Global: Tax topical focus – corporate inversions FAQ
21 August 2014
Posted by: Author: Tax-News.com Editorial
Author: Tax-News.com Editorial
To some, US companies
switching their tax residency to gain a tax advantage are economic "traitors.”
To others, they are victims of a United States tax code that effectively
punishes them for investing at home and encourages them to look for
opportunities overseas. In this Tax-News Topical Focus, we try to make sense of
the corporate inversion debate in a "frequently-asked questions” style.
What are corporate inversions?
In summary, corporate
inversions have been used by US companies when bidding for (generally smaller)
foreign companies, as a means of moving away from the high American 35 percent
corporate tax rate. A company that merges with an offshore counterpart can move
its headquarters abroad (even though management and operations may remain in
the US), and take advantage of the lower corporate tax rates in foreign jurisdictions
as long as at least 20 percent of its shares are held by the foreign company's
shareholders after the merger.
Why have corporate inversions become such an issue in the United States?
According to data
relayed to Congress by senior Treasury official Robert B. Stack in July 2014,
47 corporate inversions had taken place in the previous 10 years. So this is
hardly a new issue. Indeed, it was a major talking point in the run-up to the
2002 congressional elections. However, there does seem to have been a flurry of
deal making activity this summer, mainly involving the pharmaceutical sector.
Tax isn’t the only
reason why US multinationals choose to acquire foreign rivals. One obvious
advantage of doing so is access to potentially lucrative foreign markets. And
much greater economies of scale can be achieved when two companies are
combined. But it is the belief that companies are "gaming the system,” as
President Obama puts it, by inverting that has come to the fore. And given that
2014 is also an election year, it should come as little surprise that this
issue has taken on extra significance.
In an address to
a college in Los Angeles, the President painted corporate inversions
as a "threat" to the US tax base. These companies want to have
"all the advantages of operating in the US,” he said, but "just don't want
to pay for it." He added that, by technically renouncing their US
citizenship, the companies are "cherry-picking the rules."
"I don't care
if it's legal – it's wrong," he fumed.
According to a
Congressional Budget Office calculation, the US Treasury stands to forgo some
USD20bn in corporate tax revenue if the inversion "loophole” is not fixed. The
extent of the revenue loss to the US as a result of companies continuing to
shift their tax bases offshore is open to much debate, however. Indeed, there
is a school of thought that the Treasury could actually benefit in the
short-term, because individual shareholders resident for tax purposes in the US
will have to pay capital gains tax if they make gains on stock bought by the
Because US capital
gains tax rates vary depending on how long shares have been held and the income
level of the shareholder, and because nobody has any real idea at the moment
how many affected shareholders are US tax residents, it is impossible to say
how much capital gains tax revenue will be raised. There are ways for
shareholders to avoid capital gains tax perfectly legally, but it is thought
that new capital gains tax revenue could at best offset corporate tax revenue
losses, and at worst cushion the blow to the Treasury.
What is Congress planning on doing about corporate inversions?
Ranking Member of the House of Representatives Ways and Means Committee Sandy
Levin and Chairman of the Senate Permanent Subcommittee on Investigations Carl
Levin, both Michigan Democrats, have introduced
similar bills that would restrict the use of corporate inversions by
The two new bills
would include a proposal made by President Obama in his 2015 budget proposals –
to restrict corporate inversions by putting the minimum foreign shareholding at
50 percent. However, the bill in the Senate would contain a two-year sunset
clause, while in the House the restriction would be permanent. The restrictions
would apply retroactively to inversions after May 8, 2014.
Another piece of
proposed legislation, the Bring Jobs Home bill, takes a different approach by
providing a 20% tax credit against "eligible insourcing expenses"
associated with relocation to the US on the condition that the company increase
its workforce of full-time US employees. Allowable expenses would include costs
incurred by the taxpayer in connection with the elimination of any of its
business units (or of any of its affiliates) located outside the US, as well as
those incurred by the taxpayer in connection with the establishment of a new
business unit to be located in the US.
The bill also has a
sting in the tail for would-be inverters, denying businesses any tax deduction
for moving expenses if those costs are associated with an elimination of a
business unit in the US and the establishment of a new business unit
The bill failed to
attract the 60 votes needed to move it to a full vote in the
100-member State however, with Republicans deriding the proposals as an election
year gimmick. Orrin Hatch, the Senate Finance Committee’s senior Republican,
also pointed out that the math doesn’t add up, because while the tax credit
would cost USD357m over 10 years, denying the deduction on businesses expenses
associated with "outsourcing” would only bring in USD143m over the same period.
In a display of how
seriously Democrats and the Obama Administration are treating this issue
however, measures are now being explored that would not require new
legislation, therefore taking a deadlocked Congress out of the equation.
at a press conference after the US-Africa Leaders Summit on August 6, 2014,
Obama confirmed that he is
looking to take whatever measures he can, including utilizing his
administrative regulatory powers, while awaiting congressional action, to
reduce tax benefits for inversions.
The flow of
corporate inversions has also come about because America’s tax code has become
increasingly uncompetitive and inefficient; at 35%, the US has the highest
statutory rate of corporate tax in the OECD – that’s before state corporate tax
rates are added on – and it is said that around USD1 trillion in tax revenue is
lost each year through hundreds of special interest tax expenditures. Both
Democrats and Republicans are in agreement that the US tax code needs an
overhaul and that the corporate tax rate needs cutting, although they differ
fundamentally on what tax reform should achieve: Democrats want tax reform to
raise additional revenue to contribute to deficit reduction, while Republicans
want revenue-neutral tax reform.
are in favour of more radical corporate tax reform. Congressman Dave Camp’s (R
– Michigan) tax reform blue
print published in February 2014 calls for a switch to a
quasi-territorial tax system from America’s current worldwide tax basis –
thought to be a major reason why US multinationals have parked hundreds of
billions of dollars in profits offshore.
