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Tax inversions and intercompany debt

The U.S. Treasury has long tried to prevent inversions and cross-border avoidance maneuvers. A tax inversion occurs when an American corporation relocates to a nation with lower tax rates while continuing extensive operations in our country.

Certain rules concern corporations merging with smaller foreign companies, and then using internal corporate debt as a way of not paying taxes. However, the Treasury Department has shown a willingness to be more accommodating for companies regarding the use of this intercompany debt.

Another rule change concerns cash pooling. This is a cash management approach that concerns short-term loans involving subsidiaries. Many companies expressed concerns regarding proposed rules that would severely punish cash pooling transactions due to a number of unintended consequences.

Treasury officials conceded that cash pooling does not pose a danger of earning strippings (where corporations pay high amounts of interest to a third party to reduce taxable income). Therefore, the Treasury has put in place a number of exemptions to reduce the harshness of the rules. Instead, the treasury plans to focus its efforts on more blatant tax avoidance techniques.

The big question remaining concerns application of the federal provisions by states. States like Michigan may either closely follow federal interpretations of the rules, or may end up providing their own interpretations. This greatly depends upon the closeness of a state’s tax code ties with the federal tax code.

Especially with the results of the Presidential election, much uncertainty regarding application of the tax rules remains. We will have to see how the new administration along with the state of Michigan addresses such tax avoidance concerns. With the degree of complexity and uncertainty regarding application of the new rules, guidance of experienced tax representation is often necessary.

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