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