US Corporate Tax Inversions
Tax inversions are frequently in the news. Headlined by Medtronic’s $50B takeover of Covidien in 2014, this type of transaction is a hot topic in US business. No company wants to be put at a competitive advantage, and so most have investigated what benefit — if any — would result from following suit. Not far behind is the US government. They don’t want to sit idly by and watch taxable income shift offshore, and so inversions have been added to the list of “corporate loopholes” politicians clammer about on cable news and at campaign stump speeches.
While this issue is worthy of all this attention, it’s often misreported. To help give his colleagues a better picture of what US corporate tax inversions truly are, the head of my employer’s tax department recently gave a presentation on the subject. I’ll use this week’s post to share what I learned with you. Let’s begin with the definition: a transaction in which a US-based multinational company restructures so that the US parent is replaced by a foreign parent, often in order to avoid or minimize US tax liability.
The tax benefits can be considerable. The US is one of the few Organization for Economic Cooperation and Development (OECD) countries that uses the “worldwide” income tax concept. In contrast with the more commonly used “territorial” concept, the worldwide concept requires that regardless of where income is earned, it’s considered taxable income in the US. The United Kingdom and the European Union, for example, use the territorial concept, which only levies tax on income that is earned within their borders.
To get around this requirement, US companies will often leave income earned in a foreign jurisdiction in that country. By doing so, that income is only subject to tax in that jurisdiction — often at lower tax rates. If the company wishes to bring that money back to the US, in the next year or ten years in the future, it will be subject to US tax and at US tax rates. For obvious reasons, this is unattractive to US multinationals. Therefore, engaging in an inversion transaction with a company that’s based in a territorial country will eliminate this issue.
Until recent years, these types of transactions occurred without much fanfare. Recent political pressure has culminated into the creation of IRS Notices 2014–52 and 2015–79, which both address tax inversions. Unfortunately or fortunately, depending on what side you’re on, these notices don’t ban these types of transactions. They simply reduce the benefit of doing so. While these notices are a start, without a legislative mandate, tax inversions will continue to occur, albeit less frequently: the potential AbbVie/Shire transaction in late-2014 being the first casualty.
