Tax Inversions: a Quick Guide

by April 15, 2016
Jack Lew Dept Treasury

Treasury Secretary Jack Lew announced changes to tax inversion rules earlier in April. Photo via U.S. Treasury Department.

The trend to move corporate headquarters overseas has been growing since the 1980s. But earlier this month, President Obama lauded new U.S. Treasury Department rules that make tax inversions less appealing to multinational corporations.

Here is some basic background on inversions in case you find yourself covering corporate tax inversions and their implications.

Tax Inversions and the New Rules

In early April, the U.S. Treasury Department set new guidelines attempting to curb these so-called tax inversions. According to the Treasury Department, tax inversions are when U.S. corporations relocate their tax residence to countries with lower corporate tax rates after a foreign corporation acquires the U.S. company to reduce the U.S. tax burden on profits earned outside the U.S.

Corporations headquartered here in the U.S. are taxed on all profits, foreign or domestic, at the U.S. tax rate of 35 percent. When a company merges with one headquartered in another country, and the resulting new parent company declares its tax residence abroad, it’s no longer on the hook for foreign profits at the U.S. tax rate. However, all operations within the U.S. can remain virtually unchanged.

In order to prevent corporations from reducing tax liabilities through loopholes like these legal, but murky inversions, the Treasury Department plans to investigate what’s known as “serial inverters.” The department also plans to better target corporations that use foreign tax residence to artificially shift profits outside the U.S. and skirt our tax rate through complicated internal loans between subsidiaries known as “stripping.”

For more on the intricacies of inversions and the new Treasury Department rules, you can consult the U.S. Treasury Department’s plan.

The Pfizer Deal and Other Inversions

Following the announcement, pharmaceutical giant Pfizer scrapped a planned merger with Allergan, whose tax residence is now in Ireland, where the tax rate is 14 percent.

Irish pharmaceutical company Actavis bought Allergan in 2013 and the company based in New Jersey moved its tax residence to Ireland. Pfizer and Allergan had been in months-long talks about a merger. But the $150 million deal between Allergan and Pfizer came to a halt when the treasury announced it would crack down on so-called serial inversions.

Big Pharma isn’t the only industry taking advantage of these tax maneuvers. After its merger with Tim Hortons, Burger King’s profits in Canada are taxed at the Canadian corporate tax rate, saving the merged company an estimated $117 million in foreign profits, according to one report.

Policymakers on Inversions

Republicans and Democrats have varied responses to the move. At the national level, Democratic presidential candidates Hilary Clinton and Bernie Sanders have plans to address the trend. Clinton proposed an “exit tax” on companies inverting offshore while Sanders supports a plan blocking inversions, or taxing inverted companies, as U.S. corporations. GOP candidates Donald Trump and Ted Cruz have also come out strong against inversions, but cite the U.S.’ unfriendly tax code. Their plans would lower the U.S. corporate tax rate in hopes of making the country more competitive globally.

Congressional Research Service released a policy brief on tax inversions and possible policy solutions last year. The report notes that more than 75 corporations have inverted to save on tax expenses since 1983. Democrats in the Ways and Means Committee are pushing for a legislative solution that would better regulate, and even block, some inversions. Most Congressional Republicans agree with the GOP presidential candidates and support lowering the corporate tax rate.