Paul L. Caron

Wednesday, June 11, 2014

CRS: Tax Issues in Corporate Expatriation, Inversions, and Mergers

CRS LogoDonald J. Marples & Jane G. Gravelle, Corporate Expatriation, Inversions, and Mergers: Tax Issues, Cong. Res. Serv. (R43568) (May 27, 2014):

News reports in the late 1990s and early 2000s drew attention to a phenomenon sometimes called corporate “inversions” or “expatriations”: instances where U.S. firms reorganize their structure so that the “parent” element of the group is a foreign corporation rather than a corporation chartered in the United States in order to reduce the effect of the U.S. corporate income tax. These corporate inversions apparently involved few, if any, shifts in actual economic activity from the U.S. abroad, at least in the near term. Bermuda and the Cayman Islands—countries with no corporate income tax—were the location of many of the newly created parent corporations, and tax savings were the principal objective.

These types of inversions largely ended with the enactment of the American Jobs Creation Act of 2004 (JOBS Act, P.L. 108-357), which denied the tax benefits of an inversion if the original U.S. stockholders owned 80% or more of the new firm. The Act effectively ended shifts to tax havens where no real business activity took place.

However, two avenues for inverting remained. The Act allowed a firm to invert if it has substantial business operations in the country where the new parent was to be located; the regulations at one point set a 10% level of these business operations. Several inversions using the business activity test resulted in Treasury regulations in 2012 that increased the activity requirement to 25%, effectively closing off this method. Firms could also invert by merging with a foreign company if the original U.S. stockholders owned less than 80% of the new firm.

Two features made a country an attractive destination: a low corporate tax rate and a territorial tax system that did not tax foreign source income. Recently, the UK joined countries such as Ireland, Switzerland, and Canada as targets for inverting when it adopted a territorial tax. At the same time the UK also lowered its rate (from 25% to 20% by 2015).

Recently, several high profile companies have indicated an interest in merging or plans to merge with a non-U.S. headquartered company, including Pfizer and Chiquita. Pfizer, for example, was interested in merging with a smaller British firm, AstraZeneca, and moving headquarters to the UK. For Pfizer, which has accumulated substantial profits in subsidiaries in low tax foreign countries that would be taxed if paid to the U.S. parent, the territorial tax system is likely the most important tax benefit from such a merger. This “second wave” of inversions again raises concerns about an erosion of the U.S. tax base.

Two policy options have been discussed in response: a general reform of the U.S. corporate tax and specific provisions to deal with tax-motivated international mergers. Some have suggested that lowering the corporate tax rate as part of broader tax reform would slow the rate of inversions. Although a lower rate would reduce the incentives to invert, it would be difficult to reduce the rate to the level needed to stop inversions, especially given revenue concerns. Others tax reform proposals suggest that if the United States moved to a territorial tax, the incentive to invert would be eliminated. There are concerns that a territorial tax could worsen the profit shifting that already exists among multinational firms.

The second option is to directly target the merger inversions. The President’s FY2015 budget proposes to treat all mergers as U.S. firms if the U.S. firm’s shareholders have 50% or more ownership of the combined firm or maintains management and control in the United States. Similar legislation has also been introduced in the 113th Congress.

(Hat Tip: Bruce Bartlett.)

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I am having trouble understanding when the corporate inversion laws apply to different transaction. If for instance a foreign individual creates a U.S. corporation with the sole asset of real property. Then that foreign individual creates a foreign Corporation. All of the shares of the U.S. Corporation are transferred to the foreign Corporation and thus the Foreign Corporation owns the U.S. Corporation. This is done for estate and other tax reasons. This is still taught in CLE's and in Law Schools today. Under the American Jobs Creation act section 7874 how would this not be deemed a corporate inversion? Is the IRS just ignoring these sorts of transactions?

Posted by: Don | Jun 11, 2014 1:21:53 PM