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Global Policy Watch

Key Public Policy Developments Around the World From Covington & Burling LLP

New EU Commission Confirmed

Posted in EU Law and Regulatory, International Strategy

The new European Commission presided by Jean Claude Juncker was confirmed by the European Parliament on October 22 with 423  votes (on 751) and will start functioning as foreseen, from November 1.

Juncker presented his new team on September 10, “ in common accord” with the Council of Ministers, representing the Member States, but the whole Commission still needed to be subjected, as a body, to a vote of consent by the European Parliament.

This vote is by no means a formality: as soon as it received – in the 1992 Maastricht Treaty – the power to confirm the appointment of the Commission, the Parliament reinforced considerably its influence over the EU’s executive. José Manuel Barroso, in each of the two Commission he assembled, had to replace one commissioner at the last minute in order to pass the confirmation vote.

Juncker did not escape having to do the same. The fact that he had been “elected” by the Parliament did not help: in order to receive the green light for his Commission, he had to replace one candidate commissioner – the Slovenian Alenka Bratusek, and (slightly) reshuffle some portfolios. 

The vote in the Parliament is preceded by a hearing of each candidate organized by the Committee – or Committees – he or she will have to deal with. The “two tier” structure of Juncker’s team and the clusters of Commissioners he proposed made this process more complicated than before, partly also because this structure no longer corresponds to the Committee’s structure in the Parliament.

But the hearings were less about substance than politics: indeed, most candidate Commissioners don’t know much about their portfolios, having to rely on Juncker’s cabinet and various others in their interviews. Going too far in exposing personal views would indeed be odd – or dangerous – since all positions taken in the Commission are supposed to be collective.  

The hearings were really more about personalities, their country of origin and their political affiliations. During the process, a few fragile candidates were identified, on which pressure could easily be applied. Tracking them was made easier by Juncker’s provocative selection method of appointing commissioners with special interest in the issues they would have to deal with.

Who were at risk?

Pierre Moscovici, the ex- French Finance Minister, in charge of monitoring the national budgets, which his country will fail the test this year.

Miguel Cañete, the Spanish candidate for energy and climate, who has family ties to the oil industry

Jonathan Hill, who with the Financial Services portfolio, will oversee the City of London, even if he is British and an ex-lobbyist.

Tibor Navracsics, from Orban’s Fidesz party who was supposed to be in charge of “education, culture and…citizenship” .

And, last but not least, the Slovenian ex-prime Minister, Alenka Bratusek, who Juncker put in charge of the “Energy Union” as a Vice President, even if she had appointed herself as a candidate contrary to the wishes of her country’s new government.

There were some other unpleasant surprises: Cecilia Malmström, the future Trade Commissioner, gave two contradictory answers to a question about ISDS and Oettinger, the German candidate, showed no interest- nor competence – for the “digital agenda” he is supposed to deal with.

Those who got the best marks were:  Frans Timmermans, the Dutch Foreign Minister and well-known figure in Brussels, who will be Juncker’s number 2; Margrethe Vestager, selected for the powerful competition portfolio; and the three other “thematic” Vice presidents – ex prime Ministers: Ansip, from Estonia who impressed with his IT skills, Dombrovskis, who is expected to  share the Latvian “model” of economic recovery from the financial crisis, and Jyrki Katainen, in charge of reviving the EU economy, even if he is supposed to be a pillar of austerity policies.

Federica Mogherini did well, as she has done in all her recent appearances in Brussels – demonstrating that she is not at all “unexperienced “ for the High representative job.

But the Parliament’s attention concentrated essentially on the five potential weaknesses mentioned above.

Fortunately, party politics came to the rescue of Moscovici, a socialist – who was mainly attacked by the Christian Democrat EPP and Cañete, from Partido Popular, member of the EPP group, who was essentially criticized by the socialists. The two neutralized each other; their groups made a deal – and both were saved. To quiet those who doubted Cañete’s credentials on climate change, a new responsibility for “sustainable development was given to Timmermans!

