Corporate Inversion: Tax Evasion or Good Business?
“Inversions are a legal means by which a company lowers its tax bill. When a company’s shareholders choose to re-incorporate in another country, it is a business decision like thousands of others that executives and shareholders must make every year. It can be thought of as a move similar [to] a business relocating to Texas from California.” Tax Foundation[1]
Introduction
Corporations are a go-to scapegoat for politicians in an election year.[2] The idea that a corporation would leave the U.S. just so it wouldn’t have to pay its fair share of taxes is a surefire way to drum up support from voters. But are corporations looking for opportunities to lower taxes for its shareholders really un-American?
This post serves the purpose of examining the controversial corporate restructuring known as “corporate inversion” or “tax inversion.” In this restructuring, a domestic multinational moves its headquarters offshore to shift its citizenship and tax liability to the lower tax rate jurisdiction.[3] Some characterize the maneuver as “un-patriotic,”[4] but it is properly referred to as tax avoidance in polite company. The primary motivation for such a restructuring is the economic benefit derived from lower tax liabilities on foreign earned income.[5]
Background on U.S. Taxation
The United States has the third highest top marginal corporate tax rate in the world (39%).[6] For comparison, the average corporate rate in Europe is 18.7%.[7] The significance of these rates becomes apparent when the CFCs (Controlled Foreign Corporations) of U.S. multi-nationals begin to account for significant profits of the multi-national. The United States is notably the only globally developed nation to tax income earned abroad.[8] What this means for multi-nationals is that they pay a territorial tax in the jurisdiction in which the revenues were earned, and again (at the full corporate rate)[9] when they repatriate the money back to the U.S.[10] This creates an incentive for the company to keep its foreign earned income overseas and in some cases leave the U.S. for lower tax rates abroad.[11]
It should be noted that corporate inversion is largely a paper transaction with little to no effect on the operations of the corporation.[12] Anyone that says corporate inversions are being used to take American jobs overseas is misusing the term; a corporation’s decision to move jobs out of the U.S. has nothing to do with inversion.
Structures of Corporate Inversion
Despite the political pressures, firms continue to move abroad in great numbers. The number of corporate inversions in the past ten years has matched the totals of the previous two decades combined.[13] With a strong tax incentive to move the corporate address abroad to a new foreign parent corporation, U.S. Treasury officials are attempting to curb the obvious benefits.[14] The current law already provides potential consequences for firms if: “(1) less than 25 percent of the new multinational entity’s business activity is in the home country of the new foreign parent, and (2) the shareholders of the former U.S. parent end up owning at least 60 percent of the shares of the new foreign parent.”[15] If the shareholders of the U.S. corporation (before the transaction) own 80% or more of the foreign parent corporation (after the transaction), the IRS treats the new foreign corporation as a U.S. corporation, subject to the full U.S. tax rate (even though the company has legally moved its corporate address abroad).[16] Since September of 2014, the Obama administration has attempted to limit the number of companies reincorporating abroad by tightening the above mentioned controls.[17]
How a Corporate Inversion Takes Place
A corporate inversion can take form in several ways. Once an American corporation group finds a foreign company (approximately ¼ the size of the American corporation)[18] to acquire in a favorable tax jurisdiction, the merger transaction can begin. The form of the merger can appear in a stock deal, sale of assets, or some other statutory merger. There are a variety of merger structures that can satisfy the requirements of a tax inversion, but the specifics of such are beyond the scope of this comment. In any case, the most important point for an inversion is that the corporation’s domicile moves from the U.S. to a foreign jurisdiction.
Conclusion
The Obama administration is wise to try to reduce the exodus of American businesses as it does pose a serious risk of erosion of the tax base. The companies themselves can hardly be blamed for pursuing these tax inversions because they have every incentive to do so. The American economy gathers its strength from the free market, and in a free market capital must be put to its best and most productive use. No one can argue that paying more tax than necessary is putting capital to its best and highest use. Investment opportunities overseas are driving capital out of America and into jurisdictions with more favorable tax systems.[19]
The suggestion that these companies are not paying their “fair share” is also without merit. An inverted company pays taxes for earnings in the U.S., just as it always has; the only difference is foreign earnings are no longer under U.S. tax jurisdiction. As mentioned earlier, the U.S. is the only major country in the world that taxes worldwide income.[20]
Rather than try to stymie the flow of corporations out of the country, why not try to give them a good reason to stay? Tax reform has been proposed and scuttled more times than any political issue I can remember. When an issue (tax inversion) has bipartisan support and still can’t get off the ground, something is seriously wrong in Washington. President Obama’s chief economist, Jason Furman, has called the current double tax structure on foreign income “stupid” and Sen. Orrin Hatch (R-Utah) supports a single layer of tax at the corporate level.[21] Congress needs to get serious about reforming the tax code to compete with international tax regimes. Until politicians are ready to tackle the actual root of the problem, they should save their “unpatriotic” slings for those more deserving of the title.
