Please enable JavaScript to view this website.

Corporate Inversions: Leveling the playing field or un-American?

Two House Democrats, Sander M. Levin of Michian and Chris Van Hollen of Maryland, introduced a bill on February 23, 2016 that seeks to curb the use of inversions by American corporations. 1 A corporate inversion is a method by which a U.S. multinational restructures itself so that the U.S. parent becomes replaced by a foreign parent.2 Ultimately, this method is used to decrease the taxes that the corporation pays under U.S. law. The bill seeks to limit “earnings stripping.”3 Earnings stripping allows an American unit of a foreign company to take on debt from the parent company, while the interest payment on those debts can be deducted from the American unit’s earnings for income tax purposes, provided some conditions are met.4 The bill specifically operates on these conditions, limiting the amount of interest expense that can be deducted from 50% to 25% and now companies can only record any interest expenses about that 25% for five years rather than indefinitely. 5

The U.S. corporate income tax rate of 35% is the highest in the developed world.6 Additionally, the U.S. is one of few countries that requires its companies to pay this high tax rate on all their worldwide income, as opposed to solely domestic.7 This creates a distinction between “domestic” and “foreign” multinationals, taxing the former entities more heavily and leaving it at a disadvantage.8 The domestic entity has to pay taxes in whatever countries it makes profits in, while also paying the residual difference between those taxes and the higher U.S. taxes when it brings the profits back to the U.S.9 This provides U.S. companies with an incentive to establish their legal status abroad.

Previously, one strong barrier to inversions was that companies moving offshore were kicked off of the Standard & Poor’s 500 (S & P 500).10 However, companies became angry at their exclusion and investors wanted to own some of these excluded companies, so the S & P 500 changed its policy. It did so by changing its definition of “American,” which now only requires that a company trade on a U.S. market, be considered a U.S. filer by the SEC, and have a plurality of business and/or assets in the U.S..11

Companies often justify an inversion because they owe fiduciary duties to their shareholders. However, although an inversion can result in tax benefits and boost overall profits, it can also leave stockholders with large tax bills.12 An inversion essentially results in a sale of a U.S. firm to a foreign company, whereby stockholders exchange shares of the U.S. entity for the new foreign-based entity.13 However, studies show that these new shares often do poorly, meaning that although intended to benefit shareholders, an inversion may in fact be detrimental to the shareholders while providing benefits to company executives.14

Two common proposed solutions to the problems are increasing the difficulty of inversions or ending the practice of taxing foreign profits.15 The former solution allows us to keep taxing foreign profits of U.S. based multinationals but makes inversions more difficult.16 However, this solution leaves U.S. firms at a disadvantage in comparison to foreign ones. (New York Times) The latter stops taxing foreign profits, which encourages companies to use accounting techniques to turn their domestic profits into foreign ones, thus allowing them to escape taxes on domestic activity.17 Again, this leaves firms that exclusively operate in the United States at a competitive disadvantage to multinationals.18

A third option, encompassed in the Viard-Toder plan, abolishes the corporate income tax and increases the tax burden on shareholders to offset the revenue lost.19 This option would result in a loss of revenue because the added taxes on shareholders would only recover about half the revenue lost by abolishing the corporate tax.20 However, it is said that this problem could be solved by raising income tax rates on the same groups benefitting from the abolishment of the corporate taxes, rich people owning most personal financial assets in the U.S. and nonprofit institutions getting a higher return on investments.

Corporate inversions remain a highly contested political and economic topic. However, developing a solution that will be accepted by Congress will prove difficult.21 Though everyone seems to agree that inversions are unappealing, there are divides over how to solve the problem, with each solution producing its own set of advantages and disadvantages.22

 


  1. Liz Moyer, Two Ranking Democrats to Offer Bill Aimed at Inversions, The N.Y. Times at 1 (Feb. 22, 2016), http://www.nytimes.com/2016/02/23/business/dealbook/two-ranking-democrats-to-offer-bill-aimed-at-inversions.html?ref=dealbook&_r=1 

  2. U.S. Department of the Treasury, Fact Sheet: Additional Treasury Actions to Rein in Corporate Tax Inversions (2015), https://www.treasury.gov/press-center/press-releases/Pages/jl0281.aspx 

  3. Moyer, supra note 1 at 2 

  4. Id. 

  5. Id. 

  6. Jesse Drucker and Zachary R. Mider, How U.S. Companies Buy Tax Breaks, Bloomberg QuickTake at 2 (Nov. 23, 2015), http://www.bloombergview.com/quicktake/tax-inversion 

  7. Id. 

  8. Josh Barro, Inverting the Debate Over Corporate Inversions, The N.Y. Times at 1 (Aug. 6, 2014), http://www.nytimes.com/2014/08/07/upshot/inverting-the-debate-over-corporate-inversions.html 

  9. Id. at 2 

  10. Allan Sloan, Positively Un-American Tax Dodges, Fortune at 6 (Jul. 7, 2014), http://fortune.com/2014/07/07/taxes-offshore-dodge/ 

  11. Id. 

  12. Roberton Williams, One Downside of Inversions: Higher Tax Bills for Stockholders, Forbes at 1 (Aug. 20, 2014), http://www.forbes.com/sites/beltway/2014/08/20/one-downside-of-inversions-higher-tax-bills-for-stockholders/#70243b428760 

  13. Id. 

  14. Id. 

  15. Barro, supra at note 8 at 2 

  16. Id. 

  17. Id. at 2-3 

  18. Id. 

  19. Id. at 3 

  20. Id. 

  21. Druker & Mider, supra at note 6 at 2 

  22. Id. 

The following two tabs change content below.

Natasha Patel

Latest posts by Natasha Patel (see all)