When President Donald Trump took office in January, many on Wall Street anticipated that he would abolish regulations put in place by his predecessor aimed at curbing tax inversions — rules that drove a stake through the heart of a $160 billion merger between Allergan plc and Pfizer Inc.
Allergan CEO Brent Saunders even called then-President Barack Obama's April 2016 rules "un-American," and asserted they were specifically designed to thwart the biotechnology company's deal with Pfizer.
The proposed Allergan-Pfizer deal followed a slew of inversion transactions, in which American companies merged with corporations domiciled in countries with low corporate tax rates, such as Ireland with 12.5%, versus the 35% rate that the U.S. has kept since the 1990s.
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But Trump has decided to keep Obama's anti-inversion regulations — for now, at least, until Congress can pass his tax reform plan. The Treasury Department said keeping the rules would address base erosion and earnings stripping, while removing tax incentives for U.S. companies to invert or be taken over by foreign corporations.
"Treasury currently believes that it would be irresponsible to revoke these regulations before enactment of tax reform," the department said in an Oct. 4 statement.
Trump's Treasury Department must still go through the rulemaking process before it can officially change the Obama-era inversion regulations. But the new administration also is now facing the uncertainty of a ruling from the U.S. District Court for Western Texas in Austin, which said the Obama inversion rules are "arbitrary and capricious."
The Obama rules took aim at earnings stripping, a practice used by inverted companies to avoid paying on their American subsidiaries' profits by employing the so-called interest expense deduction mechanism allowed under the current U.S. tax code.
Those rules certainly make inversions less attractive, Lewis Greenwald, a partner in Mayer Brown focusing on international tax law, said in an interview. However, with the administration's emphasis on minimizing regulations and creating a business-friendly environment, the Treasury may be just buying time for further review, he said.
Lawsuit leaves inversion rules in limbo
The Texas decision might pressure those goals. Treasury did not respond to requests for comment on whether the government would appeal.
In the meantime, Greenwald said it is unlikely that companies will jump on inversions.
"I think they're going to want to see other things play out — whether the government appeals that decision, how tax reform goes," he said. "We've seen a bunch of clients that, because of the possibility of a much lower corporate rate, holding back on planning because, again, if it's 20%, it may be good enough."
"Just because you change a tax law doesn't mean it won't get changed back at some point," Greenwald said. "And that has to be weighed against the cost of these very complex structures."
The "Big Six" tax framework aims to lower the U.S. corporate tax rate, the highest among countries in the Organization for Economic Cooperation and Development, according to the annual competitiveness index compiled by the Tax Foundation, a think tank.
"The U.S. has an inhospitable tax system towards multinational companies," Gavin Ekins, a research economist at the Tax Foundation, said in an interview. "The framework is a good example of how to make it more competitive."
The U.S. has two options — a carrot and a stick, Ekins said. While the government has used the stick heavily in recent years through tax inversion regulations, the framework "is the first thing that they've done to try to create a carrot."
These past approaches, including the worldwide system that taxes American corporations' foreign earned income, contribute to its low competitiveness rating in the foundation's index last year — 33rd out of 35 countries in the OECD.
"I think you have to have both the carrot and the stick, but I don't think that the stick approach is ever going to really work," Ekins said. The framework on the table is looking to make the U.S. tax code more welcoming through a lower corporate rate and a territorial tax system, he added, though companies have mixed feelings on its goals for offshore cash.
The multibillion balance on inversions
The Obama rules were aimed at halting a march of U.S. multinationals toward the door that had picked up, particularly among healthcare and tech companies, in recent years.
Such overseas moves were on paper only, with most U.S. companies keeping their major operations in America, where they could take advantage of the nation's rule of law, patent protection, skilled workforce, infrastructure, and research and development capabilities, Obama said at the time.
"But they effectively renounce their citizenship," he told reporters April 5, 2016.
Multinationals that invert save an average of $70 million a year in the three years after the deal, according to a recent report by the nonpartisan Congressional Budget Office, or CBO. Meanwhile, the government loses billions in tax revenue. The CBO estimates that under current policies, $12 billion in revenue could be lost by 2027.
"The U.S. Chamber applauds the Treasury Department's and Internal Revenue Service's actions to reduce onerous regulatory burdens on businesses through the withdraw[al], substantial revocation, or substantial revision of many rules," Caroline Harris, the U.S. Chamber of Commerce's vice president for tax policy, said in a statement.
The Pharmaceutical Research and Manufacturers of America and the Biotechnology Innovation Organization declined to comment about the ruling or the Trump administration's proposal to keep the inversion rule.
Recent court decision or not, companies are largely taking a wait-and-see approach with the framework.
"The Chamber is pleased that the district court set aside the Obama administration's unlawful regulation," Harris said about the court decision. "The best way to address inversions is not through unlawful one-off regulations, but through pro-growth comprehensive tax reform that makes the U.S. more competitive."