Jonathan Hill did not belong to one of the major groups as, 5 years ago, David Cameron removed the British Conservatives from the EPP and created a “conservative” group, the ECR. His presentation was considered too weak and he was made to come to a second hearing; by then, those who still resisted his charm had to accept that it would be silly to veto the British “Lord of the Lords” nine months before the British elections. Hill then passed.

The Hungarian Tibor Navracsics made a good impression in his hearing and could use his EPP affiliation, but still, having given him a portfolio with “citizenship” was seen as a provocation. So a compromise was devised: he would be accepted, but the responsibility for “citizenship” would go to the Greek Avramopoulos, in charge of home affairs.

What helped save the four was the feeling that the Parliament would be satisfied with just one scapegoat, and the Slovene Alenka Bratusek was the ideal victim: her hearing was a disaster and she was not supported by her government, so it would be easy to replace her.

But by who?  The sense of power generated by the hearings was such in the Parliament’s political groups that the EPP and the S&D thought they could make the decision themselves – which was over-extending the limits of their institutional powers: the fellow Slovenian MEP they proposed was rejected by the new Slovenian prime minister. He sent instead his Deputy Prime Minister, Violeta Bulk, a strong business woman, whose only weakness was that she has only been in politics for a few months.

For this reason, she missed the Vice presidency for the Energy Union: Juncker gave that position to the Slovak Maros Sefcovic (who was already Vice president in the Barroso Commission) and she was given his transport portfolio (losing the “space” dimension which went to the Polish Bienkowska, in charge of the internal market).

One can argue that these hearings don’t have much sense, as long as they centre on the nationality of the candidates and their personal views on issues under community competence: Commissioners must swear that they will not defend national interests and, as mentioned above, they are not supposed to present personal views but only those agreed in the “College”.

However, what makes this open process of confirmation useful is that it is public and broadly reported in the media (at least those reporting on the Brussels bubble!), which makes the commissioners look more political – and less bureaucratic.  

Does this mean that the new Commission will really be more political? Probably: it is what Juncker wants. One of his first decisions was that the members of his team would no longer have their individual spokespersons: they are encouraged to meet the press in person and interact with the citizens.   

The new Commission to come is already preparing for its first policy challenge: presenting a united front to deal convincingly with the hot current policy issues, which will already be on the agenda of the December European Council,  the first one to be presided by the ex-Polish prime Minister, Donald Tusk. Among them the 300 billion package announced by Juncker to revive the EU economy. The new president promised it would be ready by Christmas.

 

European Tax Investigations

Posted in EU Law and Regulatory, International Strategy, Tax Reform

In June, the European Commission (“EC”) announced the opening of three investigations into tax rulings in Ireland, Luxembourg and the Netherlands and, in particular, into tax rulings applied by Ireland to Apple, by Luxembourg to Fiat Finance and, last, by the Netherlands to Starbucks. In October 2014, the EC announced the opening of a fourth investigation into the application of tax rulings of Luxembourg to Amazon. Most recently, the EC ordered Spain to recover money from companies that benefited from rules that encouraged merger activity outside of the country.

We understand that the EC also has requested that Luxembourg produce all tax rulings that were issued in 2010, 2011, and 2012.  Luxembourg has not complied with this request, and the matter will be heard by the EU Court of Justice.  Companies with tax rulings that do not withstand challenge can be responsible for up to ten years of tax liabilities.  In essence, the EC is investigating whether certain tax practices of Member States have conferred prohibited selective advantages on multinational companies via tax reductions.

The four investigations relate to tax rulings which validate transfer pricing agreements, also referred to as advance pricing agreements (APAs). Transfer pricing relates to the prices charged for commercial transactions between parts of the same corporate group (intra-group commercial transactions) e.g., the prices set for goods sold or services provided by one subsidiary of a corporate group to another subsidiary of the same group.  APAs are agreements that determine an appropriate set of criteria, or methodology, for the determination of the transfer pricing for intra-group commercial transactions. Since the prices set for these intra-group transactions will be accepted by the taxing authority that enters into the APA, APAs affect indirectly the allocation of taxable profits to that taxing jurisdiction and the tax paid by the corporate group in that jurisdiction.

