Here's the Dirty Secret of Tax-Dodging Corporate Inversions

On the Money Drugstore Loyalty Cards
Richard Drew/APWalgreen opted against a well-publicized inversion.
Corporate inversions -- when a U.S. company buys or merges with a foreign firm and then technically moves the business to the other country -- have become something all politicians can happily revile. With their two-targets-in-one opportunity to bash either corporate greed or traitorous antipatriotism, Democrats and Republicans alike have an easy target to take aim at.

So, the media rails over corporations that seek to extricate themselves from their tax obligations even as the Obama administration cracks down on companies moving overseas, as The Associated Press has reported. But there's a dirty secret: Much of what people think they know about corporate inversions is wrong and, in the grander scheme of things, inversions are small potatoes in the tax-avoidance world.

"Inversions have been made into this political, moral issue, which sometimes clouds the reality," tax attorney Elan Keller of the law firm Caplin & Drysdale told DailyFinance. "Companies invert for a number of reasons ... having little to do with tax. It just so happens that in inverting they've been able to create a tax benefit. But there has to be [a bigger] underlying business reason to invert. Otherwise shareholders or the board aren't going to agree to it."

'Misrepresentation' of the Walgreen Case

"The mega example that a lot of people had visceral reactions to was Walgreens (WAG)," said Martin Press, a tax attorney with the law firm Gunster, Yoakley & Stewart. "There's been a lot of misrepresentation. If Walgreens had gone ahead and done this, it would not have affected the income tax liability of its U.S. operations. They would pay as much U.S. income tax as they would have before."

Any company operating in the U.S. has to pay taxes on the profits it makes here. In addition, domestic companies pay taxes on their global profits. They get a credit on the tax they pay foreign countries for profits from those regions, but with our relatively high 35 percent corporate income tax, that still means a hefty additional chunk for the feds.

But a common technique used by these businesses already keeps much of that potential tax revenue out of the coffers of the Internal Revenue Service. Let's say a U.S. company owns foreign subsidiaries that do business on its behalf in other countries. So long as the profits of those companies are never repatriated home, this so-called active business income remains out of the Treasury's reach, according to Eric Toder, an Institute fellow at the Urban Institute and a co-director of the Urban-Brookings Tax Policy Center. "Lawyers tell me they're pretty successful at stripping income out of the U.S.," Toder said.

2003 Congressional Action Made Inversions More Difficult

Also, contrary to popular belief, inversions have already gotten much tougher to implement. "The benefits of inverting were greater before 2003," said Julie Bradlow, a tax attorney with Moore & Van Allen. That was the year Congress closed some major loopholes.

Inversions still certainly can have significant tax benefits. Depending on a company's global structure, new holdings in other countries might not be taxable in the U.S., even though previously created subsidiaries might be. And there are complex maneuvers they can employ, such as having a foreign parent loan money to the new subsidiary in the U.S. The company here gets a tax deduction for paying interest on the loan, lowering its tax burden, even though the interest paid stays in the corporate family. "If you do this inversion, you can strip earnings [out of the U.S.] more successfully," said Kimberly Clausing, a professor of economics at Reed College.

%VIRTUAL-pullquote-"Inversions themselves are a symptom of the sort of arbitrariness of the tax code." - Kimberly Clausing%But when it comes to legal tax dodges, inversions aren't the strongest move. Looking at various congressional proposals to reduce what is possible, "the [United States Congress Joint Committee on Taxation] has scored the legislative proposals as raising $20 billion over 10 years," Toder said. "That's less than 1 percent of projected corporate receipts." Clausing agreed, pegging her estimate of the revenue lost from corporate tax avoidance at $90 billion a year. "And inversions are probably less than 10 percent of that," she said.

"Inversions themselves are a symptom of the sort of arbitrariness of the tax code as it is now and some of the ways it's not working," Clausing said. "Ideally we'd like a tax code that didn't have such arbitrary distinctions based on simple accounting and legal shenanigans."

But that would take political will across parties, and not just in Washington. Tax jurisdiction shopping and shifting happens because competing countries use their tax policies as a way to attract companies, jobs and revenue. Until politicians, and their constituents, understand that we're all playing a losing game, nothing substantial is likely to change.

Top 10 Tax Cheaters of the Past Decade
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Here's the Dirty Secret of Tax-Dodging Corporate Inversions
As if his $65 billion Ponzi scheme and serving a 150-year federal prison sentence for it wasn't enough, prosecutors in January 2014 revealed an IRS analysis showing Madoff didn't report $242.9 million in federal taxes from 1993 through 2007. Some of his former employees are also accused of having unreported income, one as high as $3.5 million.
Wilson, the self-proclaimed "First Lady" of tax fraud, was sentenced in July 2013 to 21 years in prison, according to an IRS list of top cases it prosecuted focused on identity theft. Wilson, then 27, of Tampa Bay, Fla., was also ordered to pay $2.2 million. Larry was sentenced to 14.5 years in prison and ordered to forfeit $2.2 million. From at least April 2009 through their arrests in September 2012, the pair fraudulently obtained tax refunds by receiving U.S. Treasury checks and pre-paid debit cards loaded with proceeds from false tax returns they filed in the names of other people without those persons' permission or knowledge, according to the IRS. Wilson boasted on Facebook that she was untouchable and spent lavishly, including $90,000 on an Audi A8 and $30,000 on her son's first birthday party.
In May 2012 the leaders of a multimillion dollar fraud ring were sentenced to 334 months (Dale) and 310 months (Grant) in prison and ordered to pay more than $2.8 million in restitution to the IRS. From 2009 through 2010 they filed false tax returns using stolen identities. Dale admitted to filing more than 500 fraudulent returns that sought at least $3.7 million in tax refunds, using the names of Medicaid beneficiaries that Dale obtained while working for a company that serviced Medicaid programs.
In February 2014, Hilton, 68, was among 13 people indicted in Los Angeles and Riverside counties in California for using stolen identifies to file fraudulent tax returns. Hilton's tax scheme sought nearly $2.9 million in fraudulent tax refunds for the 2008 tax year. Hilton owns two tax preparation businesses
The doomsday prophet from Cincinnati was convicted in June 2012 of five counts of tax evasion for not paying more than $300,000 in taxes between 2005 and 2010. He funneled money into a foreign bank account, lied on his tax forms and wrote off personal expenses as church expenses, a grand jury found. Weinland has wrongly predicted the world would end a few times.
The former chief administrator of the small California city of Bell, Rizzo was sentenced in April 2014 to 33 months in federal prison for tax evasion. He also faces 10 to 12 years in prison on 69 corruption counts. He was ordered to pay nearly $256,000 in restitution to the IRS after pleading guilty in January to federal counts of conspiracy and filing a false federal tax return. Rizzo paid himself as much as $1.1 million as Bell's top administrator before he was fired in 2010. Federal prosecutors say that from 2005 to 2010 he claimed more than $770,000 in phantom losses on his tax returns. 

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