Corporate inversions are becoming more common.
A corporate inversion is where a US corporation with substantial foreign operations reincorporates in a foreign country to reduce the amount of taxes it has to pay in the United States on its foreign earnings.
A wave of inversions early in the last decade led Congress to take steps in 2004 to discourage them. Now a new wave of inversions has led to new hand wringing on Capitol Hill, but the gridlock in Congress and the lack of consensus about what action to take make any further action unlikely, at least this year.
Forty one US multinational corporations have reincorporated in lower tax countries since 1982. Of that number, at least 13 moved since late September 2010, and another eight corporate inversions were in the works as of late May. Of these 21 transactions, 11 involve reincorporation in Ireland, three in the United Kingdom, three in Holland and one each in Canada, Australia and Germany.
The attraction is not only a lower tax rate — the US corporate income tax rate is 35% compared to 12.5% in Ireland and 20% in the United Kingdom — but also the United States taxes US corporations on their worldwide earnings while the other countries impose limited or no taxes on offshore income. Another factor is the $1.95 trillion in earnings that US multinational corporations have parked in offshore holding companies and are unable to use in the United States without triggering US income taxes. A corporate inversion could make the earnings easier to redeploy.
Congress amended the tax code in 2004 to make it more painful for US companies to invert. In cases where the shareholders of the former US corporation continue to own at least 80% of new foreign parent company by vote or value, the foreign corporation is treated as a US company for tax purposes, so any benefit from a corporate inversion is eliminated. If the shareholders of the former US corporation retain at least 60% of the new foreign corporation, then a toll charge is collected on any appreciation in asset value when the company leaves the US tax net. The toll charge cannot be offset by using tax attributes such as net operating losses and foreign tax credits. In addition, some executives of the inverted company may have to pay an excise tax at a 20% rate on the value of their stock options and stock-based compensation when the company leaves the US tax net.
However, a US company can avoid the tax penalties if the affiliated group of companies headed by the new foreign parent company has substantial business activities in the new parent’s home country. In that case, it is not considered to have inverted.
Given these rules, two types of inversions are still possible.
One is a “self inversion” where the US corporation simply reincorporates abroad and has substantial business activities in its new home country. Such corporate inversions are rare. The IRS interpreted substantial business activities in 2012 to mean at least 25% of the affiliated group’s sales, assets, income and employees must generally be in the country where the new foreign parent corporation is incorporated.
Most recent transactions involve mergers of a US and foreign corporation where the shareholders of the foreign corporation continue to own more than 20% of the combined entity. In the typical “acquisition inversion,” the US company combines with a smaller foreign company. The combined company can choose a third country as its new tax home. The executive team usually remains in the United States.
The chairman of the Senate tax-writing committee, Ron Wyden (R-Oregon), said in an op-ed piece in the Wall Street Journal in early May that he plans to try to put a halt to corporate inversions by merger by requiring the shareholders of the foreign corporation to own at least 50% of the combined entity. This would leave the door open only to mergers of equals or takeovers of US corporations by larger foreign corporations.
Chiquita Brands International is moving overseas in a merger with Irish rival Ffyfes PLC, which is based in Ireland. The combined company will be a tax resident of Ireland. Chiquita shareholders would own 50.7% of the combined company. The deal is not expected to close until later this year.
Neither Orrin Hatch (R-Utah), the ranking Republican on the Senate tax-writing committee, nor Dave Camp (R-Michigan), the chairman of the House tax-writing committee, joined Wyden in threatening action. Republicans say the only way to stop corporate inversions is to reduce US corporate income taxes to bring them in line with lower taxes in other countries.
This is in contrast to 2002 when Senator Charles Grassley (R-Iowa), then ranking Republican on the Senate tax-writing committee, joined the committee chairman, Max Baucus (D-Montana), in a joint statement that Congress would act to shut down corporate inversions effective the day of the statement: March 21, 2002. However, the final bill did not become law until 2004, by which time there was a new Congress. Thus, the final effective date slipped to a date early in the new Congress: March 4, 2003.
The Wyden proposal is similar to a proposal that the Obama administration made in its budget message to Congress in March. Senator Carl Levin (D-Michigan) and his brother, Congressman Sander Levin (D-Michigan), the ranking Democrat on the House tax-writing committee, introduced nearly identical bills in May to do the same thing. The bill would also continue to treat a re-domiciled company as a US company for tax purposes if it remains managed and controlled from the US and at least 25% of its employees, employee compensation or assets are located or derived in the United States.
Meanwhile, the IRS tightened the existing rules in late April by issuing a notice that said corporate inversions would trigger US toll charges on US shareholders who receive shares in the combined new company as consideration for their shares in what was formerly treated as a “killer B” tax-exempt reorganization. The notice is Notice 2014-32.
The popularity of re-incorporations in Ireland is starting to worry the Irish government, as it could undermine Ireland’s insistence that it is not a tax haven. Some companies that have set up tax residence in Ireland use a “double Irish” structure to shift profits from Ireland to Bermuda to reduce taxes even further.