Corporate Inversion (tax inversion)

Corporate inversion, often referred to as tax inversion, is a strategy employed by companies to reduce their tax liabilities by relocating their legal domicile to a country with lower corporate tax rates, while maintaining operations in their home country. This practice has gained attention, particularly in the United States, where high corporate taxes prompt some firms to seek more favorable tax environments abroad. Companies engaging in corporate inversions typically merge with or acquire foreign firms to facilitate this relocation process.

The motivations behind corporate inversions often include significant tax savings, enhanced competitiveness, and improved shareholder value. However, this practice has sparked debates over ethical implications, as critics argue it undermines the tax base of the countries from which these companies originate, potentially leading to job losses and reduced public services. Proponents, on the other hand, contend that corporations have a responsibility to maximize shareholder returns and navigate the complexities of global taxation.

Governments are increasingly scrutinizing corporate inversions, leading to legislative measures aimed at curbing such practices. The landscape surrounding corporate inversions continues to evolve, influenced by changes in tax policy and global economic conditions, making it a relevant topic for those interested in corporate finance and taxation.

Published in: 2021

By: Joseph Dewey, PhD

Subject Terms

Corporate Inversion (tax inversion)

Last reviewed: February 2017

Abstract

“Corporate inversion” is a tax management strategy in which a U.S.-based company acquires or combines with a facility overseas, then reincorporates, naming the overseas facility as its corporate headquarters, de facto making its U.S.-based facilities subsidiaries of the overseas company. By relocating its corporate headquarters overseas (at least on paper), that company is no longer required to pay corporate taxes to the federal government. Because the corporate tax in the United States is the highest among developed industrialized countries (at 35%), corporate inversion is widely perceived as a justified strategy for a major company to maximize its profit margin.

Overview

At the center of the corporate inversion strategy is the difficult question concerning the specific responsibility CEO’s and financial officers hold to the investors and stockholders in that company. By law and by tradition, this senior administrative staff is obligated to maximize the company’s profits as a way not only to maintain corporate operations but also to protect its jobs and to ensure that the business keeps growing in competition within the free market.

In the business world, there is no such thing as an American company—only a company with operations physically in the United States. A company is a construct designed to make money for itself and for its staff. Anything a company can do within the bounds of the law to enhance that bottom line is viewed as acceptable fiduciary strategy. A corporation traditionally has three general strategies for enhancing its operations and maintaining a tight control over its bottom line. It can:

oversee its day to day operations with meticulous scrutiny to look for opportunities to trim waste and/or make the operations more efficient;
review staffing and job descriptions and look for opportunities to trim staff, combine responsibilities and/or positions, and/or convert elements of its operations to automated processes and, in turn, eliminate redundant jobs and redundant tasks and high-end human resources; and
maintain a close watch on its expenses, maximizing the elimination of wasted revenue that does not directly impact production and/or operations. Under that last rubric, company financial executives are directly charged with scrutinizing all expenses for potential trimming, including tax payments to the federal government.

In large part because the United States offers companies access to one of the most flexible and available consumer markets for goods and services, and because of the abundance of the continent’s natural resources and its utilities grid, and because the United States has one of the world’s largest and most educated workforces, companies, interested in being part of that beneficial economic landscape, have agreed to pay a hefty tax on their revenue. Currently that tax is at 35 percent, the highest tax rate of any free market country. Ireland, by contrast, taxes corporations at a 12 percent rate; the Netherlands, 20 percent; and Canada, 15 percent.

Although many of these large U.S.-based companies maintain a healthy profit margin, concerns over what is perceived to be the exorbitant U.S. business tax rate led these companies to explore the possibilities of exploiting a little-used and little-known loophole in the federal tax code that allows for a company to merge with a company overseas and/or relocate its corporate structure overseas and not be taxed the standard corporate rate, in fact not be taxed at all by the U.S. government. The idea, in the decades leading up to World War II, was to encourage American businesses—many struggling to shake off the devastating impact of the Depression—to expand their markets and to share American technology and American business savvy with developing countries.

Corporate expansion overseas was expected to operate as a kind of unofficial diplomacy that would, in turn, make the American way of life an element of the economic stability and cultural landscape of these developing nations while at the same time helping American businesses. Few of the architects of this tax loophole could envision corporations voluntarily renouncing their American citizenship as an entirely legal tax dodge.

Beginning in the last decade of the twenty-first century, in the wake of the revolution in digital technology that so greatly simplified international business transactions and made global business quite easy to conduct, major corporations headquartered in the United States began to explore the possibility of skirting what was perceived to be an onerous tax burden by simply relocating corporate headquarters in countries with far friendlier corporate tax rates—or at least appearing to do so on paper. Although relocating the entire operations would be impractical, moving the top corporate structures would be relatively simple, particularly if the company already maintained an economic presence in that country (Yang, 2016). Creating an essentially paper company would be even easier.

