Obama Budget Seeks to Eliminate Inversions

Buried in the $3.9 trillion budget request that President Obama sent to Congress on Tuesday is a clause that has Wall Street tax advisers on edge.

The proposal would essentially forbid so-called inversions, an increasingly popular maneuver that allows United States companies to legally reincorporate in a new country when they buy a smaller foreign corporation, thereby avoiding paying the Treasury Department millions or even billions of dollars in taxes.

Outlined in an appendix to the budget known as the Green Book, which describes the administration’s revenue proposals, the new language would make inversions all but impossible to pull off.

“This will essentially eliminate inversions as we know them,” said Robert Willens, a corporate tax adviser who has helped companies accomplish such transactions.

Though the Obama budget has little chance of passing in its current form, the proposed crackdown on inversions signals the administration’s willingness to confront a somewhat obscure tax loophole that has become a favorite technique for investment bankers looking to save their clients money.

“Inversion transactions raise significant policy concerns because they facilitate the erosion of the U.S. tax base,” the Green Book reads.

Inclusion of the proposal in the budget comes after several months of mounting scrutiny of the technique.

In October, Max Baucus, who was a senator from Montana at the time and is now ambassador to China, spoke out against deals that took tax dollars offshore.

“Mergers resulting in U.S. companies being owned by companies in tax-haven jurisdictions â€" like Ireland, Bermuda, or the Cayman Islands â€" are a new spin on the old ‘inversion’ problem,” Mr. Baucus said. “And it’s becoming an increasingly popular practice.”

Weeks later, Mr. Baucus proposed an overhaul to the corporate tax code that took aim at inversions by lowering the overall corporate tax rate and introducing a tax holiday.

But the Obama budget goes much further. Under current rules, United States companies may reincorporate elsewhere â€" essentially renouncing their domestic citizenship â€" if they acquire a foreign company in a deal that transfers more than 20 percent of the shares to foreign owners. The Obama proposal would raise the foreign ownership threshold to more than 50 percent, essentially requiring a United States company to buy a foreign entity larger than itself.

It would also disallow inversions if the combined company has substantial business activities or is physically based in the United States.

“There is no policy reason to permit a domestic entity to engage in an inversion transaction when its owners retain a controlling interest in the resulting entity, only minimal operational changes are expected, and there is significant potential for substantial erosion of the U.S. tax base,” the proposal reads.

Inversions have been on the rise in recent years as United States companies seek to cut their tax bills by reincorporating in countries with lower corporate tax rates.

Among the most recent companies to invert was Endo Health Solutions, a drug maker based in Malvern, Pa., which said it would pay $1.6 billion for Paladin Labs, a smaller Canadian pharmaceutical company. The combined corporation will be based in Ireland, saving at least $50 million a year in taxes.

Other larger companies have also used the technique.

Last year, Omnicom, the big New York advertising group, announced it would merge with the Publicis Groupe, its French rival, in a deal worth $35 billion. The combined company will be based in the Netherlands, delivering tax savings of $80 million a year.

Mr. Willens estimates there have been about 50 inversions in recent decades, with 20 taking place over the last two years.

And the Treasury Department is feeling the effects of those lost tax dollars at a time when the government remains starved for cash.

Tax Analysts, a research firm, said that four oil services companies that inverted saved as much as $4 billion in taxes over a decade.

Even if the Obama budget does not pass, it appears that inversions are squarely in regulators’ cross hairs.

“If you’re a fan of inversions, and a lot of investors are, you don’t like to see them on the radar screen,” Mr. Willens said. “Even if this budget doesn’t pass, members of congress might take note of this provision and stick it on to some other piece of legislation.”

If passed, the proposal would apply to deals that close after the last day of this year.