Large corporations are making all kinds of moves to decrease expenses and increase profits in an increasingly competitive global market. They’re doing this by trimming payrolls, adopting cutting-edge technology, moving facilities to cheaper overseas locations and subcontracting out entire functions when practical. In recent years, one strategy in particular has been increasing in frequency: corporate inversion.

What Is a Corporate Inversion?

The quick answer is that corporate inversion is a strategy in which a company moves its corporate headquarters from the U.S. to another country that has significantly lower corporate tax rates.

Under U.S. law, a company cannot simply pick up and move its operations to another country and declare that country to be its primary headquarters. The company first has to show that a significant portion of its income is derived from foreign sources.

In order to do this legally, the company generally must acquire a firm that operates largely in a country with a more favorable corporate tax climate. This will demonstrate to U.S. authorities that the company has a legitimate and justifiable interest in locating to that country rather than simply dodging taxes. 

How Corporate Inversions Benefit Companies

One of the reasons why corporate inversions are becoming so popular is that at 40%, the corporate income tax rate in the U.S. is the highest rate in the industrialized world. Canada’s corporate tax rate is 26.5%, the United Kingdom’s is 20% and Ireland’s is only 12.5%, which is why Ireland is a popular choice for companies that engineer corporate inversions. (For more, see "Corporate Tax Rates: The Highs and the Lows.")

Another benefit to a company using this strategy is that while the IRS taxes U.S.-based corporations on their global earnings – regardless of where those earnings are derived – other countries often impose no tax whatsoever on earnings from foreign sources. This gives the company the ability to not only lower its marginal tax rate, but also to exclude a large portion of its earnings from taxation altogether.

Yet another benefit to reincorporating abroad pertains to overseas assets. U.S.-based multinational corporations have approximately $2 trillion sitting in offshore holding companies that they cannot repatriate. Since these funds represent accumulated earnings, the companies would be required to pay tax on the amounts transferred upon moving them into the U.S.

A multinational corporation could get around all three of these tax problems by engineering a corporate inversion. It is even possible that a company that has no operations outside the U.S. whatsoever could also accomplish a corporate inversion simply by acquiring a major foreign operation in a tax-friendly country.

How Corporate Inversions Affect Us

From a national standpoint, the biggest negative effect of corporate inversions is a reduction in corporate income tax revenue. That puts a higher burden of revenue collection on individual taxes, as well as on increased borrowing by the U.S Treasury.

For example,  earlier this year, Walgreens Boots Alliance (WBA) – then Walgreens – had contemplated a corporate inversion, that ultimately did not happen. However, it was estimated that the tax cost of such a move would result in the loss of $4.6 billion in potential tax revenue over just five years.

Corporate inversions, among other legal corporate tax dodges, are having an effect on U.S. tax revenue. While corporate and individual income tax revenues were roughly equal up until World War II, individual income taxes now represent 46% of U.S. tax revenue, while corporate income tax represents just 13.5%.

How Common are Corporate Inversions?

Seventy-six U.S. multinational corporations have reincorporated in lower tax countries since 1982, and the trend seems to be increasing. From 1983 to 2003, there were a total of 29 corporate inversions; between 2004 and 2014, 47 more companies joined the ranks.

Ireland, with its very low corporate income tax rates is the most common destination, followed by the United Kingdom, the Netherlands, Canada, Australia and Germany. Companies participating in corporate inversions include household names, such as Herbalife Ltd (HLF), Tyco International (TYC) and Ingersoll-Rand PLC (IR).

Given the impact of corporate inversions, both financially and as a matter of national pride, there is a ground swell of interest in limiting the activity. However, since corporate inversions have been taking place for well over 30 years, attempts at restricting it have been limited at best. Though much noise is made about taking action, particularly from politicians, the end result thus far has been business as usual.

Last September, the U.S. Treasury Department issued new rules in an attempt to discourage U.S.-based companies participating in corporate inversions. They revised several sections of the tax code to make it harder for companies to move their tax headquarters offshore.

Among the revisions are a ban on hopscotch loans. These are loans that companies make to a new foreign parent company to avoid U.S. taxes on repatriated foreign earnings. The Treasury has also moved to stop companies from restructuring foreign units to access deferred earnings without paying taxes. These are two among several tax changes that the Treasury hopes will stem the tide of corporate inversions.

The ultimate solution, however, would be for the U.S. to lower its corporate income tax rate to levels consistent with those in other developed countries. However, at present there seems to be little motivation in Congress or the White House to make that kind of change.

Examples of Major Corporate Inversions

Two recent, prominent examples of corporate inversions involve Eaton Corporation PLC (ETN) and Medtronic PLC (MDT). In 2012, Eaton Corporation moved its corporate headquarters from Cleveland, Ohio, where it had been since 1911, to Dublin. The move came about as a result of Eaton’s purchase of Ireland-based Cooper Industries for nearly $13 billion.

Medtronic, the world’s third-largest medical device company, moved its international headquarters to Dublin, Ireland, in January 2015. Though the company operated out of Minneapolis, Minnesota since its founding in 1949 and continues to maintain its operational headquarters there, it is now legally considered to be an Irish corporation. Medtronic was able to accomplish this through the acquisition of Irish device maker Covidien, PLC for nearly $49 billion.

The Bottom Line

If current trends are any indication, we should expect more companies to enter into corporate inversions for all the same reasons: lower corporate tax rates, bypassing marginal tax rates and no taxes on overseas assets.

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