Tax Inversion

How U.S. Companies Buy Tax Breaks

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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. Now it could become an Irish firm, helping it to escape U.S. income 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 peculiarities of the U.S. tax code and has enjoyed a resurgence in the past few years among American companies. Pfizer would be one of the biggest and best known to try to join the trend.

The Situation

About 51 U.S. companies have reincorporated in low-tax countries since 1982, including 20 since 2012. 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 and how Burger King, the Miami fast-food chain, became Canadian. In 2014, Pfizer wanted to go British, though its proposed takeover of AstraZeneca was eventually rejected. Now it’s agreed to combine with Allergan, the Ireland-based pharmaceutical company, in a $160 billion deal. 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
Source: Data Compiled by Bloomberg

The Background

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 their worldwide income —  although they can defer the bill on profits attributed overseas until they bring the money home. 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. Most importantly, perhaps, companies that invert overseas can take advantage of the generous U.S. system of interest deductions for payments to their own affiliates abroad — benefits that are only available with a foreign parent company.

The Argument

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 any time soon. 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.

The Reference Shelf

  • Bloomberg News articles on how Congress created a new windfall for CEOs who invert, and how most CEOs of inverted companies continue to run them from the U.S.
  • Bret Wells of the University of Houston Law Center argues for tax reform in a 2012 article, “Cant and the Inconvenient Truth About Corporate Inversions.”
  • A paper by Elizabeth Chorvat with an account of the history of corporate inversions (beginning on p. 4).
  • Bloomberg Best (and Worst) ranking, “Biggest Companies Incorporated in Ireland,” notes that 12 of the top 20 had roots in the U.S.
  • The Pulitzer Prize website has links to the Bloomberg News articles that were honored for explanatory reporting in 2015.

(This QuickTake includes a corrected reference to the year of the first Pfizer inversion proposal.)

 

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Source: Data Compiled by Bloomberg
Source: Data Compiled by Bloomberg

First Published May 27, 2014

To contact the writer of this QuickTake:

Jesse Drucker in New York at jdrucker4@bloomberg.net

To contact the editors responsible for this QuickTake:

Jodi Schneider in Tokyo at jschneider50@bloomberg.net

Anne Cronin at acronin14@bloomberg.net