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Lions, and Tigers, and Tax Inversions! Oh, My!

This blog will address some potential legal challenges to the recent flux of corporate tax inversions.

At first one might think that because a tax inversion may require you to pay your capital gains on a stock, and if you sold the stock you would have to pay your capital gains anyways, that this aspect of a tax inversion is not something to be overly concerned with. ((See Laura Saunders, The ‘Inversion’ Tax Hit on Investors: Answers to Readers’ Questions, Wall St. J.: Markets (Aug. 5 , 2014, 10:24 AM), http://blogs.wsj.com/totalreturn/2014/08/05/the-inversion-tax-hit-on-investors-answers-to-readers-questions/.))  To pay those capital gains however, the stockholders may have to sell some of their shares in the stock of the company that is moving its headquarters out of the United States.  Still, this does not look too bad.

But here is the kicker.  On stocks that pay dividends based on the amount of share you hold, if you are forced to sell some shares in order to pay capital gains, you will make less dividends than before (because you have less shares than before) and thus the income of those shareholders is decreased, just because of the United States tax law and because the company is headquartering overseas, not because of any action of the shareholder.

Some long-term shareholders are upset with this system, and efforts are being made to restrict United States corporations from participating in tax inversions.  In September of 2014, the United States Treasury Department introduced new rules aimed at reducing the attractiveness of reincorporating overseas for United States companies.  ((See Ian Katz and Richard Rubin, Crackdown Targets Inversions Designed to Limit U.S. Taxes, Bloomberg Bus. (Sept. 22, 2014, 8:13 PM), http://www.bloomberg.com/news/articles/2014-09-22/treasury-unveils-anti-inversion-rules-against-tax-deals.))   One rule limited “hopscotch loans, which let companies access foreign case without paying United States taxes.” ((Id.))  Another rule limits the methods American companies have to reincorporate and qualify for “favorable tax treatment.” ((Id.))  The rules also are trying to tighten the loophole on “spin-versions, in which United States companies spin off units into a foreign company.” ((Id.))

Besides these rules, the Obama Administration wants to change the current law in an additional way to make tax inversions less appealing to United States corporations.  ((See id.))  One way is changing the current law, that United States companies that have reinincorporated overseas are still treated as Untied States companies under the tax law if “the former United States company’s shareholders own more than 80 percent of the combined company.” ((Id.))  The Obama Administration would like to change that number to 50 percent.  ((Id.))

As one might imagine, these rule changes are not liked by everyone, and questions have arose over if these rules will hold up in court.  However, the Department of the Treasury has a successful record in court, winning 42 out of 55 challenges to its measures in the United States Tax Court, with eight of the 13 successful challenges being upheld on appeal. ((See Victor Fleischer, Court Challenge to New Inversion Rules Would Face Long Odds, N.Y. Times (Sept. 3, 2014, 12:07 PM), (http://dealbook.nytimes.com/2014/09/03/court-challenge-to-new-inversion-rules-would-face-long-odds/?_r=1.))  In addition, in Mayo Foundation v. the United States, the Supreme Court held that Chevron Deference applied in tax cases, thus providing the Treasury Department more flexibility and more lawmaking authority in the area of tax law. ((Id.))  Thus, it is not likely that the new rules put out by the Treasury Department will be held invalid in court. ((Id.))

So have these rules halted the rush of United States corporations looking to reincorporate overseas?  A couple high profile American corporations recently reincorporated overseas, suggesting that the new rules have not been entirely effective in stopping tax inversions. ((See Rakesh Sharma, Medtronic Avoids U.S. Taxes While Saddling Shareholders With a Hefty Tax Bill, The Street (Jan. 28, 2015, 6:01 AM), http://www.thestreet.com/story/13024863/1/medtronic-avoids-us-taxes-while-saddling-shareholders-with-a-hefty-tax-bill.html.; Zacks Equity Research, Long-awaited Burger King-Tim Hortons Merger Completed, Zacks: Analyst Blog (Dec. 15, 2014), http://www.zacks.com/stock/news/157418/longawaited-burger-kingtim-hortons-merger-completed.))

In “the largest tax inversion ever,” Medtronic’s reincorporated overseas by buying the Ireland company Covidien, thus lowering the tax liability for Medtronic’s (perhaps to the point that Medtronic’s will face no taxes on its operations in the United States) and according to Internal Revenue Service rules, shareholders of Medtronic’s stock may have to pay a 33% capital gains tax as result of the inversion. ((See Sharma, supra note 12.))  In late 2014, Burger King, an American corporation, merged with Tim Hortons, a Canadian corporation, despite concerns that Burger King was reincorporating in Canada for tax reasons. ((See Zachs: Analyst Blog, supra note 13.))

So what is next?  Senate Finance Committee Chairman Orrin Hatch argues that the short-term relief methods postulated by the Government may have slowed down the rate of tax inversions but that they are not a long-term fix. ((See Mike Godfrey, Hatch: Only Tax Reform Can Cure US Inversions, Tax-News: Global Tax News  ((Jan. 27, 2015), http://www.tax-news.com/news/Hatch_Only_Tax_Reform_Can_Cure_US_Inversions____67080.html.))  Instead the United States needs to reduce the rate by which American Corporations are taxed at and “not attempt to tax worldwide income.” ((Id.))  Michigan House of Representative member Dave Camp argued along a similar vein that the current administration is only doing the “bare minimum” to stop these tax inversions, and that the United States needs active reform of its tax laws to stop this problem in the future. ((See Katz, supra note 2.))

It will be interesting to see how this problem is addressed in the future.

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