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Tax inversion, lend money to yourself then deduct the interest on your taxes

U.S. Sen. Chuck Schumer (D-NY) speaks at a press conference pitching the borough of Brooklyn to host the 2016 Democratic National Convention (DNC) August 11, 2014 in Brooklyn, New York. Schumer wants to stop corporate inversions to escape U.S. taxes.
Photo by Andrew Burton/Getty Images

On Wednesday, The Wall Street Journal, quoted Senator Chuck Schumer (D., N.Y.) who says of current IRS corporate tax rules, "It now allows you, by financial alchemy, not to pay taxes on your U.S. profits."

It's a nice trick if you can get away with it. What if you could do it? What if you could give yourself a loan, or maybe a loan to your spouse, then deduct the interest you pay on the loan on your taxes due? You can't do this of course, but U.S. companies can do a version of it, and U.S. Senate Democrats want to put a stop to it.

The Democrats propose to restrict the ability of U.S. companies to borrow money from foreign partners and to then deduct the interest they pay to their partner on the taxes they owe on profits earned in the United States. The maneuver is called a corporate inversion, whereby a U.S. company buys a foreign company in a country with corporate tax rates that are lower than in the U.S. and incorporates in the foreign land. The U.S. company then lends money from its profits to the overseas partner and deducts the interest payments on U.S. corporate taxes. The foreign partner pays taxes on the interest it receives at the lower foreign corporate tax rate. The current top U.S. corporate tax rate is 35%. The ability of large companies to shop among countries for lower corporate tax rates leads to tax rate competition and a race to the bottom among countries, creating tax havens.

Senator Schumer hopes to introduce the provision to stop corporate inversions in a package of reforms to the Senate Finance Committee in time for the Senate to consider them before the November Congressional elections.

There has been a wave of corporate inversions. Bloomberg.com reports that since 1982 about 41 U.S. companies have maneuvered an inversion, and says that the American drug company Pfizer, founded in 1849, has proposed to become a British firm this year. Bloomberg provides a list of U.S. companies that have done an inversion each year since 2009.

Despite the tax benefits of inversions many companies resist the urge. Walgreen decided against it after facing investor backlash. A proposed inversion planned by Chiquita Brands International Inc., the U.S. banana company in which they would merge with an Irish company will be reconsidered in light of an offer to buy out shares of Chiquita. The reconsideration by Chiquita may have been partly due to the threat of Congressional Democrats and the Obama Administration to limit the practice of inversions to escape U.S. taxes and the resulting adverse publicity the move would provoke.