Guest commentary: Corporate inversions are good for America
Business economics trump bad tax policy any day. Consider the mini-stampede of U.S. corporations “inverting” to become foreign corporations. If the U.S. had a rational corporate tax system, companies would not have to resort to this tactic. But bad tax policy has forced their hands. Companies are creating their own “synthetic territorial tax systems.”
A corporate inversion happens when a corporation changes its place of incorporation from one country to another. Like from the U.S. to Switzerland or Ireland.
Why does it matter where a corporation is incorporated?
Only seven countries (Chile, Greece, Ireland, Israel, Korea, Mexico and the U.S.) tax the worldwide income of their corporations. Creatively, this is called “worldwide taxation.” All other countries (including most industrialized countries) tax only corporate income considered earned within the country. Ingeniously, that is called “territorial” taxation, i.e., taxation of income earned within the territory of the country. But even the U.S. applies “territorial” taxation to the income of other corporations doing business in the U.S. This puts U.S.-incorporated companies on a different economic and competitive footing than foreign-incorporated companies doing business here.
In the U.S., if the non-U.S. income is earned through a foreign subsidiary (e.g., incorporated in Finland), the U.S. doesn’t tax the income until it is brought to the U.S. as a dividend. At that time the combined federal and state tax of 40 percent (KPMG) is imposed and a credit is given for the foreign tax paid (20 percent for Finland) (KPMG), leaving additional U.S. taxes of 20 percent. Because U.S. tax rates are higher than almost all the rest of the world, U.S. corporations are keeping more than $2 trillion (Reuters) of foreign earnings outside the U.S. to avoid these additional taxes.
The U.S. is the only global economic powerhouse hanging onto worldwide taxation of corporations. The other countries that have the system don’t suffer from it. They have lowered their tax rates so much that, after a credit for taxes paid in the other country, there often is no additional tax to pay when foreign profits are brought home. But the U.S. doesn’t seem able to turn loose of its obsolete high corporate tax rates, forcing U.S. corporations to continue to keep trillions in foreign lands.
It is silly for the U.S. to hang onto its current system. U.S. corporations are keeping their foreign earnings offshore because it costs too much to bring them back to the U.S. The high U.S. tax rates are only theoretically imposed on repatriated foreign earnings. U.S. companies are smart enough not to repatriate foreign earnings, so the U.S. tax is hardly ever paid in practice. Thus, “inversion” is a change that avoids a tax that never would have been paid anyway.
U.S. corporations want to be able to tap foreign cash for U.S. expansion. This is especially true as the U.S. is embarking on a domestic-energy renaissance that can attract more manufacturing and other business activity to the U.S. But they don’t want to take a “haircut” of the additional U.S. tax. So what to do? Create your own “synthetic territorial” system by flipping from a U.S. corporation doing business here into a foreign corporation doing business here.
If a U.S.-incorporated corporation merges into a foreign-incorporated company and the foreign company’s shareholders gain a certain minimum percentage ownership (not 51 percent control, though), the Internal Revenue Code says the merger is “not taxable.” Further, the resulting company is considered incorporated outside the U.S. Voila! The corporation has freed itself from worldwide taxation by the U.S. federal and state governments.
We have seen this strategy adopted by several pharmaceutical and health care companies recently. Now the trend is spreading into consumer goods (Walgreens announced last week it is considering the maneuver). It is an entirely rational reaction to the U.S. clinging for decades to a tax system and tax rates that have not kept pace with international developments.
What will happen to these “inverted” companies? They will be incorporated in a foreign country that uses the “territorial” system (or in the case of Ireland, a 12.5 percent rate country). Their operating headquarters will remain in the U.S. and pay U.S. tax on all U.S. income. But, if they want to expand in the U.S., they can invest their foreign earnings here and won’t pay that “haircut” for the privilege of U.S. expansion.
It would be better tax policy to adopt a territorial system or at least to lower rates so companies could afford to bring home foreign earnings. But absent rational tax policy, there is little doubt the “inversion” of these companies will benefit the U.S. Making it easier to invest in the U.S. without eroding the tax base is a good thing. But the politicians don’t like it, perhaps because they can’t take credit for it.
Maurice Emmer is a retired attorney who lives in Aspen.
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