Treasury cracks down on tax inversions. Is it allowed to do that?

The Treasury Department is moving to close loopholes that allow US companies, like Burger King, to move corporate headquarters overseas for a lower tax bill. But the debate continues over whether Treasury even has the power to limit the practice.

While we wait to see how and when the Obama Administration will use its executive authority to curb the use of corporate tax inversions, the debate continues over whether Treasury even has the power to limit the practice. In a new article in Tax Notes, Tax Policy Center senior fellow Steve Rosenthal minces no words:  “Treasury has the legal authority to curb inversions.”

Its main tool:  A provision of a 1969 law that allows the agency to define debt and equity. Citing decades of case law, Steve argues that Section 385 of that statute lets Treasury limit the ability of an inverted firm to treat certain intra-company loans as debt. That practice, known as earnings stripping, makes it possible for the firm to lower its U.S. taxes by deducting interest costs on those loans. Ending these tax benefits would not stop inversions but would make them less financially attractive and could slow deals.

This issue is the subject of heated debate among tax lawyers. Earlier this month, TPC sponsored a panel discussion on inversions following a speech by Treasury Secretary Jack Lew on corporate tax reform. In that discussion, John Samuels, Senior Counsel of Tax Policy & Planning at General Electric Co., insisted that Treasury has no legal authority to slow inversions on its own.

This, of course, is only half the issue. Even if Treasury does have the legal power to curb the practice, there is a separate argument over whether it should use it. And that, as Steve, acknowledges, is a political and policy question for Treasury and the White House to decide.

We’ll know soon enough what Treasury proposes to do about inversions. When we do, the argument will shift to whether it did enough—or too much.