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Jeff Paravano Offers Analysis of Corporate Tax Changes Possible Under Trump Administration

News / January 10, 2017

Partner Jeff Paravano is extensively quoted in an article published Jan. 9, 2017, by Tax Analysts’ “Tax Notes International.” newsletter. Excerpts from the article, “Examining Trump Adviser’s Theory of Reverse Inversions,” include:

Jeffrey Paravano, former U.S. treasury official and managing partner of BakerHostetler's Washington office, said his clients are conservatively anticipating that the new corporate tax rate will be no higher than 25 percent and could be as low as the much discussed 15 percent. “The stock prices of insurance companies  ̶  which generally have a high tax rate and don't benefit from many deductions  ̶  already reflect anticipation of a significant benefit from rate reduction,” he said.

Manufacturing companies, on the other hand, could lose the IRC section 199 manufacturing deduction but are still expecting to benefit from a rate reduction, said Paravano. Technology companies might get two rates: a new lower corporate rate and an even lower rate for royalties associated with intangible income designed to help keep both intellectual property and its development in the United States, he said.

Paravano, who said he expects more complete tax reform than a mere rate change by Congress's summer 2017 recess, said “companies are already adjusting their business plans and dividend models to account for a territorial system, which they expect to be enacted with an effective date of January 1, 2018.” Regardless of the tax rate, a territorial system itself would stop inversions out of the United States, he added.

“Inversions motivated in significant part by anticipated tax savings already have stopped in anticipation of the new territorial system  ̶  a territorial system is the only real solution to the inversion problem,” Paravano said.

Once the United States moves to a territorial system, the corporate rate is less important to whether companies are U.S.-domiciled, said Paravano. “What the rate will affect is how much economic activity there is in the U.S.,” he said. If it's competitive, it will encourage job creation; if it's high, companies might be better off operating in a low-tax jurisdiction.

The tax rate's effect on jobs becomes even more critical with a territorial system, said Paravano. If the rate is noncompetitive and the United States has a territorial system, that could encourage moving even more jobs offshore  ̶   one of the reasons Congress is talking about combining a territorial system with both a low rate and a border adjustment piece, he said.

Paravano said he expects some of the inversions by U.S. MNEs to be reversed under a territorial regime. Inversions that involved the integration of an acquired U.S. company into a large foreign buyer are not easily undone, he said. But he said he expects many technical inversions   ̶   transactions under which U.S. companies obtained new foreign headquarters and left their officers, directors, and much of their senior management onshore  ̶   to be unwound, with headquarters coming back to the United States.

True to [Donald Trump economic advisor Stephen] Moore's predictions, such unwindings will mean U.S. jobs, said Paravano. When there are decisions to be made about where to locate manufacturing and where to do research and development, “you want those decisions made by U.S.-based individuals and companies because they're more likely, all other things being equal, to favor doing those things here, when possible,” he added.

For most companies, the benefits of inversions accrue only over time, and the transaction itself imposes a fixed cost, said Eric Talley of Columbia Law School. So unless U.S. corporate tax rates are set far below Ireland's, for example, “the net upside to coming back won't be as large as it was when companies left,” he said.

But the sunk costs happened when tax reform didn't look like it was on the near horizon, said Paravano. And with a territorial system in the United States, the tax benefits from having inverted might be no greater than if the inversion hadn't occurred, because in a territorial tax system, the benefit of being taxed only on U.S.-source income will be realized without a company needing to have its tax residence overseas, he said. “There also should not be significant costs for a company mostly managed in the U.S. to move its tax headquarters back to the U.S.,” he said.

[Pinsent Masons LLP partner Heather] Self said the inability to get a tax domicile out of the United States is a concern among foreign multinationals. “I think companies are very wary of moving to the U.S.,” she said. “I think a lower tax rate would be positive to the economy  ̶  there may be onshoring of jobs that have left  ̶  but I'm not convinced it's going to make much of a difference in terms of inversions.”

If the U.S. corporate tax rate is lowered, that could reduce both the incentive for U.S. corporations to move their tax domiciles overseas and the number of outbound inversions that we might otherwise have seen, said [Jones Day partner] Anthony Eisenberg. He added that section 385 regulations have already had a similar effect, but he noted the uncertainty about their future.

Paravano said he expects the section 385 regulations to be revoked by March so that Congress can decide how to address earnings stripping and so that the regs’ replacement can be scored as a revenue-raising measure that can help pay for tax reform. However, most of Treasury's recent anti-inversion rules are likely to stay on the books for a while, ultimately becoming deadwood, he added.

“I don't think you'll see the inversion regulations repealed upfront because until tax reform is done, there’s some usefulness to having high hurdles and strong walls to prevent inversions,” Paravano said. Republicans don't believe those obstacles prevent companies from acting in their economic interests over the long run, he said, adding, “They believe in making it attractive for companies to be headquartered here.”

… A border adjustment component of tax reform is a more likely source of new jobs than a repatriation holiday, said Paravano, who added that he doubts the next repatriation holiday will come with job creation or investment strings. “Tax reform itself will have significant incentives for investment in the U.S. in the form of accelerated write-offs of certain capital investments and border adjustment mechanisms to make importing goods more expensive,” he said, adding that his clients expect low-tax repatriation to be elective and to have a time restriction.

Limits on interest deductibility also could lead to increased production activity in the United States, said Paravano. “If companies have more U.S.-sourced income or assets, they may well be entitled to larger interest deductions in addition to any accelerated write-offs,” he said.

… Paravano agreed that Trump's reforms could contribute to a global sigh of relief thanks to what he described as the somewhat causal effect of the U.S. worldwide system and artificial structures and headquarter locales. Lowering the U.S. rate and moving to a territorial system would yield structural simplification "because companies won't have to worry about taxation of worldwide income, tax credits, repatriation, and where they're headquartered," he said. "Those things will be driven more by business motivations than tax considerations," he added.

…Paravano said that with a combined rate reduction and territorial regime, the bull's-eyes on the heads of U.S. MNEs will be removed. Large foreign competitors have developed an appetite for U.S. companies in part because they are able to use, as part of the purchase price, significant tax savings associated with inversions and resulting tax redomiciles, Paravano said. “Inversions have become a mechanism to achieve a territorial system of U.S. taxation on an elective or self-help basis,” he said.

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