Congress fiddles while Treasury burns

Original Reporting | By T.J. Lewan |

June 25, 2014 — Corporate “inversions,” as they’re known in accounting parlance, are transactions in which U.S. corporations take over smaller foreign rivals from low-tax countries and allow those rivals to replace the American firm as parent of the corporate group. On paper, the newly incorporated entity — though controlled by Americans and headquartered in America — appears to be foreign, and thereby can avoid paying U.S. corporate tax.

The bill represents a “major disincentive for corporations looking to invert primarily for tax benefits.” — Edward Kleinbard

Few members of Congress will admit to being sanguine about these tax ploys: Congress’ bipartisan Joint Committee on Taxation projects $19.5 billion of tax revenues lost to inversions over the next 10 years, a dismal prospect for a country with a strained social safety net already struggling to balance its books.

When and how to stop companies from renouncing their U.S. “citizenship” — that’s where opinions diverge. Republicans refuse to act outside of a broad makeover of the tax code, which they say should include lowering the domestic corporate rate and scrapping taxes on profits generated by U.S. companies overseas. Some Democrats, while not discounting the need for broad reforms, want to stop inversions immediately before any more corporate tax revenues find their way offshore; many others, however, appear content to stand by and watch while the corporate tax base erodes further.

Companion legislation introduced in Congress in May by Michigan Democrats and brothers Sen. Carl Levin and Rep. Sander M. Levin, the “Stop Corporate Inversions Act of 2014,” would stop the bleeding, disallowing any more inversions for at least two years while Congress retools what everyone agrees is an outdated tax code. (The Senate version includes a two-year expiration date to stop the expatriation of companies while Congress works out a “grand bargain” on tax reform. The House version of the bill would stop the practice permanently.)

The bill, which mirrors a proposal in President Obama’s 2015 budget, wouldn’t be the first time Congress took on inversions; in 2004, legislation to deter companies from doing this was signed into law by President Bush. But if that effort was a STOP sign to companies looking for ways to avoid paying taxes, this bill appears to be the equivalent of a concrete divider placed across a highway, for it strengthens the current law in three ways: First, through a more stringent “shareholder” test; second, through a new “business activities” test; and finally, through an unprecedented “headquarters” test that would require companies to move most of their executives and management overseas if they wanted to escape U.S. taxation.

The $19.5-billion question is: Will it work? Is this the best way to get after corporate deadbeats and stop the erosion of the U.S. corporate tax base? Or will companies find loopholes in this legislation or other means to dodge the taxman?

Consulting with international tax experts, economists, lawmakers, and others, Remapping Debate found an overwhelming consensus on three points:

First, the Levin bill is, indeed, close to “loophole proof” and would likely save the Treasury billions of dollars for years to come; second, it would reduce the competitive disadvantage that smaller U.S. companies suffer to large, well-heeled multinationals able to exploit overseas tax havens to amass profits; third, the more time passes without legislative action, the more inversions we are likely to see.

And yet, though new inversions are in the offing, our sources unanimously said the Levin bill is not likely to be voted on this year.


Inversion parade

A decade ago, when a parade of corporate inversions last provoked a public outcry, it was easier for corporations to get out of paying taxes by claiming they were an overseas concern. Essentially, all that was needed was a drop box or a shoebox-sized office staffed by a night watchman in a low- or no-tax country like Bermuda or the Cayman Islands. Typically, they would identify themselves as foreign when they filed their taxes, even though they operated as they always had: policy decided by the same U.S. executives, on behalf of the same shareholders, from the old U.S. headquarters.

Though Democrats publicly grouse about tax loopholes for big corporations, many appear content to stand on the sidelines while inversions go on. In the Senate, where they have a majority, fewer than half of all Democrats are co-sponsors of Levin’s bill.

In 2004, Congress added Section 7874 to the Internal Revenue Code. It compelled companies seeking to reincorporate overseas to merge with or acquire international companies at least a quarter of their pre-merger size. Likewise, it mandated that foreign shareholders of the combined company wind up with at least 20 percent of the newly created firm’s stock through the merger.

Inversions abated for a time, but by 2011 they were back in vogue, with many U.S. corporations merging with firms big enough to meet the 20-percent stock threshold but too small to actually control the new entity. (Indeed, 14 of the 41 U.S. companies that have reincorporated overseas to lower their tax bills have done so since 2011; Medtronic Inc., the medical device manufacturer that aims to invert to Ireland, is one of many more in the pipeline.)

The Levin bill aims to modify Section 7874 to raise the foreign stockholder threshold above 50 percent – a change that represents a “major disincentive for corporations looking to invert primarily for tax benefits,” as Edward Kleinbard, a professor at the University of Southern California’s Gould School of Law, put it.

Kleinbard, who has served as chief of staff on the U.S. Congress’s nonpartisan Joint Committee on Taxation, said that were the Levin bill adopted, “you’d have to find a foreign merger partner that’s 101 percent bigger than your company, not one that’s just 25 percent of your size. That’s a huge difference.”

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