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(Reuters) – The proposed corporate tie-up between Pfizer Inc and Allergan Plc, both drug makers, is refocusing attention in Washington on tax-driven corporate inversion transactions.

U.S.-based Pfizer moved last week to acquire Ireland’s Allergan. Details of their deal were still unavailable, but the companies were said to be eyeing a tax inversion structure.

WHAT IS AN INVERSION?

In an inversion, a U.S. company typically acquires a smaller, foreign rival and then reincorporates into its home country, on paper at least, to escape U.S. income taxes.

In most cases, the U.S. company becomes a subsidiary of the foreign company, although the U.S. company’s core operations, such as management and research, remain in the United States.

INVERSION RULE BOOK

The Treasury Department and the Internal Revenue Service enforce the rules on inversions.

For an inverting U.S. company, the goal is to satisfy the IRS’s definition of being a company with a foreign parent, thereby escaping some of the tax burdens of being a company with a U.S. parent, while minimizing the transfer of actual control and management operations overseas.

Under IRS rules, an inverted company will not be recognized as having a foreign parent if the shareholders in the old, U.S. company still own 80 percent or more of the new, combined company, and if the combined company has no substantial business activities in the foreign company’s home country.

In cases where the old U.S. shareholders hold between 60 percent and 80 percent, the inverted company can qualify as foreign-parented under certain restrictions, even if it fails the “substantial business activities” test.

CRACKDOWN RISKS

Some Democrats have proposed a 50 percent foreign ownership test and other new limits, but legislation was widely seen as unlikely before 2017. Treasury could tighten its rules in the meantime, though it can only go so far on inversions without congressional action.

Treasury last cracked down in September 2014, when it blocked inverted companies from using “hopscotch” loans to avoid dividend taxes when tapping tax-deferred foreign profits.

It also barred inverters from gaining access to offshore profits through “decontrolling” strategies that make foreign units no longer U.S.-controlled; and it curbed “skinny down” and “spinversion” strategies aimed at circumventing inversion rules.

Another way inverted companies cut taxes is earnings stripping, or shifting U.S. profits out of the country to a low- or no-tax jurisdiction. Treasury has been expected to issue tighter rules on earnings stripping, but has not yet done so.

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