Need to Know . . .
- Inversions refer to the process by which a U.S.-based corporation becomes the legal resident of another country, generally through either an acquisition or merger with a foreign company
- When it comes to corporate location decisions, there are two particularly important tax considerations: the corporate tax rate and international tax rules
- The most effective way to keep corporations based here is to fix our tax laws and make the U.S. a desirable place to do business
In recent weeks, corporate inversions have become daily news. The term refers to the process by which a U.S.-based corporation becomes the legal resident of another country, generally through either an acquisition or merger with a foreign company. This type of transaction, although not new, has come under fire by the administration and Congress in part because of the increasing number of corporations inverting or contemplating an inversion.
Since 2011, approximately 22 companies have announced plans for inversions, with many moving their addresses to Ireland. In an effort to deter companies from moving forward with such deals, Congress introduced legislation to make relocation more difficult, and the administration announced that it is examining all of its options to end corporate inversions without congressional action. Rather than tackle the broader problem leading to these location decisions, Washington is looking, once again, at piecemeal approaches that paint corporate America as unpatriotic deserters for making sound—and legal—business decisions.
When it comes to corporate location decisions, there are two particularly important tax considerations: the corporate tax rate and international tax rules. The United States has the highest corporate tax rate among OECD countries and is one of the few with a worldwide system that taxes its citizens and corporations on all earnings, even those generated outside the United States. The most effective way to keep corporations based here would be to fix our tax laws and make the United States a desirable place to do business that allows companies to be globally competitive; however, tax reform will require difficult decisions, something unlikely to happen in an election year.
Considering we are two and a half months out from the midterm elections, it’s not unusual to hear rhetoric on economic issues directed at corporate America; however, it’s been about a decade since the sound bites have referenced treason. In 2004, John Kerry referred to “Benedict Arnold CEOs” while on the campaign trail. This year, the president and other key lawmakers have focused their attention on “unpatriotic” companies that are “renouncing their corporate citizenship.” As Walgreen moved forward with its merger with Alliance Boots and contemplated relocating to Switzerland, where Alliance Boots is based, lawmakers made the drugstore chain the poster child for inversions. The company’s shareholders wanted the company to include an inversion; however, after what seemed nothing short of a PR campaign by the administration and Senator Durbin (D-IL), the company announced it will remain based in the United States, citing protracted IRS scrutiny as one of its reasons.
Policymakers have said that inverting companies are “deserting” America and would no longer “pay their fair share” in taxes, when in fact they would continue to pay taxes on profits earned in the United States, just as foreign companies do now. The only taxes avoided would be on future foreign earnings. These political attacks may seem effective in an election year; however, they need to be taken with a handful (or bucket) of salt. As noted by Diana Furchtgott-Roth, the Department of Labor’s chief economist under George W. Bush, tax inversions can actually help the U.S. economy. Tax inversions can make it easier for companies to invest in the United States, allowing them to expand U.S. operations. As Laura Tyson, former chair of President Clinton’s Council of Economic Advisers, states, “America’s relatively high rate encourages US companies to locate their investment, production, and employment in foreign countries, and discourages foreign companies from locating in the US, which means slower growth, fewer jobs, smaller productivity gains, and lower real wages.”
In a similar vein, legislative proposals targeting them could harm direct foreign investment back into the United States. Targeting inversions outside of tax reform will also make it more attractive for foreign companies to simply acquire a U.S. corporation, something we may see play out in coming months. Chiquita Brands International had signed a deal to purchase Irish company Fyffes plc with plans to relocate outside the United States; however, on August 11, Chiquita received an unsolicited buyout offer from a Brazilian business and investment bank. One benefit of the Safra and Cutrale deal is that it would not have the same risk involved as acquiring Fyffes and relocating to Ireland.
For years, there has been consensus around the need for comprehensive tax reform. Rather than demonize corporations for not paying much higher taxes than they would otherwise, Congress needs to finally fix the outdated and broken tax code. But no one in Washington thinks there is time to get it done.
But why isn’t there time? Inversions certainly aren’t new and there have been more than a few hearings on tax reform this year alone. On January 7, 2005, President George W. Bush created the bipartisan President’s Advisory Panel on Federal Tax Reform to examine options for making the tax code simpler, fairer, and more conducive to growth. In August 2010, President Obama’s Economic Recovery and Advisory Board released its report on tax reform options. More recently, House Ways and Means Chairman Dave Camp (R-MI) released the latest draft of his tax reform plan, one he has been working on for a few years. Sen. Ron Wyden (D-OR), chairman of the Senate Finance Committee, also introduced his own plan, the Bipartisan Tax Fairness and Simplification Act of 2011. The tax code has been examined with an eye toward reform for a decade. Numerous existing proposals could serve at least as a starting point to address the tax code—the real problem.
Since the United States’ last tax overhaul, other countries have been actively making their tax laws more competitive, promoting investment and job creation; companies have a fiduciary duty to at least examine the possible advantages of inversion transactions. It has become increasingly difficult for U.S.-based corporations to ignore the real benefits of domiciling elsewhere in light of these changes.
Treasury Secretary Lew has called for a “new sense of economic patriotism,” but what does that really mean? Should calls for “economic patriotism” extend to companies that utilize other provisions in the tax code, such as the research and experimentation tax credit? Should companies forgo that incentive, which has been tied to job creation and growth time and time again? Should everyday Americans be more “patriotic” and renounce tax benefits such as the mortgage interest deduction? If they can afford to pay a little more in taxes than the law requires, should they be asked to or shamed into paying more?
Unfortunately, the latest legislative proposals and announcements to address inversions sound more like election year politics than serious problem solving. If it were about the latter, we would be reading more about reform and less about piecemeal efforts targeting corporations. Changes to international tax rules outside of reform would create further uncertainty since the business community never knows what is coming next in the name of “reform,” and this would provide more of an incentive to flee. Rather than resorting to name calling, Congress should explain to voters why it hasn’t yet fixed the code.
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