Tax rules introduced in the US last month took steps to make corporate tax inversions – when US companies move their tax residence overseas to avoid US taxes – less financially attractive.

The US Treasury and the Internal Revenue Service (IRS) issued temporary and proposed regulations on 4 April 2016 to reduce the benefits of and limit the number of corporate tax inversions, including by addressing earnings stripping.

Business tax reform is needed

The Treasury Secretary Jacob Lew also stated that further anti-inversion legislation is urgently needed. He said: “Ultimately, the best way to address inversions is to reform our business tax system, which is why Treasury is releasing an updated framework on business tax reform.” The latter includes a comprehensive approach to reforming the international tax system.

A fact sheet of the details of the inversions regulations and proposed earnings stripping regulations is available here.

US loses $100 billion a year to profit-shifting

It's clear that the Treasury is right to take action on this issue. A staggering $100 billion a year is being lost to the US government due US multinationals shifting their profits overseas to lower their tax bills, according to a study by Kimberly A. Clausing, an economics professor at Reed College, Oregan.

It's a growing problem that has increased five-fold in the past decade. Clausing's report states that “About 98 per cent of this revenue loss results from profit shifting to countries with corporate tax rates that are less that 15 per cent, and 82 per cent of the revenue loss results from profit shifting to just seven tax-haven countries.”

Clausing told the Washington Post: “It is a much bigger issue than just inversions, that is just the tip of iceberg.”

So far it seems that the US Treasury has succeeded in quashing the high-profile $160 billion merger deal between Pfizer and Allergan, which would have enabled the US pharmaceutical company to redirect its revenues through Allergan's Dublin headquarters and take advantage of Ireland's 12.5 per cent tax rate (compared to the US rate of 35 per cent).

Important milestone

However, it's unlikely that the new rules are unlikely to stop inversions completely, although the rules on earnings stripping could potentially be effective in deterring corporate profit-shifting strategies.

Bret Wells, associate professor of law at the University of Houston Law Center, told AFPonline: “The rules were an important milestone, because now Treasury is attacking the financial incentives that motivate inversions and why it’s preferable to be a foreign-based multinational corporation. And they did that not just for inverted companies but for all inbound foreign-based companies acquiring subsidiaries in the US.”