By moving the administrative offices and then filing some basic government tax paperwork, an U.S.-based corporation could legally claim it was now an international company with operations in the United States. Of course, this “corporation” was entirely a paper construction—the facility and its operations remained in the United States. The company maintained at best a skeleton staff of executive administration overseas. If the concept of inversion implies a reversal of the norm, here the corporation was, metaphorically, upended, its executive operations apparatus turned topsy turvy—hence, the word inversion.

For a company, if its operations are significantly large enough, there is no apparent downside to this relocation/reincorporation strategy. U.S. tax laws allow for corporations to be taxed for any revenue, generated either domestically or internationally. Therefore, as a company succeeds and expands its operations and, in turn, its revenue, it faces higher taxes and is in fact taxed twice. So, from a business perspective, the question is more why wouldn’t a company pursue reincorporation overseas and thus entirely eliminate the taxes being paid to the federal government? Any global company must in fact pay the American taxes and any taxes levied by countries where they do business.

At any event, corporate inversion is legal, an element of the tax code itself; thus it is actually sanctioned by the federal government. Companies are not attempting to hide income and are not creating elaborate illegal tax shelters. The process is not only legal but also, from a company perspective necessary as a way to maximize every opportunity to shore up its income margins. If executives were willing to relocate and staff operational headquarters or purchase small facilities in related fields in, say, tax-friendly Ireland or the Netherlands or Canada, that company faces few real problems.

Corporations have long sought better economic environments in other countries for elements of it operations. Given the reality of web-based operations that have long since made international operations the status quo, these businesses actually change very little in their operations by reincorporating but save millions of dollars annually in taxes.

Further, the company that opts for inversion does not face the sort of public relations nightmare that often accompanies a decision to outsource elements of its operation overseas. With corporate inversions the elaborate legal maneuvering by the companies receives little press, and no jobs are lost. In fact, companies argue, American jobs stand to be increased as the company realizes wider revenue streams by lifting a large share of its tax burden. Only a relatively small number of executives would actually be relocating, and many of these U.S. executives maintain their American citizenship and their American residences and treat any temporary overseas assignment as more of a perk.

The real loser is the federal treasury. Indeed, Congressional investigations into corporate inversions in 2014 estimated that more than $19 billion dollars was being siphoned off annually through corporate inversion strategies; private economic research foundations suggested that the actual number was considerably higher, as much as double. Government estimates suggest that between 2005 and 2012, forty-two U.S. companies reincorporated overseas. Among the most prominent included the medical equipment developer Medtronics (to Ireland); the pharmaceutical giant Mylan (to the Netherlands); playground equipment supplier PlayStar (to Antigua); apparel manufacturer Fruit of the Loom (to the Cayman Islands); food conglomerates Chiquita (to Ireland) and Sara Lee (to the Netherlands); fast food giant Burger King (to Canada); and the home security systems giant Tyco (to Ireland) (Johnston, 2014).

These companies are not interested in forgoing the obvious advantages of operations in the United States. In the United States, these companies enjoy a reliable and stable government structure; patent protection; local and government monies for research and expansion; the expectation of intellectual property patent rights; a workforce, and of course the access to the lucrative American buying markets. This so-called stateless paradise, in which companies are not quite there and not entirely here, enables companies to reap the domestic benefits of a U.S. company without paying corporate taxes.

Further Insights

The idea behind corporate inversion is simple: increase profits. The preferred strategy for corporate inversion is for a major company to simply purchase outright a small regional company in the country of choice, a company that is at least marginally related to the major company’s production operations. The U.S. company files the paperwork to merge and de facto becomes a subsidiary of its smaller regional acquisition. As a subsidiary of a foreign-based company, these U.S. companies, despite maintaining their considerable physical presence in the United States, are considered foreign businesses.

The logic, of course, is patently absurd. Major American companies with major workforces, sometimes thousands of Americans, and major facilities in the United States become legally branch operations of a minor company overseas. Many of these same major corporations have long benefitted from significant tax breaks from state and local governments; they have received significant consideration for government contracts; and they have taken advantage of a fundamentally business-friendly tax code, and yet the substantial profits enabled by an American market and workforce, but must be maximized further using an absurd trick to evade paying taxes as individual citizens must.

Viewpoints

Given the polarizing environment of American politics since the turn of the millennium, corporate inversions themselves, not surprisingly, have become a major political football. Beginning in 2012, after the midterm elections that saw the rise of the Republican Right in both houses of Congress, the Barack Obama Administration began to call publicly for Congressional action against companies attempting to exploit the loophole in the tax code.

