• Schumer-Durbin Target Earnings Stripping
  • September 22, 2014 | Author: Jonathan Goldman
  • Law Firm: Sutherland Asbill & Brennan LLP - Washington Office
  • The change from summer to fall did nothing to alter the focus of the Congressional tax debate - inversions. To that end, two Senators have introduced a new bill on “earnings stripping.”

    Senators Charles Schumer (D-NY) and Dick Durbin (D-Ill.) introduced new legislation on September 11 that would significantly limit earnings stripping by inverted companies. The Schumer-Durbin bill follows on the heels of, and in many ways closely resembles, a discussion draft introduced by Representative Sander Levin (D-Mich.) (see our prior post on the Levin discussion draft). Unlike the Levin draft, the Schumer-Durbin legislation is specifically targeted at companies which have inverted under section 7874 of the tax code. Similar to the Levin draft, the Schumer-Durbin bill would:

    Reduce the available deduction for net interest expense to 25% of adjusted taxable income, down from 50%;

    • Eliminate the debt-to-equity safe harbor for earnings stripping limitations; and
    • Eliminate the carry-forward of disallowed interest expense (Rep. Levin would allow for a five-year carryforward).
    These tightened rules are proposed as an amendment to section 7874, not the earnings stripping provisions of section 163(j). But, the reach of the amendments would be broader than the current reach of section 7874 in two ways: First, it would reduce the threshold for determining whether a company was “inverted” to 50% (i.e., more than 50% of the shareholders of a foreign acquiring corporation were also shareholders of the U.S. target); and second, the rules would be applied without regard to the March 4, 2003 effective date that generally applies under section 7874. In other words, the tightened earnings stripping limitation would apply to companies which, for other purposes, are not treated as an inverted company. While the universe of inverted companies is generally considered to be limited, this reduced ownership threshold without any cutoff date would require foreign companies to look back at past U.S. acquisitions to confirm they remain outside this earnings stripping rule.

    The new interest limitations should apply only prospectively, and it appears that an interest carry-forward from tax years prior to enactment could still potentially be deducted. The proposed legislation would also add a provision requiring pre-approval by the IRS of the terms of intercompany transactions for the 10 years following an inversion.