The term “corporate inversion” has been in the news, with the recent announcement of Burger King buying a Canadian company called Tim Horton’s. The deal brought to light the corporate tactic of purchasing another company to acquire its favorable tax status, and has provoked considerable discussion about whether the practice should continue to be permitted.
Understanding Corporate Inversion
Corporate inversion sounds like an exercise practiced in the company gym, but in fact, it is a financial term that is used to describe the process of purchasing a company in a foreign country to access that company’s favorable tax status. The “inversion” aspect can occur when a larger company buys out a smaller firm and changes its headquarters to the country of the smaller firm. Generally, in a corporate inversion, one company purchases a smaller company in a country that has a lower corporate tax rate. Although the practice isn’t currently illegal, many people feel that corporate inversion smacks of a lack of patriotism, at best, and a slick method of tax evasion, at worst.
History of Corporate Inversion
The practice of corporate inversion has gone on for at least thirty years. It is believed that McDermott was the first company to engage in the practice, announcing it would become a part of a Panamanian corporation. It subsequently re-incorporated in Panama and moved its headquarters there, allowing the company to avoid paying U.S. taxes. Since that time, the number of U.S. companies that chose to implement the practice has steadily increased. As many as 76 companies have employed corporate inversion since 1983, and 19 companies have announced their intentions to re-incorporate overseas since January 2013 alone. This exodus of American companies to foreign countries has prompted the U.S. Treasury and U.S. Congress to consider revising the laws governing corporations to limit the practice.
Why Corporate Inversion Is Bad
As a result of these companies changing their incorporation to other countries, less tax is collected, increasing the burden on other U.S. taxpayers. Meanwhile, these corporations reap the benefits of lower taxes and higher returns on investment. The Congressional Joint Committee on Taxation estimates that these inversions would have brought in an estimated $19.5 billion to the U.S. Treasury over the next decade. In addition, tax experts note that the corporate inversion process itself causes a taxable event that could affect shareholders. Even holders of mutual funds that include stock from the company could take a sizeable tax hit. These problems have prompted the U.S. Treasury to begin looking into corporate inversions.
The Crackdown on Corporate Inversions
In September of 2014, the U.S. Treasury, in cooperation with the Internal Revenue Service, announced steps targeting the practice of corporate inversion. They hope to eliminate the specific techniques that allow companies to make the inversions, as well as diminish the ability to avoid taxes by doing the inversion. They intend to strengthen the requirement that former owners of the U.S. company own less than 80 percent of the new, combined entity. These actions will make inversion less financially lucrative.
In his budget for 2015, President Obama included a legislative plan to help curtail the practice of corporate inversion and make such inversions much more difficult to accomplish. Recent efforts by the Democrats in Congress have initiated legislation to stop the practice, but it is unclear whether Republicans will support such legislation.