September 4, 2014

During much of 2014, tax inversion stories were prominent in the news. Companies with household names like Pfizer, Walgreens and Burger King attempted, aborted or accomplished corporate maneuvers designed to create corporate tax inversions. Despite the firestorm of protest from lawmakers and the general public, all indications point to a continuation of corporations opting for the tax-saving strategy.

A corporate tax inversion is a method by which companies try to reduce their corporate tax bills by re-establishing headquarters overseas, typically through an acquisition. – Chicago Tribune

If you’re not familiar with the concept, the term “tax inversion” might send you running for an umbrella and a gas mask. In reality, what you might want to protect is your wallet. According to a May 2014 report issued by Deloitte, corporate tax inversion could result in a loss of nearly $20 billion in federal tax revenue from 2015 through 2024. Fewer corporate tax revenues may well translate to cuts in services or increases in taxes, fees and other expenses for individual taxpayers.

A More Agreeable (Tax) Climate

Have you noticed that many American companies are incorporated in Delaware, even though they have few or no actual operations there? That’s because Delaware has very liberal incorporation laws. Delaware is also considered one of the most tax-friendly states for corporations to set up their legal bases of operations. But for some companies, even Delaware is not tax-friendly enough.

Corporate tax inversion occurs when American companies purchase or merge with foreign companies and move their corporate headquarters to the foreign country where the other company is located.

This allows the American company to reduce its corporate tax burden on the operations located in its corporate headquarters, because the corporate income tax rate for many foreign countries is significantly lower than the 35 percent imposed by the United States. At the same time, the company retains access to its American customer base. Business as usual, but major tax savings.

Earnings Stripping and Hopscotching

Corporations must pay taxes on profits earned within the US. But corporate tax inversion may generate tax savings on domestic revenues as well. The process is called “earnings stripping,” and it works like this.

The newly established foreign headquarters grants a “loan” to its American division. The payments that the American division makes to the foreign headquarters are subtracted from its taxable profits.

According to an August 2014 report in Newsday, American corporations are hoarding more than $2 billion overseas. Hopscotching involves US based companies funneling profits earned overseas through a foreign headquarters. This tactic allows companies to invest those earnings without paying US corporate income tax.

Related article: Should We Abolish Corporate Income Taxes?

Have It Your Way, Eh?

Tech heavyweight Seagate and Stanley, a 170-year-old tool stalwart, are just two companies that relocated their headquarters outside the US in the opening years of the 21st century. A parade of American companies, including Tyco International, Fruit of the Loom and Ingersoll-Rand either considered or executed moving their headquarters outside the U.S. to cut corporate taxes during that period.

The legislative response was a 2004 law designed to put a halt to corporate defections. The 2004 law prohibited American companies from skirting US corporate income taxes by moving their headquarters overseas but leaving the same leadership and shareholders in place. Instead, American companies would be required to acquire or merge with a foreign company. Shareholders of the foreign company must acquire at least 20 percent of the shares for the new parent company. (International Tax Review)

The most recent wave of corporate defections was designed to follow the 2004 anti-inversion law. Pfizer launched a failed bid to purchase AstraZeneca and move its headquarters to London. Walgreens announced plans to acquire remaining 55 percent of Alliance Boots GmbH, a European drug store chain, but nixed plans to move its base of operations to Switzerland under intense criticism. (Des Moines Register)

The latest defector, Burger King, made an August 2014 announcement of its plans to acquire Canadian doughnut and coffee chain Tim Horton’s and move its corporate headquarters north of the border. The move allows Burger King to trim the corporate tax burden for its headquarters to 15 percent federal tax and 11.5 percent Ontario provincial tax. It is worth noting that Prime Minister Stephen Harper lowered Canada’s federal corporate tax rate from 28 percent to 15 percent after taking office in 2006.

What Congress (Won’t Likely) Do About Inversion

During the period between 2002 and 2004, anti-inversion legislation enjoyed strong bipartisan support in both houses of Congress. Such support is absent in the highly partisan environment of the 113th Congress. So, despite an anti-inversion bill introduced in May 2014 by Representative Sander Levin and Senator Carl Levin, it is unlikely that any substantive action will occur to address corporate tax inversions. That is, at least before the November 2014 election.

The Silver Lining: You Won’t Lose Your Job

Despite the fact that American corporations seem primed to continue announcing and carrying out corporate tax inversions, there is a silver lining. Unlike off shoring or outsourcing, tax inversions do not usually involve wholesale shipping of American jobs overseas.

So at least American workers won’t lose their jobs, even if American taxpayers eventually foot the bill to fill the hole created by corporate tax inversions.