[1] Kyle Pomerleau, Everything You Need to Know About Corporate Inversions, Tax Foundation (Aug. 4, 2014), http://taxfoundation.org/blog/everything-you-need-know-about-corporate-inversions.
[2] Mollie Reilly, Donald Trump Acknowledges Something He Has in Common with Bernie Sanders, HuffPost Politics (Feb. 17, 2016, 9:49 PM), http://www.huffingtonpost.com/entry/donald-trump-bernie-sanders_us_56c51ccee4b0c3c55053bf71; Dan Mitchell, If You Think Corporate Inversions Are Bad, Blame Politicians rather than Pfizer, Int’l Liberty L. Blog (Nov. 23, 2015), https://danieljmitchell.wordpress.com/2015/11/23/if-you-think-corporate-inversions-are-bad-blame-politicians-rather-than-pfizer/.
[3] Developments in the Law -- Jobs and Borders: VI. Drawing Lines Around Corporate Inversion, 118 Harv. L. Rev. 2270, 2272 (2005).
[4] Kevin McCoy, Corporate Inversions Mean Tax Hit for Shareholders, USA Today (Sept. 23, 2014, 3:57 PM), http://www.usatoday.com/story/money/business/2014/09/22/corporate-inversions-tax-hit/15330195/.
[5] Heather Campbell, Note: When Good Tax Law Goes Bad: Stanley Works’ Recent Dilemma and How the Internal Revenue Code Disadvantages U.S. Multinational Corporations Forcing Their Flight to Foreign Jurisdictions, 31 Syracuse J. Int’l L. & Com. 95, 102 (2004).
[6] Kyle Pomerleau, Corporate Income Tax Rates Around the World, 2015, Tax Found., (Oct. 1, 2015) http://taxfoundation.org/article/corporate-income-tax-rates-around-world-2015 (39% being the combined marginal federal and state tax rate); The two highest corporate rates belong to The United Arab Emirates (55%) and Chad (40%). Id.
[7] Id.
[8] Colleen Graffy, Op-Ed., The Law that Makes U.S. Expats Toxic: A measure targeting tax evasion pushes Americans out of bank accounts—and jobs—abroad., Wall St. J., Oct. 10, 2015, http://www.wsj.com/articles/the-law-that-makes-u-s-expats-toxic-1444330827.
[9] This tax liability is offset with applicable foreign income tax credits. I.R.C. § 901.
[10] Keith Engel, Tax Neutrality to the Left, International Competitiveness to the Right, Stuck in the Middle With Subpart F, 79 Tex. L. Rev. 1525, 1530 (2001); see also I.R.C. §§ 951-65.
[11] Trent Gillies, , Greener Pastures, Lower Taxes: How to Solve the Inversion Controversy, CNBC (Jan. 31, 2016, 9:04 AM), http://www.cnbc.com/2016/01/31/greener-pastures-lower-taxes-how-to-solve-the-inversion-controversy.html.
[12] Campbell, supra note 5, at 103.
[13] Id.
[14] Press Release, U.S. Dept. Treasury, Fact Sheet: Additional Treasury Actions to Rein in Corporate Tax Inversions (Nov. 19, 2015), https://www.treasury.gov/press-center/press-releases/Pages/jl0281.aspx (clarifying major points set out in Notice 2014-52, 2014-42 I.R.B. 712 (I.R.S. 2014)).
[15] Id.
[16] Id.
[17] Id.
[18] This is to satisfy the 80% ownership threshold of the I.R.S.
[19] What’s Driving American Firms Overseas, Economist, Aug. 16, 2015, http://www.economist.com/blogs/economist-explains/2015/08/economist-explains-9.
[20] Graffy, supra note 8, and accompanying text.
[21] Brian Reardon and Tom Nichols, Op-Ed., Ending the One-Two Corporate Tax Punch: Jason Furman is Right About the ‘Stupid’ Policy on Overseas Income. Domestic Policy Also Isn’t So Bright, Wall St. J. (Feb. 25, 2016, 7:21 PM), http://www.wsj.com/articles/ending-the-one-two-corporate-tax-punch-1456446106.