or introduce legislation of his own.
On May 12 Wyden declined to directly answer a reporter's question about whether he would introduce anti-inversion legislation. "As I tried to indicate, to me this is a two-part effort," he said. "Last week was about in effect freezing the linebackers so that people would see 'effective May 8' and that I was going to do everything I can to have rules that would stop these tax schemes -- and of course work for a lower, competitive rate as part of tax reform."
Asked if his bill would include a substantive business activity test, Levin said, "That's an area where there are discussions going on as to what constitutes substantial business activity . . . and how you define that."
Although Levin said he hadn't made any final decisions about the sunset provision, he hinted that he was looking at allowing the bill to expire after two years. "That's an attractive idea to me. . . . For instance, a two-year moratorium, and then if tax reform addresses it -- which everyone will say will be within the next two years -- fine," he said.
But Levin said he is skeptical about the prospects for tax reform, given that a tax code overhaul has been talked about for years but never accomplished. "The trouble is tax reform has been a mantra for doing nothing for a long, long time," he said. "Tax reform, instead of being a way to get things done, is an impediment to getting things done."
Levin said May 15 that he plans to release his bill on May 20 and that the effective date of the legislation will be the day it's introduced. His brother, House Ways and Means Committee ranking minority member Sander M. Levin, D-Mich., has said he will introduce a companion bill in the lower chamber.
Republicans Pan Democrats' Approach
Finance Committee ranking minority member Orrin G. Hatch, R-Utah, has been one proponent of tax reform as the way to solve the inversion problem, saying that changing the international tax system could entice companies to locate their headquarters in the United States. "I share my colleague's concerns about the number of inversions that have taken place over the last few years," he said in a May 13 floor speech. "However, I do not believe that imposing confusing and arbitrary retroactive restrictions on U.S. companies is the answer."
The proposal to change the stock ownership test threshold to 50 percent would raise only $17 billion over 10 years, Hatch said. "Now, that's not really an insignificant sum," he said. "But it does demonstrate that the scope of the problem is hardly worth the draconian solutions some of my friends want to impose in order to solve it."
Hatch told reporters on May 14 that a sunset provision would not convince him to support legislation changing the inversion rules. "It's the wrong way to do this," he said. "When you do that, you're basically just making those companies captive. I don't blame Pfizer and wanting to go to England and a [lower] corporate tax rate."
Other Republicans agreed that tightening corporate inversion rules would not stop companies from attempting to locate their headquarters overseas for tax purposes. "Blaming companies for an anti-competitive tax code is exactly the wrong approach here," Ways and Means Committee member Kevin Brady, R-Texas, told Tax Analysts on May 9.
The strategy of simply tinkering with the rules on stock ownership is not enough to stop inversions, Ways and Means Committee member Charles W. Boustany Jr., R-La., told reporters. He criticized Wyden's proposal to retroactively change the stock ownership percentage test, citing his general opposition to making retroactive changes to the tax code. "I think this statement about retroactivity seems to be targeted at the Pfizer deal, but that's a much more complicated issue," he said, adding that it's inappropriate to target a specific company.
John L. Harrington of Dentons said Wyden's statement reminds him of the 2002 announcement from former Senate Finance Committee Chair Max Baucus and then-ranking minority member Chuck Grassley, R-Iowa, that they were planning to introduce retroactive anti-inversion legislation. "Following that announcement, there was a couple of years of debate not only as to what the substantive provisions of the anti-inversion legislation should be but also what the effective date of the legislation should be," he said. "I recall there being an ongoing dispute between the House and Senate until section 7874 was enacted as part of the American Jobs Creation Act of 2004. So just as in 2002-04, it is unclear how this will play out."
Harrington said that a one-size-fits-all approach will not solve the problem because inversion transactions vary from "instances in which a U.S. company seeks to change its place of tax residence from the U.S. to another country without undertaking any change in its operations, to instances in which a U.S. company acquires or merges with an existing foreign company and the U.S. and foreign company have to decide where the new top company will be located."
Tax Reform Still Needed
Wyden said in his op-ed that a longer-term solution to the problem of inversions will depend on comprehensive tax reform that brings the U.S. corporate tax rate closer to the OECD average of 25 percent. He said a reform package should incorporate changes to the inversion rules and should be enacted before the next presidential election. Wyden has previously proposed legislation that would lower the corporate rate to 24 percent as part of a comprehensive tax reform plan that would restrain the deferral of foreign-source income. (Prior coverage: Tax Notes, Jan. 27, 2014, p. 390.)
But Tax Foundation Chief Economist William McBride said Wyden's approach to tax reform would make the U.S. corporate and international tax systems less competitive. Wyden proposes moving to a worldwide system without deferral, which no other country uses, and his plan would achieve a 24 percent corporate rate by slashing cost recovery, shifting the tax burden onto capital-intensive firms rather than lowering it overall, McBride said.
Raising U.S. taxes on foreign income, as Wyden's tax reform plan would do, will just exacerbate the problem, Harrington said. "As long as our tax code is out of whack compared to other countries when it comes to taxing foreign income, the pressure to change one's tax residence, whether one is an individual or a corporation, will remain," he said. "Pulling up the drawbridge to Fortress America to keep U.S. companies in also means stopping new companies from coming in."
Boustany commended Wyden for his interest in tackling corporate tax reform but emphasized the need for a comprehensive approach. Congress should focus on creating a more favorable environment in the United States so that companies don't feel competitive pressure to relocate, he said. Boustany acknowledged, however, that base erosion is a concern and said the tax reform discussion draft that Ways and Means Committee Chair Dave Camp, R-Mich., released in February strikes a reasonable balance between those priorities.
But Democrats argue that Congress can't wait for tax reform to address the inversion issue. "We need a moratorium on this until we can come up with a solution," Ways and Means Committee member Richard E. Neal, D-Mass., said. "The failure of tax reform is complicating this." Neal added that he's working on a resolution that would point to inversions as one of the reasons Congress should get serious about tax reform.
Andrew Velarde and Meg Shreve contributed to this article.