U.S. Government Tries to Squash an Expensive Game of "Hopscotch"

Financial “hopscotch,” or “creative” loans, have enabled U.S. companies with foreign subsidiaries to lower their U.S. tax burdens, but players are finding changes in the rules of the game. On Sept. 22, the U.S. Treasury Department issued more than 40 pages of new rules. Crafted to try to eliminate the tax advantages of “hopscotch loans,” the new rules are part of the federal government’s effort to neutralize the tax benefits of corporate inversion and its components.

A corporate inversion is when a U.S. company reduces its tax liability by domiciling or relocating its registration in a lower-tax country while still principally running its operations from the U.S. There’s something about a 35% corporate tax rate that makes American multinational corporations look for ways to cut their taxes. There’s something about corporations figuring out ways to legally pay less in taxes that aggravates the government.

With “hopscotch” loans, through inversion, the foreign subsidiary could make a loan to the newly domiciled parent company and not be taxed on dividends. Previously, companies paid taxes on foreign earnings when they were brought back to the U.S. However, from this point forward the Treasury Department will view such loans as taxable dividends as these assets will now be considered “U.S. property for purposes of applying the anti-avoidance rule,” according to the Treasury Department’s Fact Sheet on rules concerning inversions and hopscotch loans.

The new wave of regulation almost immediately affected a multi-billion dollar transaction. Medtronics, a Minnesota-located medical device manufacturer, is in the midst of a $43 billion acquisition of Covidien, a healthcare products company headquartered in Dublin, Ireland. Ireland is a low-tax country. The acquisition, announced in June, would enable Medtronics to plant its flag on the Emerald Isle, and thus hang on to more of its green.

Initially it was thought that the new rules might sink the deal altogether, but Medtronics is reportedly considering making changes in the deal’s terms. On Oct. 13, Medtronics requested that European Union antitrust regulators review and approve the deal. New U.S. regulations are only part of the move to quash inversions. The Obama administration is seeking legislation that would expand the government’s power to curb inversions.

From any new law will come potential reams of additional regulations, rules, and their interpretations. It will also fuel a continuing search by companies to find ways to reduce their tax bills. That’s a rule of business life that never changes.

Tagged Accounting, Featured, Tax