PhotoOne of the main political sticking points for candidates over the years has concerned taxes – more specifically, how to make sure U.S. companies pay their fair share of them.

Many have called the tax system broken over the years because of how easy it is for a company or corporation to acquire a business overseas and move its tax address. This allows multinational businesses to engage in “earnings stripping,” which is the term that describes a company that pays deductible interest to a parent company or affiliate in another country that has lower taxes. Simply put, it allows a business to avoid paying as much as they should in U.S. taxes.

But in an interview with CNBC on Thursday, U.S. Treasury Secretary Jack Lew announced new regulations that will limit companies’ ability to take part in this kind of “egregious” tax avoidance. The new rules will seek to end earnings stripping and mandate that corporations file documentation on interest deductions on related-party loans.

“This administration has long called for legislative action to fix our broken tax system. In the absence of Congressional action, it is Treasury’s responsibility to use our authority to protect the tax base from continued erosion,” said Treasury Department Secretary Jacob J. Lew in a statement.

“We have taken a series of actions to make it harder for large foreign multinational companies to avoid paying U.S. taxes and reduce the incentives for U.S. companies to shift income and operations overseas. Such tax avoidance practices are wrong and should be stopped.”

Exceptions and exemptions

The proposed regulations were submitted back in April, and were subject to months of scrutiny from stakeholders before being finalized. As a result, the finalized version allows for several exceptions and exemptions for situations where there is a low risk of earnings stripping.

Feedback from the public also led to exemptions for foreign subsidiaries of U.S. multinational corporations, transactions between pass-through businesses, cash pools, and limited exemptions for financial institutions and insurance companies that are subject to regulatory oversight for their capital structure.

The final regulations also include more relaxed documentation requirements than those suggested in April, as well as more exceptions for ordinary course transactions like stock acquisitions associated with employee compensation plans. The regulations will go into effect on January 1, 2018.

Mixed reviews

Republicans and Democrats have remained divided on the new regulations. Rep. Kevin Brady (R-Tex) claims the regulations were pushed through too quickly and may damage U.S. workers and the economy. “By rushing the review process – despite the extensive comments received – and finalizing these regulations so quickly, it appears the Obama Administration has ignored the real concerns of people who will be most impacted by these far-reaching rules,” he said.

On the other side of the aisle, Rep. Sander Levin (D-Mich) said the new regulations were a step in the right direction towards restoring fairness to the tax system.

“For years, companies have been inverting and engaging in earnings stripping to unfairly lower their tax bills. In the absence of Republican action on tax reform, Treasury has used its Administrative authority to help bring fairness to the tax system. Today’s regulations from Treasury—which took into account extensive comments from the public and intensive meetings with Republicans and Democrats in Congress—go straight to the core of that fairness issue by strongly limiting a company’s ability to use this tax avoidance strategy, which involves disproportionately leveraging a U.S. company with debt and ‘stripping’ the U.S. tax base through deductible interest payments,” he said.

One tax expert found both positives and negatives to the new regulations, saying that some necessary steps were taken but that some parts were still worrisome.

“On the plus side, the documentation rule’s applicability of 1/1/18 and the exception – for the time being at least – for foreign issuers were responsive to comments and were absolutely necessary. . . But the rules’ general response regarding cash pooling will still be highly burdensome where they apply as will the retroactive application of the re-characterization rules,” said Ronald Dabrowski, a principal of KPMG LLP, a Washington National Tax practice.

So, based on the mixed reviews, consumers may have to wait and see if the new regulations save the tax system or lead to the collapse of the country as we know it. The smart bet may be to expect something in between. Consumers can learn more by visiting the Treasury's fact page here.


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