Can Corporate Tax Inversions Harm the Economy?

Can Tax Inversions HarmtheEconomyThe chief financial officer of drugstore giant Walgreen’s just departed his job. And while the movements of higher ups at megacorporations often resemble a round of musical chairs, this particular job change sheds light on a new trend in corporate tax evasion: tax inversion.

Tax inversion is a milk toast term for a sweeping strategy that’s being increasingly embraced by large and some mid-size American corporations: partner with a foreign corporation, dissolve the US business and reincorporate it outside the country. While technically legal, this kind of move worries entities like the US Joint Committee on Taxation, which estimates that tax inversions cost the country – and its taxpayers – nearly $20 billion annually.

Tax Inversion Exploits Tax Code Loopholes

US corporate taxes are among the highest in the world, so it’s no surprise that businesses of all sizes are constantly looking for ways to avoid the hit. And while proposals for business tax reform have been on the table for over two years, Congress still hasn’t taken action on reforming the code in ways that would benefit the economy as a whole and create a more equitable tax structure.

But the existing code does come with loopholes that savvy corporate lawyers can exploit. And one of those is a provision that creates tax benefits, not liabilities, for companies that acquire foreign corporations and then declare that they’re based overseas.

At Walgreen’s, the departure of CFO Wade Miquelin came just before the company announced its intention to acquire Alliance Boots, a Switzerland based company that has no apparent connection with pharmacies. That acquisition lets Walgreen’s reconstitute its corporate headquarters abroad – and shed a large portion of its US corporate tax burden.

Offshore tax havens aren’t new, of course. Putting US money into foreign accounts to stash it safely away from the taxman is a time-honored practice conducted by businesses large and small – as well as numerous criminal organizations. But as that strategy gets riskier, corporations are taking a different tack – recreating their corporate identify itself outside the country. Making it easier: the ability to buy up, merge or partner with an existing company in that foreign country.

Tax Inversion and Domestic Tax Revenue

The result? The new entity on foreign soil doesn’t pay corporate taxes at home on profits made through its reincarnated, offshore, version. And that, obviously, means that tax revenue ends up conspicuously absent from the domestic tax base – a scenario with the potential to affect the health of the economy and the lives of American taxpayers in a multitude of ways large and small.

According to a recent Forbes article, the immediate impact of tax inversion is felt by company shareholders, many of whom are smaller investors. If they’re left holding the bag of nearly useless shares after the company moves offshore, they may end up selling off their shares of the company’s stock at a loss – and paying the higher taxes imposed on short-term capital gains.

That’s what happened with the recent merger of US based Forest Laboratories with ActivusPLC in Dublin. Forest Laboratories closed its US operations and reinvented itself in Ireland, leaving Forest Laboratories company shareholders to cope with unloading their shares and paying the resulting capital gains taxes at the higher short term rates.

That multibillion dollar tax loss, say financial experts, also robs the country of needed funds to keep the economy humming and boost sectors such as employment and maintaining the infrastructure. But not everyone agrees.

Although corporations practicing tax inversions are able to evade taxes on revenues made outside the country, they still must pay standard US corporate taxes on revenues fro inside the US. That, some economists argue, offsets the overall loss of tax revenues. And, they say, the process itself oaf dissolving and reincorporating the company brings with it taxes and fees that return to the government.

Joining the criticism of tax inversion are supporters of the President’s recent proposal, which has languished since 2012 without government action. They say that the current loophole that allows for inversion stacks the decks against those businesses that aren’t able to accomplish a foreign merger and restructuring, and robs the country of much needed revenues for essentials like road and bridge repair and emergency response funding.

Closing the Loopholes With Tax Reform

The proposed corporate tax reforms would make it harder for a US-based company to reinvent itself as a foreign entity and continue to enjoy the perks of its US based operations. Foreign shareholders would have to hold a majority in the new entity, rather than the 20 percent now required. Those provisions were part of an earlier bipartisan proposal made back in 2004, and reform advocates hope that the changes will survive.

In the meantime, though, tax inversion remains a hotly debated issue. And as more US corporations enter into unlikely partnerships with foreign businesses for the purposes of avoiding US corporate taxes, the ultimate effect on the economy overall may be more uncertain than it first appears. But financial experts warn that because changes to the tax code won’t be coming any time soon, corporate tax inversion will affect the nation – and its taxpayers – in ways large and small.

(Top image: Flickr/KevinFowler)

Sources:

Madhani, Amer. ”Walgreen’s CFO Departs Ahead of Tax Inversion Announcement.” USAToday Finance. usatoday.com. 5 Aug 2014.

Wastall, Tim. “The US Treasure Would Not Lose $20 Billion From Corporate Tax Inversions.” Forbes. Forbes.com 5 Aug 2014.\

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