The four investigations concern the calculation methods of certain APAs as negotiated between Member States and the various affected companies as set out in the tax rulings.  In particular, the investigations concern the compatibility of these calculation methods with internationally agreed standards as well as with the arm’s length principle.

The risk for the companies involved is that, in case the aid is considered to be incompatible, the Member State is required to claim the financial advantage back from the benefited company.  In addition to the companies already under investigation, other companies may well become the target of additional investigations.  As a result, any company with an APA from an EU member state should determine ― and assess ― the State aid risk.  They should then consider whether any changes to the company’s trading structure may be merited.

Ebola Spurs Global Cooperation to Prevent, Detect and Respond to Future Health Crises

Posted in Health Issues

Well before Ron Klain was named as the U.S. Ebola czar, the USG was urging the international community to confront the fact that the world is not ready for a deadly pandemic of any sort, much less one as daunting as Ebola.  Aware that Ebola alone could kill over 1 million people if international efforts fail, President Obama — joined by Secretary of State Kerry, Health and Human Services Secretary Burwell, Secretary of Defense Hagel, and his National Security Advisor Susan Rice — met on September 26 to discuss global health security with Ministers and experts from 44 nations, the World Bank, the UN World Health Organization (WHO), the UN Food and Agriculture Organization (FAO) and the World Organization for Animal Health (OIE). 

President Obama challenged participants that, “… it is unacceptable if, because of lack of preparedness and planning and global coordination, people are dying when they don’t have to.”  In his call to action, President Obama referenced not only Ebola, but many other deadly biologic threats from superbugs to terrorists seeking to use biological weapons.  He warned that, “in a world as interconnected as ours, outbreaks anywhere…have the potential to impact everybody, every nation.” [i] Political, financial, legal and regulatory changes to accelerate and facilitate private investment and international cooperation are now under discussion.        

The President and Cabinet members cited humanitarian, economic and security threats posed by global health disasters, which could easily dwarf the costs of terrorism. [ii] “Never has it been clearer that the world’s health security depends on paying attention to our weakest links,” HHS Secretary Sylvia Burwell said. [iii] Even the United States is unprepared.  The Inspector General of the Department of Homeland Security (DHS) has reported that DHS does not have adequate supplies of ready to use equipment and drugs or effective procedures in place to undertake critical operations during a pandemic.[iv]  Yet, the US is helping to lead the way forward globally.    

“Together, our countries have made over 100 commitments both to strengthen our own security and to work with each other to strengthen the security of all countries’ public health systems,” the President said.  These commitments address 11 “Lines of Action” [v] which focus on making progress within five years to combat anti-microbial resistance, improve biosecurity, prevent animal-to-human disease transmission, ensure effective immunization systems, accelerate detection, diagnosis and information-sharing regarding public health threats and to develop work force competencies and emergency facilities, procedures and relevant policy and legal structures. Going forward, 10 countries have agreed to serve on the GHSA Steering Group.  Chaired by Finland in 2015, it includes Canada, Chile, Finland, India, Indonesia, Italy, Kenya, the Kingdom of Saudi Arabia, the Republic of Korea, the United States and international organizations.

The private sector can and must play a key role in developing, producing and supplying medicines, medical devices and technologies, health information systems, protective gear, disinfectants, management systems, waste disposal technologies, etc.  As these efforts ramp up over the next 5 years, substantial new resources and incentives (public, philanthropic and private) will flow into these activities — and efforts to strengthen health systems –  worldwide.  Laws, regulations and procedures will change to enable more effective action and investment and the private sector will want to engage vigorously in the process.

 

High Stakes in Brazil’s Election

Posted in International Strategy, South and Central America

The second round of the Brazilian Presidential election coming on October 26 will be decided between incumbent Dilma Rousseff from the left leaning PT (Workers Party) and the challenger Aécio Neves from the centrist PSDB (Brazilian Social Democracy Party).  The stakes are huge for the country and for companies doing business in Brazil. 

Not so long ago, Brazil was held up as a paragon for the developing world.  Its economy was booming.  Those days are over.  The IMF recently stated on its World Economic Outlook published in October of this year that lower potential growth in emerging market economies is a dominating factor and that “Uncertain prospects and low investment are also weighing on growth in Brazil.”  The IMF has also cut its growth forecast for Brazil for 2014 by a percentage point to 0.3%.  And, according to the Brazilian Central Bank, inflation for the last twelve months is around 6.7%.

