More than 30 years have passed since Congress passed reform of the federal tax code in President Reagan’s second term. The question of whether such reform can happen this year, during President Trump’s first term, will be getting plenty of attention in the coming days.
Somewhat beneath the radar, however, is a more specific set of issues regarding the review of regulations on so-called tax inversion transactions. In the last few years, numerous U.S. companies have used such transactions – involving the acquisition of a foreign partner and reincorporation abroad -to avoid U.S. income tax.
Will the Trump administration be keeping the regulations put in place by President Obama’s Treasury Department seeking to discourage this practice?
The short answer is that the regulations are under review. President Trump issued an executive order to that effect on April 21.
President Obama’s Treasury Department issued the regulations last April. They required detailed reporting by companies who engaged in actions such as “earnings stripping,” involving short-term loans to subsidiaries in order to avoid taxes on corporate earnings.
Various business groups, including some groups in Texas, challenged the regulations legally. Their contention was that Treasury had exceeded its authority in implementing the new rules. In October, Treasury loosened the rules somewhat by creating certain exemptions. We discussed this last year in our November 12 post.
Now, Treasury will be reviewing the regulations again. Mr. Trump’s executive order did not make clear which aspects of the regulations are under the most scrutiny. But the rules on earning stripping may be a key target.
The underlying problem is that U.S. corporate tax rates are generally higher than the rates abroad. This gives U.S. companies an incentive to seek to turn U.S. income into foreign income through inversion transactions.
Reducing high corporate tax rates in the U.S. could conceivably become part of comprehensive tax reform. But comprehensive reform happens or not, the Trump administration may change the rules on tax inversions.