Corporate Inversions: A “Get Out of Taxes Free” Card

If you don’t pay your taxes in America, you risk heavy fines or even jail time. That is, unless you are a major, profitable corporation able to merge with a firm registered in a low-tax country.

American firms have been on a buying binge lately, but some of these mergers have little to do with extending product lines or growing market share and everything to do with shedding the responsibility to pay taxes in the United States.

When a U.S. corporation buys a foreign corporation with the intent to shift its incorporation and tax domicile offshore, this is known as a “corporate inversion.” A more accurate title might be “corporate tax evasion.” Seventy-five U.S. corporations have inverted since 1994 – with 47 doing so in the last decade alone, according to new data from the Congressional Research Service.

Corporate inversions are not new. The first was completed in 1984 by McDermott International, a large engineering and construction company serving the energy industry worldwide. Nearly another decade passed before a second company, cosmetics maker Helen of Troy, followed in 1993. When, in 1996, two more firms sought to escape U.S. taxes by shifting their incorporation offshore, the IRS acted by issuing the first anti-inversion regulations. Because these rules were narrow in scope, they were largely ineffective.

Between 1996 and 2004, when Congress took up the issue, an additional 27 corporations shed their U.S. incorporation for registration in foreign countries, most often those with low or no taxes on corporate earnings. In 2004, under the American Job Creation Act (the same law that granted U.S. corporations a huge tax holiday on their offshore earnings), the bar was raised for corporate inversions: firms were no longer simply allowed to engage in a paper transaction that shifted their registration from the U.S. to another country. They were instead required to show that 20 percent of the stockholders of the new company were not stockholders of the U.S. company prior to the merger, and that at least 25 percent of the merged company’s employees, sales, and assets were in the new country of incorporation. These rules forced companies seeking this tax dodge to merge with established businesses in order to avail themselves of tax loopholes.

Companies seeking corporate inversions are looking to avoid taxes on past profits, as well as future profits. Loopholes that allow corporations to shift profits earned in the U.S. offshore are well known and have been widely reported. At present, U.S. companies have more than $2 trillion in untaxed profits held offshore. Should a company bring those profits back to the U.S. in order to pay dividends or make an acquisition, it would owe U.S. taxes. However, if a corporation, through inversion, shifts its incorporation outside the U.S., it becomes a foreign corporation in the eyes of the IRS, and the tax liability on its offshore profits vanishes.

The numbers are not insignificant. Medical technology giant Medtronic is presently seeking to buy Covidien, an Irish-registered company managed from Massachusetts. At the end of April, Medtronic had $20.5 billion in untaxed offshore profits, more than twice the $9.7 billion it had socked away offshore five years earlier. If it moves ahead with its inversion plans, the tax savings alone from its offshore stash could cost the public as much as $7 billion in lost revenue.

After inversion, Medtronic will lose much of its responsibility to pay U.S. taxes, even while it retains its right to have U.S. taxpayers pay for significant amounts of its research and development bill. The research and experimentation tax credit saved Medtronic $18.5 million in its last fiscal year. It will continue to receive this support from the American people as long as that research is conducted within the U.S.

With the abuse of inversion rules now front-page news, and with estimates that the new wave of inversions could cost the Treasury $20 billion over the next decade, Congress is once again poised to act.

The Levin brothers, Sen. Carl (D-MI) and Rep. Sander (D-MI), have partnered to introduce The Stop Corporate Inversions Act of 2014 (S. 2360 with 21 co-sponsors and H.R. 4679 with 12 co-sponsors). The bill would impose a two-year moratorium on inversion transactions in order to give Congress the time to craft a permanent solution to the problem. The bill mandates that a U.S. company would have to give up control to its foreign partner by stipulating that the merged company would be considered a U.S. company unless 50 percent of the shares of the new company are owned by stockholders who were not shareholders of the prior corporation. The bill would also consider the merged entity a U.S. corporation for tax purposes if its management and control was conducted from the United States and 25 percent or more of the new firm’s sales, employees, or assets were located in the United States.

Another vital solution to the growing problem of corporate inversions is to close the gaping loopholes that continue to allow corporations to shift the profits they earn in the U.S. offshore for tax purposes. These loopholes cost the Treasury more than $90 billion a year in lost corporate tax revenue, and they provide the fuel that keeps the inversion fire burning.