Tax Inversion - How US Companies Buy Tax Breaks
Feb 3, 2015 9:43 AM EST
Pfizer has been a U.S. company since a German-born chemist by that name opened a red-brick laboratory in the Williamsburg section of Brooklyn in 1849. Last year, it proposed to become a British firm. The reason had nothing to do with manufacturing costs or access to foreign markets. It was to escape taxes. A financial exercise known as an “inversion” would allow it to lower its tax bills by acquiring a legal address abroad. Strange as the idea sounds, it’s an inevitable outgrowth of a peculiarity of the U.S. tax code and has enjoyed a resurgence in the past few years among American companies. Pfizer was one of the biggest and best known to try to join the trend.
About 47 companies have reincorporated in low-tax countries since 1982, including 16 since 2012. Five more plan to do so in the coming year. A lot of drug companies are doing it, and low-tax Ireland is a popular corporate home. They’re doing it despite a 2004 law that legislators had promised would end the practice, despite rule-tightening by the Obama administration to limit it, and despite two decades of efforts by the Internal Revenue Service to rein it in. Nowadays, most companies achieve inversion by acquiring a foreign company at least 25 percent their size. That’s how Medtronic, the medical device giant founded in a Minneapolis garage in 1949, turned Irish; how Burger King, the Miami fast-food chain, became Canadian; and how Pfizer proposed to go British, through the takeover it sought of AstraZeneca was eventually rejected. A change of address doesn’t necessarily mean a real move. Companies are free to keep their top executives in the U.S., and most of them do.
Source: Data Compiled by Bloomberg
It’s easy to see why multinational companies like to flee the U.S. tax system. The U.S. corporate income tax rate, 35 percent, is the highest in the developed world. The U.S. is also one of the few countries that makes its companies pay that rate on all the worldwide income it brings home — even if the profit was generated by a subsidiary in a foreign country with low taxes, such as Ireland. Many nations, including the U.K. and Canada, tax only domestic profits. One perverse result is that an independent U.S. company can end up paying more taxes than an identical U.S. company owned by a foreign parent. By creating or buying a foreign parent, a company escapes U.S. tax on worldwide income. Drug and technology companies find this particularly enticing because their profits stem from intellectual property such as patents. Transfer those patents to a subsidiary in a zero-tax jurisdiction like Bermuda, and voila! The bulk of profits, which would otherwise face the 35 percent income tax rate, aren’t taxed anywhere.
Source: Data Compiled by Bloomberg
Neither Democrats nor Republicans like inversions, but they disagree on what to do about them. Republicans call them the inevitable consequence of a flawed tax system, and say the only solution is a full revamp of the tax code, including lowering the corporate rate and limiting taxes on foreign profits. Although some Democrats agree on the broad outlines of a corporate-tax revision — Obama’s 2016 budget calls for lowering domestic and foreign rates – the parties disagree on so many other things that there’s little chance that a big tax bill will pass Congress this year. In the meantime, tightened rules have made the deals less attractive, but the Obama administration has warned that only legislation could stop them completely. One proposal from Congressional Democrats would prevent $19.5 billion from escaping the U.S. tax system over the next decade. Proposals like this are unlikely to clear a divided Congress. The deadlock means that more and more executives will embrace the do-it-yourself fix.