Corporate tax scam watch: The ‘inversion’ craze

Apple CEO Tim Cook: a fan of international tax break-hunting.
(Jeff Chiu / AP)

Apple’s done it. Herbalife has done it. Pfizer wanted to do it. What could be wrong with a corporate maneuver eyed by these fine, upstanding American corporations--and nearly 50 others in the last decade?

The subject is “inversions,” the catch-all name for corporate restructurings to make an American company appear to be a foreign firm for tax purposes. A recent report by the Congressional Research Service identified 47 inversions undertaken in just the last decade, involving firms in the pharmaceutical, financial services and manufacturing industries, among others.

The report was released this week by Rep. Sander Levin, D-Mich., who has introduced a bill to clamp down on this tax-driven scam, which he says could cost the U.S. treasury $17 billion over the next decade.


Inversions are an old game in corporate planning. They continue to be “a fruitful area of tax planning” for big companies, as Bret Wells, a tax expert at the University of Houston, has observed.

In the old days, the preferred device for inversions was to incorporate in a tax haven such as Bermuda or the Cayman Islands, where the corporate tax rate was zero. (The latter is where Herbalife calls home.) Congress shut that door with the JOBS Act of 2004, which ended shifts of corporate domiciles to tax havens where no real economic activity was taking place.

But it left several loopholes open. Inversions were still allowed if the company had at least 10% of its business operations in its new domicile, or if it merged with a foreign partner and the original U.S. shareholders owned no more than 80% of the merged firm. In 2012, the Treasury increased the business operations standard to 25%, which effectively ended that maneuver.

But the merger rule still exists, which accounts for a surge in international merger proposals by U.S. companies. The favored domiciles for the new partners are Ireland, the Netherlands, Switzerland and Canada, which all have low corporate tax rates and a so-called territorial tax system, in which foreign source income isn’t taxed.

Ireland is Apple’s tool. As we reported last year, Apple has vested a healthy portion of its intellectual property rights in an Ireland-based affiliate, Apple Operations Inc., which has claimed to account for 30% of the company’s total net profits. The cracks between Irish and U.S. tax rules allow the affiliate to avoid paying any but minimal tax on those profits: According to the Senate Permanent Committee on investigations, which examined the Apple scheme last year, it allowed the company to save $7.7 billion in U.S. taxes in 2011 alone.

Similar tax savings explain a host of merger proposals that have come up in recent years. Canada-based Valeant Pharmaceuticals, which is pursuing a hostile merger with Irvine-based Allergan, the maker of Botox, has cited the tax benefits of reincorporating in Canada as a rationale for the deal.

And the drug-maker Pfizer was perfectly candid about the tax break it would get--worth as much as $1.4 billion a year--by reincorporating in Britain if it could acquire London-based AstraZeneca. Pfizer abandoned the overture in May after AstraZeneca resisted. But don’t expect the U.S. company to stop looking for a foreign partner. Pfizer sometimes seems to devote more creativity to tax planning than to developing new pharmaceutical products--when the U.S. declared a temporary tax holiday on repatriated overseas dividends in 2005, Pfizer repatriated $37 billion, the largest sum of any company.

Corporate executives argue that, given their obligation to “maximize shareholder value,” they have no choice but to beat the bushes for tax-cutting schemes like these. it’s not so simple, however. Shareholders sometimes take a big hit, because they have to pay tax on their accumulated capital gains at the moment the company becomes a foreign firm.

Moreover, the surge of inversions has finally gotten Congress’ attention--and it’s a bipartisan issue. The remedies, however, don’t cross the partisan aisle. Democrats say the answer is to close off the remaining loopholes; Republicans that the solution is to cut the corporate tax to the bone to make the U.S. rate competitive with foreign rates.

The problem is that the only rate that would achieve that end would be zero. And that would shift a huge revenue burden on to individual taxpayers who have already taken up the slack from a long-term decline in the corporate tax burden.

In 1952, about 32% of federal revenues came from the corporate tax, 42.2% from the individual income tax, and 9.7% from the payroll tax. Today, the individual income tax still accounts for nearly the same percentage, but the corporate tax has declined to 8.9% of tax revenue and the payroll tax is up to 40%. Seen in that light, payroll taxpayers--that is, America’s working men and women--have financed the decline in the corporate tax burden (which benefits mostly wealthy shareholders).

And don’t be misled by claims that U.S. corporations pay the highest corporate taxes in the world. While the top U.S. corporate tax rate is 35%, few pay it. The Government Accountability Office calculated last year that the average effective tax rate is about 17%, including state and local taxes. And as a share of gross domestic product, corporate taxes in the U.S. are, at 2.6%, equal to or lower than those of some of those foreign tax havens, such as Canada and Britain. What that tells you is that inversion maneuvers are all about playing the loophole game.

Rep. Levin’s preference is to close the loopholes that allow U.S. corporations to claim they’re foreign companies even though a minimal portion of their economic activity is conducted overseas. He would raise the required foreign ownership of a merged company to 50% from 20%, which would end inversion mergers except in cases where the foreign partner was as big as, or bigger than, the American firm. Those cases are relatively rare--the Pfizer/AstaZeneca merger, for instance, wouldn’t qualify.

That’s the right approach. Through inversions, American companies have been taking advantage of our laws to save themselves money. There’s nothing wrong with that, in principle, except that they still want to take advantage of our laws and our huge markets, but they want to stick the little guy with the bill.

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