Camp believes that
his proposal would end the "lock-out effect" that discourages
companies from bringing foreign earnings back to the US, putting American
companies on a more level playing field with foreign competitors.
Democrats on the
other hand, while in favour of cutting corporate tax, want to take America
further towards a full worldwide basis of income tax.
However, some tax
experts, like Edward Kleinbard, disagree that US multinationals are suffering
as a result of the US tax code, because they are already paying effective tax
rates in the low teens.
A former Joint
Committee on Taxation chief of staff and currently University of Southern
California Gould School of Law professor, Kleinbard asserted in a recent paper
on the subject that the recent surge in interest in inversion transactions is
explained primarily by US-based multinational firms' "increasingly desperate
efforts to find a use for their stockpiles of offshore cash,” and a desire to
'strip' income from their US domestic tax base through intragroup interest
payments to a new parent company located in a lower-taxed foreign jurisdiction.
motives," he adds, "play out against a backdrop of corporate
existential despair over the political prospects for tax reform, or for a
second 'repatriation tax holiday' of the sort offered by Congress in
2004," not international tax rate competitiveness.
In any case, the
chances of comprehensive tax reform taking place this side of the midterm
elections are next to zero.
How is the corporate world responding to the threat?
At least one US
company intending to flip its tax residence appears to have got cold feet as
the corporate inversion debate has snowballed. In exercising its option to
purchase its remaining 55 percent stake in Alliance Boots, Walgreens, America’s
largest drugstore chain, has decided
against moving its tax residence from the United States to
Switzerland. It is thought that the move could have saved Walgreens around
USD4bn a year in tax, but the company wasn’t confident that the transaction
would withstand scrutiny by the Internal Revenue Service. Walgreens said it was
also "mindful of the ongoing public reaction to a potential
inversion” with a major portion of its revenues derived from
government-funded reimbursement programs.
However, most of
the business world remains defiant in the face of increasingly fierce criticism
from Democrats and their sympathisers. During remarks made in conjunction with
release of the company's interim financial results to June 30, 2014, Mylan
Inc's CEO Heather Bresch confirmed that it is to proceed with its plan to
acquire some of Abbott Laboratories' non-United States businesses and
move its tax residence to the Netherlands. Mylan's tax rate is expected to be
lowered to around 20-21 percent in the first full year, and to the high teens
thereafter, as a result of this transaction.
Bresch felt that
"it would be challenging to change the US tax code to stop inversion
without punishing other foreign companies. Being punitive and not allowing us
to be competitive, I do not believe, is in our country's best interest.” She
also condemned the "uneducated” nature of the corporate inversion debate.
for International Investment (OFII), a lobby group for the US operations of
some of the world’s leading companies, warns that any inversion "quick fix” could backfire
on the US economically by inadvertently affecting its members,
making the US a less attractive place for FDI.
The OFII is
specifically concerned by the calls to tighten rules governing the deduction of
interest expense, which it fears may not be limited to US companies that
re-incorporate abroad through inversions, but instead impact all US
subsidiaries with foreign ownership. Another proposal of concern is that
management and control provisions may be tightened to such an extent that
foreign companies could be treated as resident in the US for tax purposes even
if they have a relatively small presence in the country.
barb that the accounting industry is just as culpable for the increasing number
of corporate inversions by helping companies find "loopholes” brought a
predictably prickly response from the New York State Society of Certified
Public Accountants. The Society’s Scott Adair responded that the President
"should be aware that US corporations hire accountants for their distinct
ability and expertise in seeing that clients fulfil their tax obligations as
required by the laws adopted by Congress. In fact, it is a CPA's unique ability
to legally navigate an extraordinarily complex tax code that makes a CPA's
services so valuable to his or her individual and corporate clients."
Comprehensive tax reform is the answer to the corporate inversion issue, Adair
advanced communications provider, has however, decided to take another route
towards escaping America’s high corporate tax by planning to spin off its
telecommunications network assets into an independent, publicly-traded real
estate investment trust (REIT). REITS do not pay US corporate tax as long as
they distribute at least 90 percent of their taxable income to shareholders
annually in the form of dividends. As "pass through" entities, their
owners and shareholders pay individual income tax on the dividends they receive.
The IRS’s recent
acceptance that non-traditional real estate assets (such as office buildings,
warehouses, shopping centers, and health care facilities) may be held in a REIT
appears to have encouraged more American corporations to consider converting,
or at least spinning-off assets, into REITS. However, it won’t be very
surprising if these types of transaction also come under the microscope, given
the politicised nature of the corporate tax avoidance debate.
So is there any realistic possibility of change?
Republicans sympathise with President Obama’s call for more "economic
patriotism” from corporate America, in reality, Democrats and Republicans are
probably too far apart on this issue for legislation to be passed restricting
the benefits of inversions.
With Congress not
set to return from its summer recess until September, there is precious little
legislative time left before the election hiatus. Some commentators suggest
that it is more likely that the Treasury will act unilaterally to plug the
inversion loophole, but others think that the tough rhetoric on this matter
coming out of the administration is merely sabre-rattling designed to deter
further corporate inversions.
In an op-ed written
for the Washington Post, Senator Hatch confirmed
that there may be steps that Congress can take in the
short-term to address the problem, but, although concerned by the recent spate
of inversions, he continued to urge a cautious approach from lawmakers.
He continued to
insist that any fix should not be punitive or retroactive, but suggested that
there may be a way to address this issue in a "bipartisan manner.” However, if
these two Republican conditions are set in stone – and recent experience
suggests they probably are – it would seemingly rule out the possibility of a
This article first appeared on tax-news.com.