President Obama decried the practice, essentially calling out the companies as anti-American and corporate deadbeats, fleeing their own country just to make money, in effect renouncing their citizenship and their allegiances in pursuit of greater profits but, hypocritically, all too willing to take advantage of the business-friendly culture in the United States. As he said, “My attitude is, I don’t care if it’s legal. It’s wrong” (Mider, 2014). Obama called for a federal law that would mandate that a company actually move if it declared itself an overseas corporation. At least 50 percent of the company’s operations would have to relocate overseas in order to be exempted from the federal tax rate.

For corporations, attempting to comply with the rule in order to take advantage of tax inversion would have represented a catastrophic loss of revenue and complications to operations and interruptions in work flow. Obama’s rule was, indeed, intended to be so punitive that companies would decide against pursuing inversion. Some have argued that rather than targeting the corporate inversion itself, the government could rather maintain heightened scrutiny of the company’s business and financial actions after the inversion. The promise of such tight monitoring might be enough to persuade corporations to rethink the strategy in the first place (Wood, 2016). Few Republicans, historically pro-business in party policy, joined the effort, seeing in such machinations government overreach and a move against what was essentially a smart business strategy.

Although presidential candidate Donald Trump, himself a career entrepreneur, came out strongly in favor of stopping inversions, he offered few practical ways for actually doing it. Elizabeth Warren, then a freshman Democratic senator from Massachusetts and widely seen as a vocal critic of the logic of greed behind many big business practices, led a very public campaign to expose this business practice as pernicious, pointing out in great detail exactly what the corporate maneuvering cost: government monies critical to providing basic social services. But without a viable political base in either house of Congress, the President and the Democratic leadership could do little more than rail publicly against the practice. Under a limited executive order, the federal income tax department in spring of 2016 acted to at least curtail some of the benefits companies enjoyed through corporate inversion practices in the hope of causing companies to reconsider the strategy. Obama’s secretary of the treasury Jacob Lew remarked, “What we need as a nation is a new sense of economic patriotism, where we all rise or fall together” (Marcum et al, 2015).

Despite the concentrated negative publicity, little anti-inversion legal action was taken against the companies, or could be for that matter (Schmidt & Thompson, 2016; Chiu, 2015). The negative publicity was not sufficient to effect changes to the tax rule (Rao, 2015). Rather, company executives and conservative politicians, tapping into the grassroots sea-change of anti-government feeling generated by the Trump candidacy and by his ultimate victory, placed blame for corporate expatriation on the government for overtaxing successful businesses. With the incoming Trump presidency and Republican majorities in both houses of Congress, financial experts in 2016 predicted any act of Congress to close the original loophole and end tax inversion was extremely improbable.

Terms & Concepts

Executive Order: A presidential mandate directed to a body of the federal government.

Fiduciary: Having to do with legal actions that are designed to benefit a designated party.

Incorporation: The act of creating a legal entity for the purposes of producing a good or service.

Outsourcing: A company’s decision to contract facilities (and staff) in a different country to produce goods as a way to save costs.

Punitive: Actions designed to punish.

Shelter: A financial and/or business arrangement designed to avoid tax payments.

Subsidiary: A minor branch facility or office of a major company.

Bibliography

Chiu, D. (2015). Inversion subversion: Corporate inversions and the new federal laws against them. Fordham Journal of Corporate and Financial Law, 20(3), 717–743. Retrieved October 23, 2016, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=103017095&site=ehost-live

Johnston, D. C. (2014). Corporate deadbeats. Newsweek Global, 163(10), 28–33. Retrieved October 23, 2016, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=97901383&site=ehost-live

Marcum, B., Martin, D. R., & Strickland, D. (2015). Merger waves and corporate inversions: Causes and consequences. Journal of Corporate Accounting & Finance, 26(5), 85–91. Retrieved October 23, 2016, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=103224300&site=ehost-live

Mider, Z. R. (2014). The greatest ever told tax story. Bloomberg Businessweek, (4408), 50–53. Retrieved October 23, 2016, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=100018950&site=ehost-live

Rao, N. (2015) Corporate inversions and economic performance. National Tax Journal 68 (4), 1073–1097. Retrieved October 23, 2016, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=111526721&site=ehost-live

Schmidt, P. M., & Thompson, A. L. (2016). New treasury guidance chills inversions. Journal of Taxation of Investments, 34(1), 3–38. Retrieved October 23, 2016, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=119108046&site=ehost-live

Wood, R. (2016). Hunt for corporate inversions. M & A Tax Report 24 (6), 1–4. Retrieved October 23, 2016, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=112088799&site=ehost-live

Yang, J. (2016). Current developments in corporate inversions. Journal of Taxation of Investments, 33(2), 45–58. Retrieved October 23, 2016, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=114060656&site=ehost-live

Corporate Inversion (tax inversion)

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Subject Terms

Corporate Inversion (tax inversion)

Abstract

Overview

Further Insights

Viewpoints

Terms & Concepts

Bibliography

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