If it is so simple, why is it not just banned?

Because borrowing between group companies is a normal, legitimate part of how businesses fund themselves, and interest on real debt is a genuine cost. You cannot ban interest deductions without harming ordinary companies. So instead of banning it, governments cap it: deductions are allowed up to a percentage of earnings, and anything above that is denied. That draws a line without outlawing legitimate finance.

Why pair it with an inversion?

An inversion alone stops new foreign profit being taxed by the United States, but the US operating business still earns US profit that is still taxed. Earnings stripping attacks that remaining US profit, by loading the US subsidiary with debt to the new foreign parent. The two together are far more powerful than either alone, which is why the 2016 rules went after the combination specifically.

Earnings Stripping, Explained

ByLoopholeKiln EditorialPublished17 June 2026

Figures current as of1 January 2026·Corrections

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Earnings stripping is the bluntest tool in the set, and the easiest to understand. Put a loan into a company in a high-tax country from a parent in a low-tax one. The company pays interest. Interest is deductible, so it shrinks the taxable profit in the high-tax country, and it lands almost untaxed with the parent. The profit has been "stripped" out. It is now capped in the US and across the EU, but not abolished.

What it is

A mechanism, used both within a country and across borders, in which an operating company in a high-tax jurisdiction is made to pay large amounts of interest to a related party in a low-tax jurisdiction. The interest is deducted from the operating company's taxable income, eroding its tax base, while the matching receipt is taxed little or not at all in the lender's home. It is the same logic as the royalty structures, but using debt and interest instead of intellectual property and royalties.

How it works, step by step

A parent company in a zero-tax or low-tax jurisdiction lends money to an operating company in a high-tax jurisdiction.
The operating company pays interest on that loan back to the parent.
The interest is fully deductible for the operating company, which reduces its taxable income in the high-tax country.
The interest is taxed lightly or not at all in the parent's jurisdiction.
Done at scale, a US subsidiary can be loaded with so much debt to a Cayman parent that the interest payments wipe out most of its US-taxable income.

The link to inversions

Earnings stripping is the natural follow-on to a corporate inversion. Once a US company has inverted and acquired a foreign parent, that parent can lend heavily to the US subsidiary and charge interest, draining the US tax base further. The inversion changes the address; earnings stripping then hollows out what is left behind.

Is it still open, and when did it close

Constrained, not closed. The main brakes are caps on how much interest can be deducted:

In the United States, section 163(j) caps the deduction for net interest at 30 per cent of a company's adjusted taxable income. (This basis was restored to an EBITDA-style measure from 2025, after a tighter EBIT measure had applied.)
Across the European Union, the first anti-tax-avoidance directive (ATAD I, Article 4) imposed a similar 30 per cent cap on net interest deductions, in effect from 2019.

On the inversion side, it was the United States Treasury regulations of April 2016, under sections 7874 and 385, that targeted post-inversion earnings stripping and contributed to the collapse of a high-profile 2016 US-to-Ireland pharmaceutical inversion. (A later notice, 2016-73, issued in December 2016, dealt with related but separate issues and came after that deal had already fallen apart.)

So the technique still exists, but the interest-deduction caps limit how much profit it can move.

Sources