Mr. Neves, a former state governor, has the support of the private sector, and has been an avid advocate for the improvement of the relationship with the United States and the EU.  He has vowed to cut government spending, control inflation and jumpstart growth.  Whether he will be able to do that remains to be seen.  But before he gets there, he will have to prevail in the election.

Recent polls show the two candidates running neck and neck.  By getting to this point, Neves has shown a vote garnering strength that has surprised many.  In the first round, it appeared likely that Neves would lose out to Marina Silva, the candidate of the Brazilian Socialist Party.  Last week, Ms. Silva announced her support for Mr. Neves causing a blow for Dilma Rousseff. 

As this election campaign goes down to the wire, it is likely to become increasingly hard fought.  The result is very much in doubt, and is likely to remain that way until October 26.

Prospects and Challenges for Africa

Posted in Africa, Health Issues, International Strategy

The October 2014 Africa’s Pulse released by The World Bank confirms that economic growth in Sub-Saharan Africa continues to be strong.  The average growth in the region is projected to increase to 5.2 percent during 2015-16 (up from 4.6 percent in 2014) and to 5.3 percent in 2017.  Some markets and industries are looking to be more promising than others but certain regional challenges continue to present unknown variables.

The Markets. Although growth in the region generally remains favorable, the differing fortunes of the region’s largest economies has moderated that growth.  Economic activity in Nigeria remains robust with the growth strengthening from 6.2 percent in the first quarter to 6.5 percent in the second quarter.  Low-income countries — including Cote d’Ivoire, Ethiopia, Mozambique, and Tanzania — also enjoyed healthy economic growth.  In contrast, the economies of South Africa, Angola, and Ghana each experienced far more modest expansion. 

The Industries. The primary drivers of growth are significant public infrastructure investment (e.g., power, ports, and transportation), “a rebound in agriculture,” and the services sector (e.g., telecommunications, financial services, and tourism).  Importantly, the services sector has been “the big gainer” in the region’s economic transformation and presents “an important path” for economic diversification and accelerating poverty reduction.  However, weak global growth (and related factors) has resulted in a decrease in foreign direct investment, which is an important financing source for all of these industries.

Regional Challenges. The Ebola outbreak has ravaged economic activities in Guinea, Liberia, and Sierra Leone.  Initial estimates are that the combined output loss to the countries could total $359 million, which would translate to a 3 percent drop in the GDP growth of Sierra Leone and a halving of the GDP growth of both Guinea and Liberia.  This crisis must be addressed and the private sector should play a critical role.  Provided rapid control of further contagion, regional spillover is projected to be modest and limited to Ghana and Nigeria, which already has contained the outbreak.  However, a slower containment presents a far more dire scenario for the countries and the region.  Regional disruptions also may result from further intensification of the conflict in South Sudan and/or the Boko Haram insurgency in Nigeria.

Tackling Trade Barriers

Posted in International Strategy, Trade Agreements

Advances in our rules-based global trading system have been slow in recent years as efforts to establish new rules and assure compliance with existing rules have struggled.  Last week, I participated in a panel discussion of the Information Technology & Innovation Foundation’s (ITIF) new report, entitled “The Global Mercantalist Index: A New Approach to Ranking Nations’ Trade Policies”. The report catalogues a troubling increase in favoritism of domestic companies at the expense of foreign companies and in turn the global trading system.  It also further documents a trend highlighted last year by ITIF in its report “Localization Barriers to Trade: Threat to the Global Innovation Economy” and by the Peterson Institute for International Economics in its study entitled “Local Content Requirements: A Global Problem”.

Unfortunately, this growing trend is not offset by great advances in trade-liberalization.  Recent efforts to craft new trade rules at the World Trade Organization (WTO) have stalled, and many wonder whether the WTO will still be able to secure implementation of a December 2013 “Bali trade package” – a small undertaking compared to earlier efforts to revise more comprehensively our global trade rules as part of the Doha Development Agenda. 

