By Kevin Drawbaugh

WASHINGTON (Reuters) - President Barack Obama could act without congressional approval to limit a key incentive for U.S. corporations to move their tax domiciles abroad in so-called "inversion" deals, a former senior U.S. Treasury Department official said on Monday.

By invoking a 1969 tax law, Obama could bypass congressional gridlock and restrict foreign tax-domiciled U.S companies from using inter-company loans and interest deductions to cut their U.S. tax bills, said Stephen Shay, former deputy assistant Treasury secretary for international tax affairs in the Obama administration. He also served as international tax counsel at Treasury from 1982 to 1987 in the Reagan administration.

In an article being published on Monday in Tax Notes, a journal for tax lawyers and accountants, Shay said the federal government needs to move quickly to respond to a recent surge in inversion deals that threatens the U.S. corporate tax base.

"People should not dawdle," said Shay, now a professor at Harvard Law School, in an interview on Friday about his article.

If the administration were to take the steps he discusses, Shay said, some of the many inversion deals that are said to be in the works might be halted in their tracks.

The regulatory power conferred by the tax code section he has in mind, known as Section 385, is "extraordinarily broad" and would be a "slam dunk" for the Treasury Department, he said.

A recent sharp upswing in inversion deals is causing alarm in Washington, with Obama last week urging lawmakers to act soon on anti-inversion proposals from him and other Democrats. But Republican opposition has blocked Congress from moving ahead.

Meantime, investment bankers and tax lawyers are aggressively promoting inversion deals among corporate clients, with U.S. drugstore chain Walgreen Co one of several companies known to be evaluating such a transaction.

Medical technology group Medtronic Inc, based in Minnesota, and drug maker AbbVie Inc, of Illinois, are in the midst of inverting to Ireland by buying smaller Irish rivals and shifting their tax domiciles to that country.

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The biggest attraction of inversions for U.S. multinationals is putting their foreign profits out of the reach of the U.S. Internal Revenue Service. But another incentive is to make it easier to do so-called "earnings stripping" transactions.

This legal strategy involves making loans from a foreign parent to a U.S. unit, which can then deduct the interest payments from its U.S. taxable income. Plus, the foreign parent can book interest income at its home country's lower tax rate.

Section 385 empowers the Treasury secretary to set standards for when a financial instrument should be treated as debt, eligible for interest deductibility, and when it should be treated as ineligible equity.

If a corporation has loaded debt into a U.S. unit beyond a certain level, Section 385 could be used by the government to declare the excess as equity and ineligible for deductions.

"The stuff I'm describing should be putting a crimp in tax-motivated deals," Shay said.

(Editing by Eric Walsh)