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Senator Chuck Schumer (D-NY) recently floated the Democrats’ latest plan for limiting or preventing corporate inversions. His proposal doesn’t directly address inversions but attempts to make them less advantageous by limiting the resulting firm’s ability to move money among the firm’s various subsidiaries via intra-company loans.
Because intra-company loans can be used to shift profits and expenses among different tax jurisdictions (a process known as earnings stripping) and thus reduce total taxation of the firm, intra-company loans have been restricted for decades. The IRS adopted formulaic rules that limit intra-company loans and thus the ability to earnings strip. Schumer proposes modifying the earnings stripping formula that has been in place for decades for firms that have inverted.
While this approach may sound reasonable it is fraught with problems. It is overly complex, raises little new revenue, is contrary to decades of tax law, potentially violates the non-discrimination clause of existing tax treaties, and would likely harm employment growth and international investment in the US. Moreover, while it might make some inversions less advantageous, it is not likely to stop inversions. It does nothing to address the taxation of future foreign source income or the increased access to foreign cash reserves that are the primary reasons for an inversion.
In addition, the proposal is not likely to raise substantial new revenues. When similar proposals to limit earnings stripping for all companies, not just inverted companies, was floated a few years back, it was estimated to raise only $2.7 billion over ten years. Is it really worth making a mockery of the tax code for two cents worth of revenue?
Finally, Sen. Schumer is not yet sure even how to define an inverted company.
It would be much better to deal with inversion, earnings stripping and other international issues in the context of comprehensive tax reform. We don’t need a two bit non-solution, we need real reform.