Within this context, the ITIF’s reports calls for the creation of an annual “Global Mercantalist Index” that would rank countries based on a range of policies – such as forced technology transfer as a condition of market access, intellectual property (IP) theft, and restrictions on cross-border data flows – that threaten today’s global trading system.

Such a ranking could provide a useful snapshot of protectionist trends across a number of countries.  In that regard, this survey complements a variety of other important efforts to identify or quantify existing and emerging challenges, including, for example, the recently released U.S. International Trade Commission (USITC) study on digital trade barriers, the U.S. Chamber’s annual Global IP Index, and the Organization for Economic Cooperation and Development’s (OECD) Services Trade Restrictiveness Index. 

The report also provides a platform for discussing not just enforcement of existing trade rules but also what new trade rules and enforcement tools might be necessary to maintain fairness in the global trading system.  Not all localization barriers may be inconsistent with existing WTO rules.  However, existing rules offer a roadmap for negotiators.  As the U.S. pursues an ambitious trade agenda- including Trans-Pacific and Trans-Atlantic trade deals and an ambitious investment treaty with China – the ITIF and other recent reports provide important fodder for establishing new rules to promote fair and non-discriminatory treatment of foreign companies.  

The Bali trade package would have represented the first update to our global trading rules in 20 years.  As we face another WTO impasse, we should press forward with bilateral, regional and plurilateral trade agreements that can address the increasing web of trade barriers.  Meanwhile, the U.S. and its trading partners must vigorously enforce current trade rules that, as the reports highlighted above suggest, some of our trading partners may be flouting. 

Managing Political Polarization in Congress

Posted in Congressional Action

Few can dispute the dysfunction of recent Congresses.  The 112th Congress proved the least productive in modern history as measured by laws passed.  The dramatic federal government funding standoff in the 113th Congress culminated in a 16-day shutdown that drove congressional approval to its lowest level ever.  Yet despite these failures, a close look at recent Congresses demonstrates the remarkable ability of the institution to adapt and address internal challenges.

In an article in the Utah Law Review, I show how House of Representative Speaker John Boehner’s strategic use of the Hastert Rule allowed him successfully to navigate a treacherous political path of managing his divergent caucus, preserving his leadership position, and passing key legislation even when a majority of his caucus did not support it. 

The rise of the Tea Party and the ideological divisions within the Republican Party created challenging conditions for Speaker Boehner.  To balance the competing factions in the House Republican caucus, Speaker Boehner selectively used a political and procedural tool known as the Hastert Rule.  It provides that the Speaker will not schedule a bill for a floor vote unless a  majority of the majority caucus favors the legislation. 

Undoubtedly, the use of the Hastert Rule strengthened the hand of Tea Party members to influence legislation.  At the same time, selectively ignoring the Hastert Rule allowed Speaker Boehner to relieve some of the political pressure that the Tea Party members exerted in an effort to address critical public policy concerns and to preserve the future electoral viability of the Republican party.  

Speaker Boehner allowed five bills to pass without a majority of the Republican caucus in 2013 and 2014, the most since 2008.  The list of bills that merited special treatment is instructive.  Bills to fund the federal government, raise the debt ceiling, and provide emergency funding to respond to a natural disaster passed with predominantly Democratic votes.  Clearly, the need to safeguard the economy from substantial harm and protect his political party from significant missteps that could diminish their electoral changes in the future motivated the Speaker to schedule these bills for floor votes despite the need to override the Hastert Rule.  Speaker Boehner also dispensed with the Hastert Rule to pass the Violence Against Women Act (“VAWA”) Reauthorization.  In doing so, he was responding to the substantial gender gap that Republicans have faced in elections since 1990.  Passing VAWA was Speaker Boehner’s attempt to respond to a political weakness of his party. 

Political polarization in Congress, and particularly in the Republican Party, has heightened congressional dysfunction.  Speaker Boehner’s strategic use of the Hastert Rule allowed him to maneuver through this difficult period.  Understanding these dynamics helps us understand Congress now and in the future. 

