More and more U.S. companies are taking advantage of a tax strategy called a corporate inversion, more commonly known as a tax inversion. Under the U.S. Tax Code, a company may relocate its corporate headquarters on paper to a nation with a lower income tax rate, while maintaining operations in the United States.
Why are more companies using this strategy to minimize their tax liabilities? The United States is unique, in that we alone tax the repatriation of the profits U.S. companies conducting business overseas at a top marginal rate that hovers around 40 percent. Combined with the fact that income U.S. companies earn is already taxed in the nation in which it is earned, many U.S. companies are caught in a double taxation trap.
In other words, if U.S. companies conducting business overseas want to bring the money they earn back to the U.S., they are subject to both the taxes they have already paid overseas and additional taxation when that money is repratriated.
This creates huge incentives for companies to take advantage of corporate inversions and relocate to countries such as Ireland, the U.K. and the Netherlands, all of which have more reasonable top marginal income tax rates, ranging from 12.5 percent in Ireland to 25 percent in the Netherlands, according to the accounting firm KPMG Global.
While the practice is legal, many prominent financial figures worry about the potential implications to the domestic tax base, most notably Secretary of the Treasury Jack Lew and Warren Buffet (Wall Street Journal). Many politicians are concerned about the immediate consequences stemming from the loss of tax revenue, and the long-term consequences of the erosion of the U.S. tax base. President Obama has gone as far as saying that he is considering using executive action to stem the tide of American companies leaving U.S. shores according to USA Today.
Congress is trying to take action. According to Bloomberg, Senator Chuck Schumer, the third most powerful Democrat in the Senate, has drafted a proposal to make inversions less attractive to U.S. companies. If Congress were to pass the law (which at the present seems highly unlikely), companies that have engaged in a tax inversion in the last 20 years would only be able to deduct interest on 25 percent of the foreign debt incurred in the process of a tax inversion, as opposed to the current 50 percent deductible limit.
Robert Willens, a tax professor at Columbia University’s Graduate School of Business, told Bloomberg, “[The proposal] would have a very profound and immediate effect on these companies and would be very effective at reducing the attractiveness of inversions.”
Prominent companies such as Medtronic, AbbVie and even Cleveland-based Eaton Corporation would be heavily affected by the proposed reforms. Companies that have used a tax inversion to relocate their corporate headquarters would face heavier tax bills as a result of Schumer’s proposal. But will penalizing companies that have already relocated to overseas addresses really discourage others from following suit?
Editor’s Note: Information from KPMG Global, The WallStreet Journal, Bloomberg.com and USA Today was used in this article.