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The topic has been all over the media, as you know. Whether a controversy or a debate with pros and cons, it’s always about the taxes that some big multinational corporation pays - or doesn’t pay. Of course, everybody is entitled to an opinion, so, without any intention of taking sides, we think it would be useful to present some facts that may be of interest to you as a taxpayer, maybe even as an employee or shareholder in a large corporation.
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All articles or discussions on the subject begin with a definition or explanation of the term, but, in case you missed it, here it is again.
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Corporate inversion (or tax inversion) is a tax reduction technique which takes advantage of some loophole in the Internal Revenue Code that allows, under certain conditions, a U.S. domiciled corporation to buy or merge with a foreign entity and move their official headquarters out of the U.S.
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Through corporate inversion, companies restructure their businesses abroad, in hopes of reducing their tax burden. This includes re-incorporating under a wholly owned international subsidiary, or simply buying a foreign company.
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The impact on operations is often minimal, with manufacturing activities and the markets in which it operates remaining unchanged.
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Combined with a web of cross-border transactions between companies owned by the same group, such inversions can play an important role in shifting profits within an international business to low-tax jurisdictions, boosting returns for shareholders.
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| From the IRS point of view, a foreign corporation is generally treated as a surrogate foreign corporation under section 7874 if pursuant to a plan (or a series of related transactions): |
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(i) the foreign corporation completes after March 4, 2003, the direct or indirect acquisition of substantially all of the properties held directly or indirectly by a domestic corporation;
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| (ii) after the acquisition, at least 60 percent of the stock (by vote or value) of the foreign corporation is held by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation; and |
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(iii) after the acquisition, the expanded affiliated group that includes the foreign corporation does not have substantial business activities in the foreign country (relevant foreign country) in which, or under the law of which, the foreign corporation is created or organized, when compared to the total business activities of the expanded affiliated group. Similar provisions apply if a foreign corporation acquires substantially all of the properties constituting a trade or business of a domestic partnership.
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Practically, with a majority vote from the shareholders in favor of the inversion, the corporation establishes itself outside the United States, preferably in a country that is friendly towards their business type and offers tax advantages not found within the States.
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| The new corporation purchases the U.S. based corporation to transfer ownership to the new country and to take advantage of the new tax structure. Shareholders sell their shares in the old company to the new company for an equal ownership stake so that the owners retain control through the newly established holding company without losing share value. |
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| The company recreates the same corporate leadership structure in the new corporation as the old and matches leadership positions precisely in order to avoid leadership issues during the transition period. |
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| And thus business is conducted as usual. The inversion does not require that the corporation has to physically move operations to the new country, so business can continue without any pause in operations. |
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| With their tax domicile then based in that country, the IRS can’t touch their earnings since the income earned outside the U.S. is only taxed when it is repatriated, and the tax rate is currently 35% less any credits that may be available from the payment of taxes to the foreign country where the income was earned. Income earned in the U.S. is still taxed at the ordinary corporate rate. Inversions do not impact these taxes. |
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Some corporations resort to inversion not only to escape the 35% tax rate they have to pay on all the worldwide income they bring home, but also in an effort to keep up with foreign competitors which are not taxed on their revenue earned abroad and are therefore free to invest as they please.
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| As far as shareholders are concerned, under current IRS rules, if a company’s re-incorporation is accomplished through a stock transaction, in which the overseas corporation purchases significantly all the shares of ownership in the domestic corporation, existing shareholders (whether or not they become share-owners in the new, foreign corporation) may face capital gains taxation at the time of inversion. |
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Nevertheless, it is anticipated that the savings in corporate taxes from the inversion over the long-term is of greater value than the immediate capital gains hit. Thus, in theory, an inverted corporation’s stock should appreciate in value enough to overcome the wealth lost in capital gains tax.
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| And yes, it takes a small army of lawyers and accountants to make sure that all steps taken, operations and transactions comply with the law and the IRS regulations, as well as with the laws and tax regulations of the country where the reincorporation takes place. |
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| With the hope that this was informative for you, let’s just add that tax inversion is not the only loophole in the IRS regulations that companies, as well as individual taxpayers, can take advantage of, so everybody is looking forward to an overhaul of the tax code, whenever that will happen. |
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