Ebola Response Missing A Key Player

Posted in Africa, Health Issues

The Obama Administration has mobilized a number of government agencies to respond to the Ebola crisis in West Africa and to prevent its spread into the U.S. At the frontline of the Administration’s response is the Pentagon, the Department of Health and Human Services, the Center for Disease Control, the U.S. Agency for International development and, more recently, the Department of Transportation.

Conspicuously missing, however, is the Department of Commerce, which traditionally is the link to the U.S. private sector.

This omission is significant because U.S. companies are likely to get materials to the stricken countries of Liberia, Sierra Leone and Guinea more quickly than the Pentagon.  In the instances in which they operate locally, the companies provide a valuable source of information and delivery infrastructure.

For example, in mid-August, more than 20 leading medical companies shipped 40 tons of supplies and protective equipment to Liberia.  The airlift was coordinated  by the California-based NGO, Direct Relief, and facilitated by Fedex. Companies such as Pfizer, Teva, Merck, Kimberly-Clark and Mylan Laboratories contributed 2.3 million gloves, 65,000 masks and 185,000 tabs of antibiotics. As of September 20th, Direct Relief had coordinated 11 shipments of supplies.

Equally important is the Ebola Private Sector Mobilization Group (EPSMG) which is a network of more than 40 companies active in West Africa and, especially, Liberia, Guinea and Sierra Leone. Chaired by ArcelorMittal and including companies such as Chevron, Rio Tinto and BHP Billiton, the group seeks to provide a single access point for the private sector to help mobilize and coordinate a response.  The group’s first principal is to “be part of the region’s long-term economic and social recovery and development.” EPSMG has met with Dr. Margaret Chan, Director General of the World Health Organization, and the U.S. ambassador to Liberia, Deborah Malac, and engaged with organizations such as the UN Ebola Task Force, the World Bank and various NGOs.

The in-country private sector plays other important roles.  ArcelorMittal, which has a workforce of nearly 3000, provides health care for its workers and their families and uses its internal communications network to convey accurate and timely information about the epidemic.  Firestone Rubber, which has been in Liberia since 1926, detected in first case of Ebola on march 30th, according to NPR. Since then, the company went into crisis mode, built its own treatment center and developed a comprehensive response that effectively stopped the transmission of the virus among more than 80,000 employees and family members who live on the sprawling plantation.

Local companies such as the National Oil Company of Liberia and the Sierra Leone Produce Marketing Company have also made contributions to combatting the virus.

The importance of the private sector’s role in responding to health emergencies cannot be underestimated.  Companies such as Anglo-American, SABMiller and Ford Motor Company played critical roles in combatting the HIV/AIDS crisis in South Africa by making medicines and quality health care available to their employees and their families, and they continue to play this role.

The U.S. Chamber of Commerce and the Corporate Council on Africa are to be applauded for the role that they have played in helping to coordinate and publicize the U.S. private sector response to the Ebola crises.

The Obama Administration has effectively integrated the private sector into key development initiatives such as Power Africa and the New Alliance for Food Security and Nutrition, which is the private sector component of Feed the Future.  It would do well to establish a similar mechanism as part of its Ebola response. Controlling the spread of Ebola and the development of viable health care systems in the three affected countries will require the sustained engagement of governments, NGOs, international organizations and agencies and the private sector.  The sooner that all parties are able to coordinate their efforts the more likely this virus will be controlled.

Russian Response To Sanctions?

Posted in International Strategy, Russia

On October 8, the Russian Duma approved the first reading of a bill that would permit Russian citizens whose property is “unjustly” seized as a result of foreign court decisions to claim compensation from Russia’s treasury.  The bill further authorizes the Russian government to recoup the loss by seizing the property of the foreign state in question, including property that would otherwise be subject to sovereign immunity under Russian law.

Dubbed the “Rotenberg Villas” law by parts of the Russian press, the measure is rumored to have been pushed by Arkady Rotenberg, a wealthy businessman and longtime associate of President Putin, who has been placed on both the EU and US sanctions lists following the Russian interventions in Crimea and eastern Ukraine.  As a direct consequence of those sanctions, the Italian government has frozen Mr. Rotenberg’s assets in that country, which include villas and a hotel.

