WASHINGTON – U.S. Senator Chris Coons (D-Del.) joined Senators Chuck Schumer (D-N.Y.) and Dick Durbin (D-Ill.) Wednesday to introduce legislation aimed at stemming the recent tide of corporate inversions. The bill would remove a key incentive driving companies to re-incorporate abroad to dodge U.S. taxes – a practice that threatens U.S. jobs and results in state and federal revenue losses.

The bill specifically targets the practice of ‘earnings stripping,’ an accounting gimmick that inverted companies employ to avoid paying U.S. taxes.

“American families that live and work here pay taxes here, and American corporations should do the same,” Senator Coons said. “Accounting gimmicks like ‘earnings stripping’ allow U.S. corporations to dodge their tax responsibilities and incentivize more companies to abandon their obligations in pursuit of higher profits. Delaware nearly lost thousands of jobs earlier this year when Pfizer attempted to take over AstraZeneca and move its tax residence to the U.K. While there is more Congress must do to make our tax code more competitive, closing this loophole is an important first step to stem the tide of inversions and protect U.S. jobs.”

Earnings stripping is a practice that allows inverted companies to load their U.S. subsidiaries up with excessive debt “owed” to the foreign headquarters so they can deduct interest payments on the debt and avoid paying U.S. taxes. A recent Barclays report estimated that if Walgreens had inverted, its total savings would have been $797 million annually, 98 percent of which would have been attributable to debt interest-related earnings stripping.

The legislation is the first Senate Democratic proposal to address the practice of earnings stripping by companies that move their domicile overseas. The bill is designed to work in harmony with Finance Chairman Ron Wyden (D-Ore.) and Senator Carl Levin’s (D-Mich.) efforts to build a comprehensive package of legislative proposals to address corporate inversions.

The legislation addresses the practice of earnings stripping in two ways: First, it will serve as a deterrent for those considering an inversion, as they will no longer see that opportunity to avoid U.S. taxation post-inversion. Second, the tax consequences would be prospectively applied to all companies that invert, including companies that have already inverted.  Thus, the legislation ensures that the earliest inverters do not have a competitive advantage over their U.S. counterparts.

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 percent (down from 50 percent) 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

The legislation is also co-sponsored by Senators Sherrod Brown (D-Ohio), Jay Rockefeller (D-W.Va.), Debbie Stabenow (D-Mich.), Ben Cardin (D-Md.), Jack Reed (D-R.I.), Bob Menendez (D-N.J.) and Edward Markey (D-Mass.).