President Barack Obama recently called corporate tax inversions an “unpatriotic tax loophole.” The multinational American corporations that are the beneficiaries of the loophole responded by saying that, if the United States had a lower corporate tax rate and a simpler tax code, fewer companies would pursue inversions. Although tax inversions have been around since the early 1980s, tax inversions were in the news in 2014.
What, exactly, is a tax inversion? How much do tax inversions actually affect corporate taxes? Is the tax inversion loophole different than other tax loopholes? How soon are tax inversions going to be shut down by Washington?
According to Wikipedia, a tax inversion, or corporate inversion, is a largely American term for the relocation of a corporation’s headquarters to a lower-tax nation, or corporate haven, usually while retaining its material operations in its higher-tax country of origin.
An article from The Economist in September 2014 provides a concise explanation about the benefits of inversions:
The incentive is simple. America taxes profits no matter where they are earned, at a rate of 39 percent — higher than in any other rich country. When a company becomes foreign through a merger, or “inverts,” it no longer owes American tax on its foreign profit.
How much do tax inversions affect corporate taxes? A December 2014 bloomberg.com article posted by Zachary R. Mider describes the results of data compiled on 15 companies that inverted between 1994 and 2009. According to the article, these businesses effectively lowered their average tax rate to 15.7 percent from 33.5 percent.
The downside to tax inversions is, obviously, less tax revenue to the Internal Revenue Service. Mider states that American companies that have already carried out inversions are likely to lower the amount of revenue collected by the federal government by $2.2 billion or more in 2015. This is is twice the amount of revenue the IRS lost to inversions in 2014, and we know the IRS revenue lost to inversions will increase in the future. An exerpt from Mider’s Bloomberg post frames the potential future impact of tax inversions pretty well:
… That doesn’t include the impact of companies that shift their legal addresses abroad in the future, which one congressional study pegged at about $2 billion a year over the next decade. Since the first inversion in 1982, the deals have cost more than $9.8 billion in inflation-adjusted dollars …
— Zachary R. Mider, bloomberg.com
The federal government stands to lose quite a bit of revenue through tax inversions. Congress agrees as a whole that something should be done, but is deadlocked on what to do and how to do it.
Right now, tax inversions legally lower taxes owed to the IRS, so there is no practical difference between tax inversions and any other legal tax mitigation strategy. In fact, some midmarket companies may start following the lead of the large multinationals in seeking foreign corporate mergers. Whether this is a reasonable business tax strategy depends on a lot of variables, including how committed the organization seeking the tax inversion is.
Tax inversions are dependent on the acquisition of a foreign company. This is, at best, a resource-heavy executive and administrative effort that could take years to consummate. We also know that the laws will eventually change, we just don’t know when or how.
Although the split in federal government power and ideology means there is no real risk of the tax inversion loophole closing any time soon, the risk grows greater as federal tax revenue goes down because of it.
Corporate tax inversions are interesting as much for the real impact they have on taxes as they are for the political positioning we observe due to their high-profile existence. Any future changes in corporate tax law to manage tax inversions will likely affect companies of all sizes, not just the big multinational ones. They are worth paying attention to.
— This article was written by the Tax & Business Law Teams at Rogers, Sheffield & Campbell LLP of Santa Barbara. Click here to read previous columns. The opinions expressed are their own. This article is not intended to provide legal advice. For legal advice on any of the information in this post, click here for the form or phone number on the Rogers, Sheffield & Campbell Contact Us page.