Corporate Inversions Why It Happens: Veronique De Rugy Fiscal Policy Analyst The Cato Institute

Corporate Inversions Why It Happens Veronique de Rugy Fiscal policy Analyst The Cato Institute The Cato Institute

Overview • The number of corporate inversions is increasing • What corporate inversions are • What corporate inversions are not • Why are U.S. firms moving out? • Proposed legislation • Conclusion The Cato Institute

The number of corporate inversions is increasing • • • • • • • • • • • • • • • • • •

Coopers Industries Everest Re Group Foster Wheeler Fruit of the Loom Global Crossing Ldt Ingersoll-Rand Co Ldt Leucadia National Corp McDermott Inc Nabors Industries Noble Drilling Sante Fe International Corp Seagate Technologies Trenwick Group Triton Energy Corp Tyco International Veritas DGC Weatherford International Inc Stanley Works …

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What corporate inversions are • A legal transaction in which the US parent company is placed under a newly created foreign company formed in a low tax jurisdiction. • A step that has no real effect on the operation of the company, which still maintains its U.S. operations • A transaction that allows the firm to no longer pay U.S. tax on its overseas The Cato Institute

Corporate inversions and tax competition • Corporate inversions are part of a broader dynamic of rising global tax competition • Tax competition is a powerful weapon in promoting good tax policy • Inversion is the expression of the right of people and their property to move freely.

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What corporate inversions are not • Inversions are not an easy step for U.S. companies • Inversions are costly Treasury notes: “The inversion transaction itself involves significant tax cost in terms of gain recognition at the corporate level, the shareholder level, or both, as well as other significant transaction costs.” • The decision to re-incorporate abroad is difficult because the complexity of the transactions involved in an inversion is striking The Cato Institute

Inversion is not tax evasion • If the company maintains its U.S. operations, it will pay taxes to the U.S. government on all income earned in America • Even Senator Grassley admits that much: “Inversion transactions are not illegal, but they are immoral.” • This process is not tax free The Cato Institute

Inversion transaction is costly, difficult, painful ….

It means that U.S. firms would not engage in inversion unless there was something seriously wrong in the U.S. system

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Other forms of Corporate Expatriations • Foreign Parent Merger: Placing the US parent under a large foreign parent forming abroad instead of in the U.S. Daimler Benz AG-Chrysler, Air Touch-Vodafone, Amoco-British Petroleum According to NFTC, “over the past 4 years 80% of all large acquisitions involved foreign companies buying U.S. ones” • A start-up firm may decide to incorporate abroad to enjoy the same tax savings as the one available through a subsequent inversion The Cato Institute

What is wrong with the U.S. system?

U.S. firms would not engage in inversion unless there was something seriously wrong in the U.S. tax system

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What is wrong with the U.S. tax code? • The global economy promotes competition, which makes good tax policy especially important • U.S. international tax policy does not acknowledge this reality and keeps US firms at a competitive disadvantage • The degree to which the U.S. tax code intrudes upon business decision-making and the cost it imposes is unparalleled in the world

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The 3 main problems • Corporate income tax is too high • The U.S. taxes income on a worldwide basis • The US rules for taxing foreign income are incredibly complex

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The U.S. corporate income tax is too high • • • •

In 1986, the US cut its federal corporate tax rate to 34 percent and was perceived as a low tax jurisdiction Most countries cut their tax rates to stay competitive. U.S. lawmakers raised the federal corporate rate to 35 percent Today, the U.S. corporate income tax rate of 40 percent (federal plus state) is the fourth highest in the 30 OECD country The Cato Institute

The U.S. taxes income on a worldwide basis •

•

A US company is subjected to the US corporate income tax on the income earned by its foreign subsidiary when repatriated (unless it is subjected to antideferral rules) WT is based on the notion that the tax burden of U.S. multinational and U.S. domestic companies should be equalized The Cato Institute

Worlwide taxation means competitive disadvantage • Half of the OECD countries tax income on a territorial basis : a parent company generally is not subjected to tax on income earned through a foreign subsidiary • Under a worldwide tax system, at least a portion of the earnings of a US parent company is taxed by two countries The Cato Institute

An example of how WT works • A French firm competing with a US firm for business in Ireland • Both subsidiaries are subjected to the 10 percent Irish rate on their Irish incomes • The US parent receiving the dividends from its Irish affiliate includes the dividends and corresponding Irish taxes paid in its US income • The U.S firm may be able to utilize a foreign tax credits generated by the tax paid in Ireland by the subsidiary. • If the foreign tax credit is lower than the US tax rate-as it is often the case- then the US firm will have to pay the US rate on that income (minus the tax credit) The Cato Institute

The US rules for taxing foreign income are incredibly complex • The foreign tax credit has a number of deficiencies that increase the complexity and prevent the full double tax relief • The epitome of this complexity is the US anti-deferral rules, called “subpart F” • All in all, US rules raise the tax rate on foreign investment higher than the tax rate imposed on foreign investment by companies headquartered in other major countries

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A striking quote: • Intel’s vice president of taxes Robert Perlman: “If I had known at Intel's founding what I know today about the international tax rules, I would have advised that the parent company be established outside the U.S. This reflects the reality that our Tax Code competitively disadvantages multinationals simply because the parent is a U.S. corporation.” The Cato Institute

Inversion helps U.S. workers and U.S. shareholders • To remain competitive, some US firms have decided to expatriate so that they no longer have to pay U.S. tax on its overseas income • Expatriation allows a firm to compete on a level playing field with foreign competitors, and lets a company's tax savings be reinvested for the benefit of the firm's shareholders The Cato Institute

Inversion legislation • According to Treasury Secretary O’Neill, “if the tax code disadvantages US companies competing in global markets, then we should address the anticompetitive provisions of the code.” • Yet, the bills introduced recently offer only a superficial response to issues raised by the inversions and do not tackle the underlying problems The Cato Institute

Proposed legislation • Emotion is the driving force behind efforts to restrict inversions • Legislation includes Rep. Richard Neal’s (DMass.) H.R. 3884, Rep. Scott McInnis’s (RColo.) H.R. 3857, and S. 2119 introduced by Sens. Max Baucus (D-Mont.) and Charles Grassley (R-Iowa) • They generally aim to tax foreign parent companies created for an inversion as if they were U.S. companies, if they retain basically the same structure they had before inversion The Cato Institute

Potential effects of the proposed legislation • Foreign firms will continue to acquire U.S. firms at a rapid pace • U.S. firms will continue to be at a cost disadvantage in world markets • U.S. firms will have less cash available to hire U.S. workers and pay U.S. shareholders

• They would damage the US economy without stopping corporate expatriations The Cato Institute

Conclusion • A growing number of U.S.-based multinational corporations seek to lower their tax bills and compete more effectively by engaging in so-called “corporate inversions” • The U.S. tax code is reponsible for the inversion trend • Proposed legislation would damage the US economy without stopping corporate expatriations

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