Understand the issues: corporate tax inversions
Last fall, the U.S. Treasury acted to rein in corporate tax inversions. But why? And how do the Treasury’s actions protect your business?
The following questions and answers can help you understand the issues surrounding corporate tax inversions, corporate tax reform and the potential impact on your business’s finances.
Q: What is a corporate inversion?
A: It’s a transaction in which a U.S.-based multinational corporation restructures so that the U.S. parent company is replaced by a foreign parent. The company carries on business as usual for its American operations, employees and customers, but has a new legal home in a foreign country.
Q: Why is it done?
A: An inversion allows the company to avoid U.S. taxes it would otherwise have to pay.
Q: Are corporate taxes higher in the U.S. than in other countries?
A: Yes, the corporate tax rate set in the tax code is the highest in the world. The federal tax rate is 35 percent, and there are state and local taxes, too. California’s tax rate for C corporations is 8.84 percent. But U.S. companies apply a long list of tax credits, subsidies, loopholes and other exceptions, so most of them pay much less than the top rate. Some have found ways to pay no tax at all. Policymakers say that the U.S. corporate tax rate should be reduced, but that any rate reduction must be accompanied by the reduction or elimination of the special tax exceptions many companies enjoy. The difficulty, of course, is that each loophole has a company or industry lobbying to protect it.
Q: What did the Treasury do to make inversion deals less attractive?
A: The new rules:
- Prevent inverted companies from accessing a foreign subsidiary’s earnings while deferring U.S. tax through the use of “hopscotch” loans. (A hopscotch loan is made by the controlled foreign corporation (CFC) to the new foreign parent to avoid repatriating profits.) Those loans are now considered U.S. property for purposes of applying the anti-avoidance rule, and the same dividend rules will now apply as if the CFC had made a loan to the U.S. parent prior to the inversion.
- Prevent inverted companies from restructuring a foreign subsidiary in order to access the subsidiary’s earnings tax-free.
- Close a loophole to prevent an inverted company from transferring cash or property from a CFC to the new parent to completely avoid U.S. tax.
- Make it more difficult for U.S. entities to invert by strengthening the requirement that the former owners of the U.S. entity own less than 80 percent of the new combined entity.
Q: How do corporate tax inversions affect my business?
A: Because multinational companies have tax avoidance options not available to strictly domestic companies, many domestic companies face a disadvantage when competing against them.
Inversions also have the potential to make corporate tax reform more difficult than it might otherwise be. With less tax revenue coming from companies that have legally moved the parent company overseas, there are fewer tax dollars for policymakers to juggle as they seek to balance lowering the tax rate with clamping down on tax loopholes.
Understanding the issues around corporate tax inversions and corporate tax reform may help you better judge how various proposals would affect your business.