A recent development on Capitol Hill has been the outcry from President Obama and certain members of Congress regarding the number of so called “Inversions" by large U.S. corporations. Such inversion transactions allow these corporations to substantially reduce their U.S. federal income tax liability by essentially reincorporating outside the U.S. This matter, and a recent IRS regulatory development, are discussed further below:
A. U.S. Treasury Should Consider Use of Tax Regulations To Deter Corporate Inversions
On July 29, 2014, Stephen Shay, a former international lawyer with the Treasury Department and now a professor at the Harvard Law School, stated that the Treasury Department should immediately issue "stopgap regulations" to make corporate inversions transactions less lucrative. These transactions are commonly referred to as "inversions" since, for example, a large U.S. multinational corporation becomes the subsidiary of a much smaller foreign corporation. In Professor Shay's opinion, the Obama administration has the power to unilaterally limit "inverted" corporations from taking advantage of various tax-driven transactions peculiar to such "inverted" corporations. One of his suggestions was to limit the ability of the "inverted" corporation to take deductions for interest paid on loans from the new foreign parent corporation. According to Professor Shay, "if you take away the incentives, a large portion of these deals would not happen because they are indeed tax-motivated".
B. Democrats To Introduce Legislation Banning Government Contracts with "Inverted" Corporations
In a Congressional proposal to curb corporate inversions, four Democratic lawmakers (Representatives DeLauro and Doggett, and Senators Levin and Durbin) said they intend to introduce legislation to block federal contracts with companies that reincorporate in foreign countries as "inverted" corporations. Under the new bill entitled "No Federal Contracts For Corporate Deserters Act”, the U.S. government could not contract with any company that 1) reincorporates in a foreign country, 2) is at least 50% owned by U.S. shareholders, and 3) does not otherwise have substantial business opportunities in the country of reincorporation.
C. Pressure Over Corporate Inversions Prompts Walgreen To Remain a U.S. Corporate Taxpayer
The Walgreen Company, the biggest U.S. drugstore chain, has announced that a transaction in which it will buy all the stock of a British corporation will not be used as a means to achieve a corporate inversion. Walgreen had considered moving its headquarters overseas to reduce its U.S tax liability. However, the company has come under mounting political pressure not to enter into a corporate inversion transaction. This development comes even as other U.S. health care companies, such as AbbVie, Inc. and Pfizer, Inc. recently contemplated inversion transactions. Reportedly, moving overseas could have saved Walgreens at least $4 billion in federal income taxes over the next 5 years.
D. Surprisingly, the U.S. Treasury Department Helped Delphi Automotive, PLC to Engage In A Corporate Inversion
President Obama has stated that U.S. corporations using inversion transactions to avoid U.S. federal income taxes are employing an “unpatriotic loophole.” However, the U.S. Department of the Treasury helped one large U.S. corporation do just that. As part of the bailout of the auto industry in 2009, the U.S. Treasury Department authorized spending $1.7 billion of government funds to rehabilitate a bankrupt Michigan auto parts maker. Part of the rehabilitation plan involved the company reincorporating in England. Executives of Delphi Automotive, PLC continued to manage the company from its Detroit headquarters. However, having the legal headquarters in England reportedly is reducing the company's U.S. federal income tax bill by as much as $110 million a year. The Obama administration's role in aiding Delphi Automotive in this fashion may complicate President Obama's current campaign against corporate inversions.
E. Long-Term Fix To Corporate Inversion Problem At Least Two Years Off
Many tax analysts believe that no matter how Congress responds to the latest corporate inversion transactions, the most that can be accomplished is a temporary fix to the problem. According to David Burton, a senior fellow at the Heritage Foundation, the recent controversy over corporate inversions illustrates that the present provisions in the Internal Revenue Code are just not capable of halting this trend. Mr. Burton further remarked that only a comprehensive reform of at least the corporate tax provisions in the Code, which unfortunately has not yet been seriously considered by Congress, will put the brakes on this practice.
On July 18, 2014, the IRS issued TD 9680, dealing with research expenditures under IRC Section 174. This TD made changes to proposed regulations which had been issued in 2013, and adopted the revised regulations as final. The final regulations are effective as of July 21, 2014, but can be utilized by taxpayers in open tax years.
The final regulations will affect taxpayers engaged in research activities. These regulations amend the definition of research and experimental expenditures under IRC Section 174. In particular, these final regulations provide guidance on the treatment of amounts paid or incurred in connection with the development of tangible property, including pilot models.
The changes made in the final regulations are generally taxpayer friendly, particularly to those taxpayers whose research activities require the building of expensive prototypes. Affected taxpayers would include, for example, manufacturers in a variety of industries.
The Section 174 regulations deal with the deductibility (and capitalization) of research expenditures. However, these regulations are important to those taxpayers seeking to claim a tax credit under IRC Section 41. This is because by definition, all expenditures qualifying for tax credit treatment under IRC Section 41 must first qualify as research expenditures under IRC Section 174.
For additional information regarding these topics, please contact your local UHY LLP professional.