In recent months, several major U.S. corporations — among them Walgreens, Medtronic and AbbVie — have announced possible plans to renounce their U.S. corporate “citizenship” and move their corporate address offshore by merging with a foreign company. The merged corporation then pays most of its taxes to a foreign government — usually a tax haven — with a low tax rate. This allows it to dodge paying its fair share of U.S. taxes. The process, known as an “inversion,” takes place primarily on paper as most corporate operations remain here.
If corporations use inversions to dodge their tax obligations, American taxpayers have to pick up the tab even though the firms will continue to enjoy the enormous benefits of being headquartered here. Inversions are likely to become a central issue in the debate over corporate tax reform. Conservatives claim that corporations are forced to leave America because the corporate income tax rate is too high. Progressives argue that corporations are already avoiding paying their fair share of taxes due to many loopholes, including inversions.
A corporate inversion occurs when a U.S. company merges with a foreign one, dissolves its U.S. corporate status and reincorporates in the foreign country. The U.S. company becomes a subsidiary of the foreign one, but the foreign firm is controlled by the original U.S. firm.
A U.S. corporation can invert if after a merger the owners of the U.S. corporation retain less than 80% of outstanding stock of the new merged company, or if after the merger the new merged company has “substantial business activities” in the foreign country equaling at least 25% of operations. So, with just a 20% change in ownership, a company can become “foreign” even if it largely operates in and is controlled from America.
Corporations undergo inversions to take advantage of much lower tax rates, usually in tax-haven countries. Once inverted, a company no longer pays U.S. taxes on its global income. Instead, it is only responsible for paying taxes on income generated in the U.S. For example, Walgreens, which had $72 billion in U.S. sales last year, would likely avoid $4 billion in U.S income taxes over five years if it inverts with a Swiss firm. Pfizer, which tried to do an inversion with AstraZeneca in the U.K., would dodge $1 billion a year in taxes here.
Also, U.S. companies with billions of untaxed profits offshore can escape paying taxes on those profits in America if a company inverts. Medtronic reportedly could use $20.5 billion in its untaxed profits now offshore to invest back here and avoid paying taxes on those funds.
Companies that invert will continue to take advantage of the things that make the U.S. the best place in the world to do business — our educated workforce, legal and transportation systems, and federally-funded research. And they will continue to be able to get government contracts and to sell products to millions of American consumers.
But they will pay far less than their fair share for these services, passing on the cost to American taxpayers and to other companies.
Obama’s budget proposed to make inversions very difficult for companies that have the majority of their operations and ownership in the U.S. He would prevent them from reincorporating abroad if they are owned by at least 50% of the former U.S. parent’s stockholders (the current threshold is 80%). He would also require that the new foreign corporation be primarily managed and controlled from abroad.
Key members of Congress have introduced legislation based on Obama’s plan. Sen. Carl Levin (D-MI), Chairman of a subcommittee that has investigated tax avoidance by Apple and other corporations, has introduced the Stop Corporate Inversions Act of 2014 (S. 2360). Rep. Sander Levin (D-MI) has introduced a companion bill in the House of Representatives (H.R. 4679) that would raise $19.5 billion over 10 years.
Drawn from Americans for Tax Fairness’ 2014 Tax Fairness Briefing Booklet.