Schumer Details Interest Deduction Limits in Inversions

A proposal by Senator Charles Schumer to limit deductions for U.S. companies taking a foreign address to reduce corporate taxes expands multi-pronged efforts by Democrats to make the deals less attractive.

Schumer, a New York Democrat, wants to curb a practice known as “earnings stripping,” in which companies that engage in inversions load their U.S. operations with debt and reduce their U.S. taxable income by deducting interest costs.

“We cannot stand idly by while corporate deserters abuse and avoid the U.S. tax system,” Schumer said in a statement released yesterday with an outline of his plan. “This proposal is just one piece of the puzzle needed to address corporate inversions.”

Schumer’s plan, and the broader effort by Democratic lawmakers to curb inversions, face significant hurdles. Congress won’t return to Washington from a five-week summer break until Sept. 8 and members are deadlocked over the issue.

The Obama administration is trying to prevent a handful of deals by companies such as Medtronic Inc. and AbbVie Inc. from turning into a wave that undermines the U.S. corporate tax base.

Business Merger

In inversions, U.S.-based companies merge with a smaller foreign business and take a non-U.S. address for tax purposes, typically without moving their operations or executives. The deals, which are legal, let companies deploy cash overseas without paying U.S. taxes and make it is easier for them to reduce U.S. taxes on income earned in the country.

Senate Finance Committee Chairman Ron Wyden, an Oregon Democrat, said in a statement yesterday that he appreciated Schumer’s efforts. In a “parallel” process, Wyden said, he is working with the panel’s top Republican, Orrin Hatch of Utah, on a bipartisan plan.

“This issue demands a resolution in the near term and I hope to have bipartisan legislation in place come September,” Wyden said.

Aaron Fobes, a spokesman for Hatch, reiterated the Republican’s openness to a “targeted, bipartisan solution” to inversions. Hatch opposes a retroactive bill and favors a proposal that would move toward a revamp of the tax code.

Deductible Interest

“He appreciates the work of his colleagues on this issue and will continue to work with lawmakers on both sides of the aisle to see if there is an interim solution that fits his criteria for a fix,” Fobes said in an e-mailed statement.

Schumer’s proposal would reduce the amount of deductible interest for inverted companies to 25 percent of U.S. taxable income from 50 percent. It also would require such companies to obtain approval from the Internal Revenue Service for transactions between different parts of the same company for 10 years.

Schumer also proposes restrictions on companies’ ability to carry deductions forward to future years. A 2007 Treasury Department study found that inverted companies routinely engage in earnings stripping.

His plan is designed as a complement to proposals from other Democrats that would make it effectively impossible for U.S. companies to take a foreign address by buying a smaller business.

Bret Wells, a law professor at the University of Houston who has studied earnings stripping, said Schumer’s proposal is a meaningful first step that doesn’t go far enough to reduce the advantages available to all foreign-owned companies.

Lawmakers, he said, should broaden the proposal beyond inverted companies and beyond interest deductions to include royalties and leasing transactions that companies can use to reduce U.S. taxable income.

‘Real Problem’

“He’s trying to attack a real problem in a real way,” Wells said. “The reactive tax planning that would result would demand that Congress would have to come back and deal with the other forms of earnings stripping.”

Schumer didn’t release the text of his proposed legislation or an estimate of how much revenue it would raise for the U.S. Treasury.

Separately, the Treasury Department is reviewing its authority to act on making inversions less attractive, which could include curbs on earnings stripping. President Barack Obama said last week that he wants the government to act “as quickly as possible.”

Schumer’s proposal will be written to apply only to inverted companies, not all foreign-owned companies, a Schumer aide said. The administration’s efforts, too, are focused only on inversions, not the broader universe of companies, an administration official said this week.

Both spoke on condition of anonymity to discuss details that aren’t public.

Foreign-Owned Companies

The trouble with such limits is that it can be difficult to create a consistent definition that doesn’t affect other foreign-owned companies, said Nancy McLernon, president and chief executive officer of the Organization for International Investment. The Washington trade association advocates for foreign-based companies operating in the U.S.

Members of the group include the U.S. subsidiaries of Siemens AG and Diageo Plc, as well as companies involved in inversion transactions such as Shire Plc.

“You never legislate in a white-hot political environment,” McLernon said at a Bloomberg Government breakfast yesterday in Washington. “There’s always going to be overreach.”

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