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Senate Bill Targets ‘Earnings Stripping’ by Corporate Inverters

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Top Senate Democrats Charles Schumer, D-N.Y., and Richard Durbin, D-Ill., introduced Wednesday legislation to curb the recent spate of corporate inversions, specifically targeting the practice of earnings stripping.

Schumer and Durbin cited the need to deter American companies like Burger King from inverting and cited a recent Barclays report that estimated that if Walgreens had inverted, its total savings would have been $797 million annually, 98% of which would have been attributable to debt interest-related earnings stripping.

The two senators called earnings stripping “one of the most egregious practices of corporate inversions,” as the practice involves inverted companies loading “their U.S. subsidiary up with excessive debt that is ‘owed’ to the foreign headquarters so they can deduct interest payments on this debt, further allowing the company to avoid paying U.S. taxes.”

The Schumer-Durbin legislation is the first Senate Democratic proposal to address the practice of earnings stripping by companies that move their domicile overseas, and the senators say it will work “in harmony” with efforts by Senate Finance Chairman Ron Wyden, D-Ore., and Sen. Carl Levin, D-Mich., to put together a comprehensive package of legislation to address corporate inversions.

Schumer and Durbin also noted that proposals to address the recent wave of corporate inversions must also be used as a bridge to comprehensive corporate tax reform.

“Earnings stripping is the number one incentive driving the wave of inversions we’ve seen in recent months and we need to shut it down,” said Schumer, in a statement. “This bill curtails the incentive for companies to use shady accounting gimmicks to avoid paying their U.S. tax obligations. The only way to solve this problem for good is passing legislation, and our preference is to work with our Republican colleagues to pass a strong bill.”

Specifically, the legislation will:

  • Repeal the debt-to-equity safe harbor so that limitations on the interest expense deduction will apply to all inverters, regardless of their financial leverage;
  • Reduce the permitted net interest expense to no more than 25% (down from 50%) of the subsidiary’s adjusted taxable income;
  • Repeal the interest expense deduction carryforward and excess limitation carryforward so that inverters cannot take advantage of the deduction in future years; and
  • Require the U.S. subsidiary to obtain IRS preapproval annually on the terms of their related-party transactions for 10 years immediately following an inversion.

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