NEW YORK (Reuters) - The US Congress' assault in the against companies moving to countries like Bermuda with more favourable tax structures grew stronger over the holiday.

Top US toolmaker Stanley Works dropping its controversial plan to reincorporate here, the US Senate blocked the granting of defence contracts to companies which will relocate overseas and US President George W. Bush told American companies they "ought to pay taxes and be good citizens".

Stanley said it withdrew the proposal, announced in February, saying pending Congressional reforms would eliminate the need to move to the offshore tax haven.

But it came after widespread criticism of the plan - which could have saved Stanley millions of dollars in taxes.

The Stanley plan drew fire from lawmakers, shareholders, labour groups, and officials in Connecticut, where it has been based for 159 years. State Attorney General Richard Blumenthal has filed suit against Stanley to block the move, alleging irregularities in May's shareholder vote on the matter.

The Democratic-led Senate approved the amendment on a voice vote that was added to a $355.4 billion spending bill for the Pentagon for next fiscal year that starts on October 1.

The measure would apply to companies that incorporated offshore after December 31, 2001, and could affect firms including PricewaterhouseCoopers consulting, Cooper Industries electrical equipment, and Weatherford International.

"No American company should be penalised for staying put while others renounce US citizenship for tax breaks," said Sen. Paul Wellstone, a Minnesota Democrat who pushed the amendment.

Republican Sens. Don Nickles of Oklahoma and Phil Gramm of Texas said the amendment was misguided, and would send more federal contracts to overseas companies that do not employ US workers.

"We're using US contracts and threatening thousands of US jobs," Nickles said. "There's nothing in this amendment that says other companies in other countries need not apply."

President Bush said there is a growing problem with US companies relocating to offshore tax havens - an issue his opponents are exploiting with an eye on upcoming legislative elections.

In what's known as a "corporate inversion" a company sets up a shell headquarters in a tax haven such as Bermuda while keeping most operations and jobs in the United States, potentially saving millions of dollars in US taxes on income from foreign sources.

The practice is legal, but Democrats have been hammering away at the issue for months as yet another example of corporate irresponsibility.

Members of Bush's Republican Party have been scrambling for a response beyond their standard claim that the relocations are triggered by complicated, burdensome US tax laws.

Speaking with reporters at the White House, Bush stopped short of endorsing proposals that inversions be outlawed - but he did urge greater scrutiny of the issue.

"I think we ought to look at people who are trying to avoid US taxes as a problem," the president said. "I think American companies ought to pay taxes and be good citizens."

John Trani, chairman and chief executive officer of Stanley Works, said of the controversial plan: "We have been asked by the congressional leadership on both sides of the aisle to support their efforts towards rectifying this situation by enacting legislation that will create a level playing field for companies incorporated in the US."

He added: "We have honoured their request, and the ball is now in their court."

"Our court action has produced a victory for fairness in taxes and corporate accountability, which Stanley Works sought to dodge," Blumenthal told Reuters. "National attention should now shift to other companies that have exploited a Bermuda move to unfairly avoid taxes and shareholder accountability, most especially Stanley Works' competitors."

Stanley, headquartered since 1843 in New Britain just southwest of Connecticut's capital city, Hartford said the move would save $30 million a year in taxes.

"We were able to stop this from happening because of an alliance between institutional shareholders, workers, and the attorney general's office in Connecticut," said Steve Sleigh of the International Association of Machinists and Aerospace Workers, which represents about 700 Stanley employees.

"Given the times and the fact that we were paying attention as a stakeholder, our union was acutely aware of the impact this would have on us and the community in Connecticut," Sleigh said. "We were able to rally the public and shareholders against it."

Shares of Stanley Works were down 94?, or 2.6 percent, to $34.78 in morning trading on the New York Stock Exchange on Friday.

"We were forecasting and valuing the company with the assumption that the reincorporation wasn't going to happen," said Joe Sroka, an analyst at Merrill Lynch. "From an operational perspective, it makes no difference to us and, if anything, we think it's going to remove the noise from the stock."

Other US companies that have re-based to Bermuda include Stanley competitors Ingersoll-Rand Co. Ltd. and Cooper Industries Inc., as well as Tyco International Ltd. , driller Nabors Industries Inc., and others.

"Our ability to compete is being undermined by the US tax code, which is archaic in today's global market, putting US companies that compete globally in an untenable position," Stanley Chairman and Chief Executive John Trani said in the company's statement.

But, recent proposals in Congress would address those inequities, Stanley said.

Sponsored by the House Ways and Means Committee Chairman Bill Thomas, a Republican from California, the pending bill proposes to stop companies from running to offshore tax havens while bringing tax laws into compliance with world trade rules. The bill would imposed a three-year moratorium on companies such as Stanley from setting up shell headquarters overseas to avoid paying US taxes.

In its release Stanley said the decision not to reincorporate would have no effect on previous earnings guidance. The company said when it released earnings on July 17, that its earnings view included the costs, but excluded the possible benefits of its plan to move its corporate headquarters to Bermuda.

Stanley held a shareholder vote on the issue in May, and claimed it had received the required level of support. But groups led by employees and retirees alleged irregularities in the voting process. Stanley agree to a re-vote.

In a letter to the Securities and Exchange Commission in June, Blumenthal accused Stanley Works of making "misleading statements" in a proxy sent out to shareholders for the first vote in May. Blumenthal asked the SEC to delay a second vote until an investigation was completed.