PFE Pfizer Inc

By Richard Rubin 

WASHINGTON -- The U.S. Treasury Department spent nearly three years reshaping international corporate transactions, reinforcing the U.S. tax base and deterring inversions, the controversial maneuvers that put companies' addresses in low-tax countries.

Now, all that work, capped with a crucial set of final rules in October, could come undone.

The sudden fragility of the new regulations arises from the election and the gridlock preceding it. Skeptical Republican legislators and an incoming administration vowing to repeal government rules could quickly tear down the regulatory framework that helped kill large deals planned by Pfizer Inc. and AbbVie Inc.

President-elect Donald Trump, who has said that he wants to stop inversions, has suggested that a lower corporate tax rate would sharply reduce companies' incentives to take a foreign address. Mr. Trump and Steven Mnuchin, his pick to run the Treasury, have proposed cutting the corporate tax rate to 15% from 35% as part of a bigger revamp of the tax code.

As they wrote the rules, Treasury officials used generous assessments of their own authority, with Congress deadlocked, to make it much harder for companies to exploit gaps in the U.S. tax system.

"We have a problem. We asked Congress to address it," said Robert Stack, Treasury's top international tax official. "They didn't do anything."

After an April draft prompted fierce lobbying by business groups and corporations, Treasury's final rules in October pared back the impact on U.S.-based companies, focusing the impact on foreign-owned firms.

Those final rules, which could produce $600 million annually in taxes, capped the Treasury's work. In all, the government erected new barriers that made it harder for firms to escape the U.S. tax net and ended some tax-avoidance techniques companies could use once they had a foreign address.

Still, Republican complaints could prevail if Treasury officials didn't erode businesses' objections far enough. Congress could repeal the rules. The Treasury under Mr. Trump can withdraw them.

"I'm hopeful that he stops those regulations cold," said Rep. Kevin Brady (R., Texas), chairman of the House Ways and Means Committee, after the election. "They built a regulation wall to keep investment out of the United States."

The October regulations themselves drew cautious relief from businesses. Treasury officials had listened to business feedback, especially on this year's most expansive rules. Those limit a tax-avoidance technique called earnings stripping, in which foreign companies use internal loans to generate interest deductions against the 35% U.S. tax rate and push income into lower-taxed jurisdictions. Companies that invert often strip earnings to get the full benefit of a foreign address.

Inversions had barely registered during President Barack Obama's first term, but they started getting public attention in 2014 when Pfizer announced it was considering an inversion, and when Medtronic Inc. and Mylan Inc. announced their own deals.

Democrats, worried that more firms would flee, proposed targeted legislation that would make it impossible for companies to invert by buying a smaller foreign target. Republicans resisted, pushing for a broader tax-code overhaul.

That left any action to Treasury, and as corporate departures entered bankers' routine pitches to companies on how to lower tax bills, the department began to explore its own powers, said Mark Mazur, assistant secretary for tax policy, who oversaw the rule making.

That happened in the background while Mr. Obama and Treasury Secretary Jack Lew prodded Congress. Mr. Mazur, a 60-year-old longtime government economist, described a bottom-up process, driven more by Treasury staff.

"At first we thought that we didn't have authority to do much or anything substantive," he said.

Publicly, that posture flipped quickly, and Mr. Obama urged them along. Announcements followed in September 2014, November 2015 and April 2016, produced by a core group of about 12, along with an Internal Revenue Service team.

The Treasury's team worked outside public view to protect market-moving information from leaking to investors before releasing rules that curtailed benefits for foreign-owned companies. During that whole rule-making period, Treasury's senior tax officials, virtually unknown outside the tax world, operated under unusual scrutiny from people invested in cross-border deals. Mr. Stack recalled seeing the same investors or their representatives over and over, conspicuous at tax conferences where everyone knows everyone.

The investors sought mundane scraps of information such as Treasury Department holiday schedules to unearth details of the decade's most consequential tax rules. They peppered another official with questions in a hotel elevator. "They're always looking for some little hint," Mr. Mazur said.

Treasury's move in April was its most surprising, curbing what the government called "serial inverters," or companies growing through multiple inversions. That killed Pfizer's plan to buy Allergan PLC and take an Irish address. Treasury officials were aware of transactions but insist they weren't targeting particular companies.

Simultaneously, Treasury proposed an earnings-stripping rule, which alarmed U.S.-based companies because it relabeled some internal debt as equity and imposed steep compliance costs.

Treasury officials met with roughly 50 companies and trade groups this year. Some CEOs went straight to Mr. Lew, who directed their tax and finance experts to Mr. Mazur. Eventually, Mr. Mazur's team joked they would have covered the entire Fortune 100 with just a few more meetings.

Treasury "proved to be much more flexible and much more accommodating" than experts expected, said David Golden of Ernst & Young LLP.

Inversions are "less attractive" now, but the rules still discourage foreign investment, said Jason Bazar, a partner at Mayer Brown LLP.

Write to Richard Rubin at richard.rubin@wsj.com

(END) Dow Jones Newswires

December 02, 2016 07:14 ET (12:14 GMT)

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