Corporate Inversions

by Ugh

So the latest and greatest tax news in the popular press (MSM, if you must) is about corporate inversions where a U.S. parented company becomes a non-U.S. parented company via a merger with a non-U.S. company (often significantly smaller than the U.S. company, but not always), thus escaping large amounts of the "contributing to the fisc" part of the Internal Revenue Code (there are other parts?!!?).  The latest being Burger King who is absconding to the Great White North (sorry Canada).

It is a little amusing to watch this play out publicly and politically, i.e., not in the dedicated tax press.  You have Obama and other Democrats talking about "unpatriotic" corporations (a Hobby Lobby penumbra, presumably) and demanding an end to the practice.  You have Republicans and CEOs talking about how this is even more evidence of our broken tax code requiring an immediate reduction in the federal corporate tax rate and the adoption of a territorial tax system.

A few things to note here:

1. This is all tied to treating multi-national corporations as "U.S." corporations/residents just because the ultimate parent filed its incorporation documents in the United States - as opposed to some other measure of corporate resident.  If Burger King (or any of the other companies that have inverted or are considering it) had the foresight to incorporate the parent company in the Cayman Islands years ago, this wouldn't even be a discussion.  Indeed, tax advisors tell start up companies to set up the parent company of their new venture in a tax haven all the time, although usually other considerations outweigh (e.g., they aren't making any money now anyway so why bother, certain financing advantages).  But somehow switching to the Caymans after the fact is a problem.

2.  The current round of inversions are different from those 10+ years ago.  Back then, you could invert by simply changing where you were incorporated with minimal operating costs and almost no operational changes, although there were still potential adverse U.S. tax consequences.  Now, thanks to section 7874 enacted in 2004 (during W's reign and with an R-controlled House/Senate, no less*) you actually have to have a "real deal" to invert, i.e., Burger King's inversion will be much much more than filing a few papers and reaping huge tax benefits.  This is part of the reason why you're not going to see any movement in Congress in tightening the rules, despite the talk.

3.  It's not at all clear that lowering the corporate rate to, say, 25% and switching to a territorial system as suggested by the R's would stop any of this.  A 12.5% rate (Ireland) or 0% rate (a tax haven) is still much lower than 25%, plenty of incentive to invert and, once inverted, erode the U.S. corporate tax base.  Things might slow down, but they won't stop.  And the U.S. rate is not going to 0 or even 12.5%.

4.  On the other hand, I'm not sure why trapping businesses in the United States just because they happened to originally incorporate here decades ago is all that good of an idea either, especially under the post-2004 rules.  Locating a business where it is "Managed and controlled" as a way to try and keep them in the United States seems like an incentive to shift management and control elsewhere (and, depending on how the test is set up, may also be easily manipulated).

If this needs a solution, I'm not sure what it is.  One might be to treat the entire enterprise as a single entity for tax purposes by ignoring the corporate form, this would eliminate any inter-entity transactions as is done for financial accounting purposes, and then taxing profits "where they arise."  This would be a territorial system, but would also eliminate a lot of simple base stripping opportunities (no more deductions against your U.S. income for interest payment to your wholly owned non-U.S. financing company).  But it seems this is a non-starter.  The OECD is attempting to solve a lot of these problems in its Base Erosion and Profit Shifting project while still respecting inter-group transactions (for the most part) - but odds are not looking good for it to be a resounding success.

*Although this is giving them way too much credit as the AJCA of 2004 was otherwise a giant slobbery kiss to corporations on the U.S. international tax front.

Comments

[wj]

Part of the problem, not all of it but part, is that the US treats the entire profits of any US company as taxable by the US at US rates. (OK, it's more complicated than that. But that approach is why inversion is worthwhile at all.) From what I hear, we are essentially unique in this -- American exceptionalism strikes again!

We likewise are essentially alone in charging our citizens US income taxes even if they live and work elsewhere in the world. I can see taxing ex-pats something; but given that they are making no use of US infrastructure, and minimal use of US government services, taxing them at the full rate seems over the top.

If we got past that one issue, a noticable part of the inversion problem would go away.

But better still, we could go from an imcome/profits tax to a value added tax. That not only is fairer to the companies, it also removes the perverse incentive to do things just so as to evade taxes.

I rather doubt that these minor considerations will actually lead to a change in the US tax system any time soon. Maybe if we see Google, JPM Chase, IBM, John Deere, etc. all doing inverstions -- say half of the Fortune 50 -- it will finally concentrate minds in Congress. But somehow I doubt that anything short of a catastrophe will convince our politicians to do more than orate on the subject.

[liberal japonicus]

We likewise are essentially alone in charging our citizens US income taxes even if they live and work elsewhere in the world. I can see taxing ex-pats something; but given that they are making no use of US infrastructure, and minimal use of US government services, taxing them at the full rate seems over the top.

Unfortunately, the general pattern is reactive, so the increased tax scrutiny is resulting in more and more US citizens renouncing their citizenship, which results in this. Despite the fact that, as the first link points out

It’s rare that an American living abroad would actually have to pay anything to the U.S. Internal Revenue Service, said Fortin.

The FBAR filing is what is driving this and this article discusses the penalties that often fall more heavily on the people who actually have less. More stories here

[wj]

LJ, thanks for the correction. (I realize that, located as you are, you know about this first hand.)

[liberal japonicus]

Actually, it was less a correction and more of a slight revision. Yes, the US is one of the few nations that taxes its citizens overseas (that is why in the UK, it is called the Department of INLAND revenue), but almost everyone who doesn't have a battery of accountants and huge holdings pays more in taxes in the country they live in now which offset their taxes, but we still have to file the paperwork which is really onerous and incredibly complicated if you have any assets back in the US, regardless of them being taxed or not.

[Ugh]

wj - as noted in #3, the US could lower its rate and shift to a territorial system, but it's not at all clear that would stop the wave of inversions. At most, it would slow them down a bit. There would still be an incentive to invert and then erode the U.S. tax base via related party interest payments and royalties to subsidiaries in tax havens or countries with a lower marginal tax rate.

[Ugh]

It’s rare that an American living abroad would actually have to pay anything to the U.S. Internal Revenue Service, said Fortin.

What's interesting about this is the reason for not actually paying anything to the U.S. - which is that foreign income tax rates on individuals, as opposed to corporations, tend to be higher than in the US, as the article notes. These taxes can be credited against your U.S. income tax liability, wiping it out. Those countries also typically have a VAT.

[Jay]

A tax on revenues derived from U.S. sources, possibly enacted as an alternative minimum tax, might be a good idea. Keep our current tax of 35% (roughly) of profits, but not less than (say) 10% of revenues from U.S. customers.

[bobbyp]

If this needs a solution, I'm not sure what it is.

I'd be interested in Jay's proposal...think of it as a VAT on sales, but I am no tax expert, just an intolerant asshole liberal/socialist.

[Barry]

Posted by: Ugh: "wj - as noted in #3, the US could lower its rate and shift to a territorial system, but it's not at all clear that would stop the wave of inversions. At most, it would slow them down a bit. There would still be an incentive to invert and then erode the U.S. tax base via related party interest payments and royalties to subsidiaries in tax havens or countries with a lower marginal tax rate."

IIRC, before the last wave of corporate tax cuts, the corporations said that they'd create more jobs and bring cash back in and etc.

They didn't.