As the posturing that surrounds the 2016 election season continues, the talk occasionally will turn to the United States’ tax policy. The one tax trend that ruffles the feathers of the candidates faster than any other is arguably that of the “corporate tax inversion.” Corporate tax inversions are designed to allow a U.S.-based company to acquire a foreign company (usually much smaller than the U.S. company) and domicile in the foreign country, which is home to a much more favorable tax structure.
Since the beginning, some 50 U.S. companies have re-domiciled into low-tax jurisdictions—more than 20 in the last four years. Pharmaceutical companies are some of the biggest players in the corporate inversion game. Companies are looking to Ireland, the United Kingdom, Netherlands, and Canada, each of which is home to a much more favorable tax structure.
In a typical conversion, a corporation will acquire a foreign company at least 25% its size. Two of the most recognizable “inverters” have done just that. Medtronic abandoned its Minnesota roots and became Irish through the acquisition of Covidien, while Burger King moved from sunny Miami to Canada during a 2014 acquisition of the smaller Tim Horton’s. The idea of “moving” probably would be better stated as “re-domesticating,” because most inverters change very little about their U.S.-based operations, and executives almost always remain stateside.
What started this trend?
The United States has one of the highest tax burdens in the civilized world, and the 35% corporate tax rate is top among developed nations. Coupled with that high tax rate is the somewhat outdated use of a worldwide system of taxation. Taxation on worldwide income requires a relatively complex system of credits and deductions for taxes paid to foreign countries. In contrast, territorial systems (like those in place in the United Kingdom and Canada) simply tax the income that is sourced to the taxing jurisdiction. Under a territorial system, U.S. taxes only would be levied on U.S.-sourced income. The worldwide system as implemented here in the U.S. lends itself to increased complexity, and higher overall tax rates, driving companies into the welcoming arms of a more hospitable partner.
Corporate inversions are an attempt to rectify the situation by creating or buying a foreign parent in one of those more taxpayer-friendly territorial jurisdictions. In addition, the U. S. allows deductions to the U.S.-based company for any interest paid to the foreign affiliates, but only to companies with a foreign parent. This climate of high corporate tax rates has caused companies to seek out these sophisticated tax mitigation strategies.
What is being done to reverse this trend?
While there is bipartisan disdain for the corporate inversion, very little agreement exists on how to combat the issue. Republicans want to leverage these corporate inversions and other perceived injustices into comprehensive tax reform. This would come with lower tax rates, but also might lower tax burdens on foreign operations. Democrats generally are more reluctant to go with broad-based reform, and would be more likely to pass specific legislation without so much potential political fallout. After all, the corporate stigma is strong with constituents represented by those lawmakers. While most legislators believe that significant changes to the tax code will be required to reverse the trend, there might be evidence to suggest otherwise. Recent tax regulations were released in April, and those regulations resulted in drug giant Pfizer abandoning its plans to purchase the Irish-based, but U.S.-run, Allergan. At $160B, that would have been the largest inversion to date.
The tax reform discussions that gained so much steam 18 months ago have slowed to a simmer over recent months, but moving to a tax system that is more competitive globally could be crucial to reverse the trend in any meaningful way. However, even with broad reform, there will be opportunities for companies to mitigate their tax burdens with thoughtful strategies. PYA is available to discuss tax opportunities for your business. Contact one of our executives below at (800) 270-9629.
