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Blog: Targeting Companies That Move Overseas to Dodge Taxes

May 23, 2014 | By Carolyn Burstein, NETWORK Communications Fellow

Corporate tax-dodging deals known as “inversions,” in which a U.S. multinational shifts its tax domicile to a lower-tax country, would be restricted for two years under legislation proposed in both houses of Congress on May 19, 2014. Representative Sander Levin and Senator Carl Levin, brothers from Michigan, proposed both bills, each of which had more than a dozen co-sponsors, all Democrats. The rationale behind the two-year moratorium would give Congress time to pursue broad changes in the corporate tax code. As Senator Ben Cardin (D-MD) said, “I look forward to redoubling our efforts on broader tax reform legislation that can fix our corporate tax code and make it more competitive.”

How does “inversion” work? Under current tax law, companies can create the deal of inversion and move overseas if foreign shareholders own 20% or more of their stock. Even if most of the business activity and corporate headquarters of the “new” company are in the U.S., the company would still be a “foreign” corporation for tax purposes. Many U.S. companies climb the 20% barrier by acquiring a foreign rival. The Levins’ bills would increase the threshold to 50% for two years, a threshold much more difficult to achieve. This proposal mirrors one in the President’s 2015 budget submission, which the Treasury estimates would raise $17 billion in revenue over the next decade.

Once a corporation is foreign, any profits earned in the U.S. are subject to U.S. taxes, but offshore profits are not. According to Citizens for Tax Justice, inversion makes it easier for a corporation to avoid U.S. taxes because corporate inversions are often followed by “earnings-stripping,” which makes U.S. profits appear, on paper, to be earned offshore. Corporations load the American part of the company with debt owed to the foreign part of the company, and the interest payments on the debt are tax deductible, thus reducing American profits “on paper.”

“These transactions are about tax avoidance, plain and simple,” said Senator Carl Levin (D-MI) chairman of the Senate Permanent Subcommittee on Investigations, who is the bill’s lead sponsor, in introducing the bill in the Senate. “Our legislation would clamp down on this loophole to prevent corporations from shifting their tax burden onto their competitors and average Americans while Congress is considering comprehensive tax reform.” Tim Kaine (D-VA) also stated: “This is about leveling the playing field and rooting out flagrant tax abuse in our system that could lead to billions of dollars of lost revenue.”

A splurge of deals resembling those of Pfizer (who recently made a bid to acquire the British pharmaceutical Astra-Zeneca, but was recently rebuffed and made it clear the company would not pursue a hostile takeover) or the U.S. advertising firm Omnicon Group Inc. might increase the chances of enactment of the Levins’ bills, but the odds are not bright that the bills will pass in either house. Not only is the opposition coming from Republicans in Congress, but also outside organizations, such as the Alliance for Competitive Taxation, the Rate Coalition and Right Wing News argue that the U.S. corporate tax system is unnecessarily complicated and global rivals pay less than the U.S. corporate rate of 35%. (As a matter of fact, both parties agree on these facts). However, Fortune 500 corporations that were consistently profitable from 2008 through 2012 paid, on average, just 19.4% of their profits in federal income taxes over that period. In fact, 26 corporations paid nothing in taxes over that 5-year period.

Most Republicans say they want to address inversion as part of broader tax code changes. Democrats respond that they (Republicans) ran away as fast as they could from Dave Camp’s (R-MI) bill to revise taxes. Democrats themselves have problems with several parts of Camp’s bill, e.g., moving to a territorial system under which 95% of the foreign earnings of U.S. companies would not be taxed at all. However, since the U.S. corporate rate of 35% is the highest among developed countries, lawmakers in both parties advocate lowering it, but disagree on the particulars. With the two parties deadlocked over how to proceed on tax revision, it’s highly unlikely that any changes will occur this year, leaving a window for firms like Pfizer and others considering a move.

Citizens for Tax Justice point out that no matter what the U.S. corporate tax rate is, there will always by a few countries with tax rates that are lower than ours – maybe even 0 – and these countries are definitely tax havens. In 2011, 40% of U.S. foreign profits were booked in Bermuda, Luxembourg, Switzerland, the Netherlands and Ireland, all of which are tax havens. Is it fair for American companies to pretend that their profits are earned in these countries even when they are plainly carrying out their business in the U.S.?    

Reports indicate that at least 15 other U.S. corporations are presently considering corporate inversions similar to that of Pfizer. Pharmaceutical companies have been especially active in merging with other pharma companies in Ireland, where the corporate tax rate is only 12.5%. Many of the inversions have been done by health care companies. But technology firms, including Applied Materials and even the banana producer Chiquita have moved overseas, at least for tax purposes. U.S. drugstore chain Walgreen Co. has been under pressure from some investors to do an inversion with European rival Alliance Boots Holdings, the Financial Times reported. Walgreen bought a 45% stake in Alliance Boots in 2012, with an option to buy the rest in 2015.

As Richard Murphy commented in an August 13, 2013 article in the Financial Times, when corporate inversions to Bermuda were all the rage in the early 2000s, the U.S. clamped down on the practice when the abuses became too flagrant. Senator Charles Grassley (R-Iowa) said in 2002 during this rash of inversions: “These expatriations aren’t illegal, but they’re sure immoral.” In 2004 Congress passed rules treating such firms as U.S. businesses for tax purposes unless they had substantial business in the new location. In 2012 these regulations were strengthened further.

If lawmakers were able successfully to prevent the most egregious forms of inversion as recently as 2012, certainly Congress can put a stop to this latest round by tightening the rules via the Levins’ bills. Preventing corporate inversions should not be complicated, and Congress should move quickly to pass this stand-alone legislation at this time, with the intent to tackle full-scale corporate tax reform in 2015. There are many proposed methods for achieving tax reform, but the Center for American Progress strongly supports a corporate minimum tax, which would eliminate current incentives to park money in tax havens, since any foreign earnings taxed at very low rates would be immediately subject to the minimum tax.

Reforming the tax code is an essential component of building a competitive economy along with investing in workforce development, education, science, infrastructure and ensuring the common good through adequate safety-net precautions. As the Faithful Budget states so well, we must have “reasonable revenue for responsible programs.” While tax reform is an important goal, it should not be used as an excuse to block actions that will stop tax avoidance through schemes such as corporate inversions. As Senator Carl Levin said in introducing the bill, “The Treasury is bleeding red ink and we can’t wait for comprehensive tax reform to stop the bleeding.”