Tax inversion transactions, part 2: Lawsuit challenges new rules

Let’s continue the discussion of tax inversion transactions that we began in a post last week.
As we noted, transactions by which a U.S. company acquires a partner abroad and avoids U.S. taxes by reincorporating have attracted increasing attention from federal regulators.

Last spring, the Treasury Department put into effect new regulations to remove the tax benefits of these transactions.

In this part of the post, we will update you on a lawsuit filed against these rules by business groups.

The business groups are the U.S. Chamber of Commerce and the Texas Association of Business. Another Texas connection is that the suit was filed in Austin, in U.S. District Court for the Western District of Texas.

In the suit, the business groups contend that the Treasury Department overstepped its legal authority by imposing the new regulations. The authority to do this, the suit argues, lies with Congress, not an executive branch agency.

This is not merely an abstract dispute about separation of powers theory as an underpinning of the U.S. government. There is a lot of money at stake because the corporate income tax rate in the U.S. (35 percent) is so high.

That rate is the highest in the industrialized world and has naturally prompted U.S. companies to consider strategies for avoidance. And after all, tax avoidance is perfectly legal; it is by no means the same as tax evasion.

Treasury contends that the new regulations do not restrict legitimate cross-border deals, but instead limit transactions driven by a desire to escape U.S. taxes.

The regs themselves have many complexities. They involve issues such as what constitutes “earnings stripping” and the recognition of stock in a foreign parent company.

For all these complexities, however, the premise of the lawsuit challenging the rules is a simple as a high-school civics class: The legislature, not the executive branch, is supposed to make the law.