New steps by the Obama administration are designed to slow the trend of corporations shifting their legal address overseas, lowering their tax bills in the process.
It’s a problem that has grabbed news headlines this year as a string of US companies, from pharmaceutical firms to the restaurant chain Burger King, have announced plans in which merging with foreign firm allows them to shift their domicile – and tax burden – overseas.
It’s called “tax inversion,” or corporate inversion, because the official identity of the company flips overseas, even though the bulk of its operations and leadership may remain in the US.
What makes perfect sense for companies – at least to corporate bean counters focused on tax liabilities – threatens the US Treasury with the loss of billions of dollars in revenue and has been labeled by President Obama as unfair.
The Obama Treasury Department can’t turn off the inversion spigot unilaterally. The steps announced Monday merely buy a little time for Congress to reform a corporate tax that lately seems to be driving business away rather than luring new investment to US shores.
What the Obama administration announced, to reduce the appeal of tax inversions, are several regulatory tweaks:
- Making it harder to invert in the first place, by strengthening a requirement that owners of a US entity must own less than 80 percent of the new combined entity.
- Cracking down on “hopscotch loans,” by which a company combines the inversion strategy with inside-the-company loans to give the US firm lower-tax access to earnings from abroad.
The moves won’t be retroactively applied to corporations that already have completed inversions, but they will apply to firms that have made announcements but have not yet completed the transactions.
Some affected firms saw their stock prices fall in response to the news.
Still, it’s not clear how big an impact the Treasury actions will have. For one thing, businesses might fight back in court. For another, it’s not unusual for tax lawyers to respond to new rules by finding ways around them.
Finally, some inversions will still make financial sense with the new regulations in place.
Both Obama and Republicans in Congress agree the real answer is to overhaul an outdated corporate tax code. But the two sides remain far apart, at least for now, on how to do this. With elections just weeks away, legislation is unlikely before next year.
Finance experts have little doubt about the need to act.
"With the highest corporate income tax rate among [advanced] nations and the double taxation of international operations, the United States with its tax code has made itself increasingly uncompetitive as we vie for companies to locate and to expand operations here,” writes Michael Faulkender, an associate professor of finance at the University of Maryland.
He says it’s possible to lower corporate tax rates in a way that attracts business investment and keeps firms in the US, while ensuring through other tax changes that the US Treasury gets the revenue it needs to pay the government’s bills.