If the rumors are true, yesterday’s vote is a telling indication of Mr. Rotenberg’s influence.  While its critics have characterized the bill as a raid on the public coffers by the well-connected and wealthy, the Russian government voiced its support for the measure on September 25.  In the Duma yesterday, the bill passed by a margin of 233 to 202, with all 233 votes in favor coming from members of United Russia, the party led by Prime Minister Dmitry Medvedev.

At first blush, the bill’s implicit threat of government seizures of foreign state property appears to risk a further significant erosion in Russia’s economic relations with the West.  In reality, though, it is too early to tell where yesterday’s vote will lead.  The bill is subject to amendment before it receives its second reading and the Duma’s legal department has already indicated that many terms used in the bill will need clarification.  One such provision, which apparently has attracted little attention to date, confusingly limits the scope of application of the bill to foreign court decisions “on matters that should be reviewed by courts or commercial courts of the Russian Federation.”  And, even if the bill is eventually enacted into law, it remains to be seen how eager the Russian government will be to use the power it confers to seize foreign state property.  This is, nonetheless, an unfolding story that merits continuing close attention.        

Inversion Transactions Addressed in Treasury Notice

Posted in Congressional Action, International Strategy, Tax Reform

On Monday, September 22nd, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) published Notice 2014-52 (the “Notice”) announcing their intention to issue regulations that would address corporate inversion transactions. If issued in the form described in the Notice, the regulations would prevent certain narrow categories of inversions, including so-called “spinversions” and transactions involving a foreign company with predominantly passive assets. In most circumstances, however, the rules described in the Notice will only reduce, not eliminate, the tax benefits from an inversion. The precise impact of the rules on a particular proposed transaction will depend on the specific circumstances of the companies involved. The Notice states that its rules will apply retroactively to transactions that were completed on or after September 22, 2014, the date of the publication of the Notice.

In a corporate inversion, the ownership of a U.S. corporate group is restructured in a way that causes the U.S. group to become owned by a non-U.S. parent company. Inversions have a long history, beginning in the 1980s, and previously inspiring anti-inversion regulations in 1995 and legislation in 2004. Under the 2004 legislation, if the former shareholders of the U.S. company own 80 percent or more of the equity of the new foreign parent, the inversion is effectively disregarded, with the new parent being treated as a U.S. corporation for all U.S. income tax purposes. If the former shareholders of the U.S. group own 60 percent or more of the combined group (but less than 80 percent), the non-U.S. status of the new foreign parent is respected, but certain adverse tax rules apply. Although earlier inversions generally involved an internal restructuring of a single U.S. company that redomiciled its parent corporation outside the United States, the recent wave of inversions typically involve mergers of two companies, each with significant business operations, but which nonetheless fall between the 60 percent and 80 percent tests because significant ownership of the combined group is acquired by shareholders of the non-U.S. target company.

Although such inversions involve a significant business combination, they may also provide a number of tax advantages. The principal U.S. income tax benefits from these transactions include: (1) reducing the U.S. taxation of the group’s U.S. operations through the use of arrangements that result in the payment of interest (or other deductible expenses) to a foreign affiliate; (2) providing access to the U.S. group’s “deferred” foreign earnings; and (3) eliminating the residual U.S. taxation of the group’s future earnings from foreign operations.

The Notice seeks to nullify certain inversion transactions.  It also seeks to limit access to deferred foreign earnings.  On the other hand, the Notice does not alter the definition of a pure inversion, the statutory 80 percent ownership threshold remains the standard for nullifying an inversion except in the three narrow circumstances identified in the Notice.  Nor does it address the use of interest deductions to reduce the U.S. tax burden on the company’s U.S. operations, although it does state that Treasury and the IRS “expect to” issue additional guidance addressing inversion, including possibly the U.S. interest deduction, and that this guidance would apply to companies that inverted on or after September 22, 2014.

In sum, while the Treasury Notice is an important chapter in the ever-changing inversions narrative, it is not the end of the story.  The focus now turns to the effect of the Treasury Notice on the several publicly announced deals as well as the possibility of additional transactions in the coming months, and the impact of these developments on the possibility of further action by Congress or Treasury.