Treasury Secretary Lew's comments on tax reform yesterday indicate that in the absence of legislative activity to address the expatriation of US-based companies, the Treasury will lay out its own plans "in the very near future." Goldman interprets this to mean an announcement in the next couple of weeks. While the substance of the Treasury's forthcoming announcement is still unknown, Lew's comments seemed consistent with Jan Hatzius' expectation that the steps the Treasury will announce will be incremental and not enough to fundamentally alter the outlook for these transactions.
Via Goldman Sachs' Jan Hatzius,
Tax-focused activity in Congress is also likely to pick up. Legislation is expected to be introduced in the House and Senate in coming days to reduce the economic incentives for companies to move their tax domiciles. While a vote in the Senate is possible over the next couple of weeks, we continue to believe enactment of legislation on the issue is very unlikely prior to the election. In the "lame duck" session of Congress following the election in November/December, Congress looks likely to pass legislation renewing expiring or expired corporate tax provisions; those bills do not address inversions, but it would not surprise us to see some lawmakers try to raise the issue again in that context.
More generally, we continue to hold the view that "something has to give" regarding corporate tax policy. The less the Treasury is able to address inversions through regulation this year, the more pressure will grow on Congress to address next year. Many lawmakers have said they prefer to address the issue as part of broader tax reform, and next year they will presumably have to at least try to do so. There are plenty of reasons that corporate tax reform legislation might not be enacted in the next two years, but the list of reasons it might be enacted does seem to be growing.
Treasury Secretary Lew's speech today (September 8) at the Tax Policy Center marks the start of what is likely to be a period of increased activity related to corporate tax policy:
Secretary Lew’s comments suggest regulatory changes are forthcoming... Lew’s discussion of tax issues today held few surprises. Regarding inversions, he did not announce any new measures but announced that the Treasury Department, which oversees the IRS, is “completing” an evaluation and that it will “make a decision in the very near future.” We have expected the Treasury to announce changes in its regulatory interpretation of current tax laws regarding inversion-related issues in the next month or so to address certain aspects of inversions. Lew’s comments today suggest such an announcement may be coming sooner than we imagined, with an announcement possible in the next week or two, once it becomes clear that Congress will not enact legislation prior to the election.
...But there is little clarity yet on what the Treasury might do. Over the last six weeks there have been a number of articles written by tax lawyers, former Treasury officials, and other observers about what statutory authority the Treasury has to address the inversion issue without Congress. In general, the options fall into three broad categories: (1) tighten the rules governing which inversion transactions qualify for tax benefits, (2) deny inverted companies the use of certain tax strategies, or (3) deny all foreign-owned US companies the use of certain tax strategies. Our expectation is that the first two options face obstacles: the laws governing inversion transactions do not leave much to interpretation, and most experts are skeptical whether the Treasury could apply tax rules to inverted companies that differ from the rules applied to other companies without instructions from Congress to do so. The third option, to tighten certain rules for all companies, appears to offer the best opportunity for the Treasury to address inversions, presumably by focusing on strategies that mainly inverted companies rely on. One potential area for action could be an attempt to limit companies' use of unrepatriated earnings generated prior to the completion of inversion. Whether the Treasury will attempt to do this, and whether it could implement rules to do this effectively, remains to be seen, but we expect some clarity from the Treasury in the next couple of weeks.
Renewed congressional activity is also likely over the next couple of weeks... Earlier this summer, the legislative debate focused on tightening the rules governing inversion transactions, by requiring that more than half of the ownership of the company needed to change as part of such a transaction, up from 20% currently. The legislative focus has now shifted to limiting the economic benefits of such transactions, similar to the Treasury's apparent focus. Sen. Schumer (D-NY) is expected to introduce legislation this week to limit so-called "earnings stripping" by former US companies, which involves a multinational's US subsidiaries borrowing from and paying tax-deductible interest to the firm's foreign subsidiaries to lower taxable US profits. House Ways and Means Ranking Democrat Sander Levin (D-MI) looks likely to offer legislation targeting the practice as well. Both bills would limit the amount of tax-deductible interest to 25% of a US subsidiary's taxable income (from 50% currently), but the Schumer bill would apply only to inverted companies while the Levin bill would apply to US subsidiaries of all foreign-owned companies. The Levin proposal would also attempt to limit inverted companies' use of untaxed foreign profits, which the Schumer bill does not address. The House of Representatives seems very unlikely to vote on these proposals. By contrast, there is a possibility the Senate could vote on the Schumer proposal in the next couple of weeks, though it is unlikely to have sufficient support to pass in our view.
...and following the November election. Following the November 4 election, Congress returns for a "lame duck" session. One of the key pieces of unfinished business on the agenda at that point will be tax "extenders" legislation to renew expired or soon-to-expire (mostly corporate) tax provisions. While the extenders legislation has little to do with inversions, it is possible that amendments could be offered to address the issue, though we would be surprised if Congress ultimately enacted changes to inversion rules as part of that bill.
In the longer term, it may take tax reform to address inversions. If we are correct that the Treasury will be able to make only incremental changes related to inversions, it is possible that companies could view whatever the Treasury does announce as providing companies with an "all clear" to proceed with additional transactions. Ultimately this seems likely to put the onus on Congress to address the issue. Many congressional Democrats support short-term action on inversions while Congress contemplates longer-term reform. By contrast, many Republicans prefer to let the inversion issue drive action on broader tax reform, which may otherwise fail to gain momentum. Our take is that while tax reform is inherently difficult and our base case is that Congress will not enact reform prior to the next presidential election, events are raising the probability that Congress might manage to reach agreement on some version of corporate tax reform.
