Tax inversion

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Tax inversion, or corporate inversion, is a largely American term for the relocation of a corporation's legal domicile to a lower-tax nation, or corporate haven, usually while retaining its material operations in its higher-tax country of origin.[1][2] The first inversion in the U.S. took place in 1982, but the practice became common only in the late 1990s, with US corporations seeking to relocate to tax havens such as Bermuda.[3] More recently, because of changes in US law, a second wave of corporate inversions took place by way of merger with companies in lower-tax foreign countries such as Ireland. The issue drew public attention in 2014 when Pfizer proposed to invert to the U.K. through a takeover of AstraZeneca.[4][5]

Tax inversions are a form of tax avoidance, whereby corporations and individuals arrange their affairs to legally reduce their tax obligations. Unlike that of most other developed nations, the U.S. tax code imposes income tax on the profits of American corporations' foreign subsidiaries.[6] This creates a strong incentive for American companies with large overseas markets to seek to recharacterize themselves as a foreign corporation. [7]

Inversion transactions usually involve the transfer of stock of a corporation by one or more shareholders to a wholly or partly owned subsidiary of that corporation in exchange for newly issued shares of the subsidiary's stock. I.R.C. § 7874 (Rules relating to expatriated entities and their foreign parents) contains the tax rules related to inversions.

Recent publicity[edit]

U.S. corporate effective tax rates fell from 29% in 2000 to 17% in 2013.

Tax inversions as a tax reduction maneuver became a public policy issue in 2014 because of a series of high-profile inversion proposals. While both Democrats and Republicans have called for reforms of the tax code to eliminate the underlying incentives to invert, they split over whether to enact short-term measures to discourage inversions in the meantime. Legislation proposed by Congressional Democrats that would prevent some merger-driven inversions was blocked by Republicans. President Barack Obama called the maneuvers "unpatriotic" during a speech in July 2014, and Treasury Secretary Jack Lew issued regulations in September 2014 meant to crimp some of the tax advantages of the transactions.[8][9][10][11]

The Economist has called recent calls in America to restrict companies from relocating abroad by way of merger "misguided" and called for wider tax reform to address what it describes as more fundamental flaws in the American corporate tax system instead.[12] Democratic lawmakers attempted again in September 2014 to propose a tax reform that would focus on slowing the number and rate of corporate inversions via taxing any earnings outside the U.S. as income, until the inversion occurs. Republicans and Democrats have several proposals that could possibly address the issue.[13] An additional consideration surrounding any proposed inversion regulations is whether the regulations would apply retroactively, and further, whether such a retroactive application would be constitutional.[14]


In 2014, when Pfizer proposed to invert to the U.K. through a takeover of AstraZeneca, public attention was drawn to tax inversion.[15][16] On November 19, 2015, the US Treasury Department announced new rules that would "restrain U.S. companies from putting their addresses in foreign countries to reduce tax through a tax inversion.[17] In November 2015, the Wall Street Journal reported that "Allergan PLC and Pfizer Inc. are considering structuring a merger of the drug companies so that it is an acquisition of Pfizer by Allergan."[18] The article described how,[18]

"However the deal is technically structured, the much larger Pfizer will effectively be buying the Dublin-based Allergan and assuming a lower offshore tax jurisdiction. Allergan shareholders would receive a premium and end up with 40% to 45% of the combined company, some of the people said. The deal is expected to be mainly in stock, but it could contain a small cash component."

— Wall Street Journal

Tax Rationale for Inverting[edit]

The U.S. is unique among developed nations in imposing both a high statutory corporate income tax rate of 35 percent (effective corporate tax rates are lower) and imposing tax on the profits that domestic corporations collect from their subsidiaries abroad. This policy of taxing foreign profits is called a "worldwide" system of taxation, and it contrasts with the "territorial" system employed by most developed countries including the United Kingdom and Canada, which generally tax only profits from domestic activities. The result is that U.S. corporations with subsidiaries in lower-tax jurisdictions face higher taxes on those foreign operations than they would if they were incorporated elsewhere. As Bloomberg View columnist Matt Levine wrote in 2014, "If we're incorporated in the U.S., we'll pay 35 percent taxes on our income in the U.S. and Canada and Mexico and Ireland and Bermuda and the Cayman Islands, but if we're incorporated in Canada, we'll pay 35 percent on our income in the U.S. but 15 percent in Canada and 30 percent in Mexico and 12.5 percent in Ireland and zero percent in Bermuda and zero percent in the Cayman Islands."[19]

The Economist explains:

In addition to allowing U.S. corporations to avoid tax on non-U.S. profits, inversion also allows them to avoid taxes on some domestic profits because it facilitates several techniques for re-allocating U.S. profits to lower-tax foreign jurisdictions. One of the most common such techniques, known as "earnings stripping," uses loans between different divisions of the same company to shift profits out of high-tax jurisdictions and into lower-tax ones. One study of four inverted companies in 2004 found that most tax savings was generated by earnings stripping, not by avoiding tax on genuinely foreign profits.[21]

Because other countries do not generally tax foreign earned income in the same way that the United States does, the concept of corporate inversion (and the potential tax relief that such inversions seek) is a largely limited to the U.S. The United Kingdom suffered a similar flight of domestic companies before it abandoned a worldwide taxation system several years ago.

By changing its domicile to another country with a territorial tax regime, the corporation typically pays taxes on its earnings in each of those countries at the specific rates of each country. Further, the corporation executing the tax inversion may find additional tax avoidance strategies allowed to corporations domiciled in foreign countries not available in the U.S. For example, the corporation may find ways of defining its revenue or costs such that they are taxed in lower-tax countries, although the customers may be in higher-tax countries.[19]

The Congressional Budget Office also described how tax inversions work in a January 2013 report.[22]

Mechanics of inversion[edit]

Although inverting companies are colloquially said to "change" their domicile to a foreign country, technically inversion usually involves creating a new parent company that sits "on top" of the corporate structure and is incorporated in the desired foreign jurisdiction. The legacy U.S. corporation retains its domicile and becomes a mere subsidiary. Since the profits of subsidiaries of U.S. corporations are typically subject to tax, a U.S. company that establishes a new foreign parent typically seeks to shift as much of its profits as possible out from under the legacy U.S. corporation, so that profits can be delivered directly to the ultimate foreign parent company without passing through a U.S. entity.

Importantly, corporate inversions do not by themselves require a change in the location of the actual corporate headquarters. In about 70 percent of inversions out of the U.S., the chief executive officer remained in the U.S. Confusingly, many inverted companies claim "headquarters" in the new foreign jurisdiction even though all their most senior officers remain in the U.S. To complicate things further, companies seeking to establish tax residency in certain jurisdictions, such as Ireland and the U.K., may have reason to claim their "principal executive offices" are in those locations. This can typically be achieved by holding a majority of board meetings in these jurisdictions, and does not require the senior executives to actually work at these locations.

History of inversions[edit]

McDermott Inc. and government response[edit]

The first inversion took place in 1982, when McDermott Inc., a New Orleans-based construction company, became Panamanian. McDermott had accumulated a large amount of profit in a Panama-registered subsidiary that served as the holding company for the company's non-U.S. operations. Rather than pay corporate income tax on those profits, the company took the unprecedented step of flipping its corporate structure, so that the Panamanian subsidiary, McDermott International, became the parent. This would allow the company to pass the Panamanian profits to shareholders in the form of dividends without facing a U.S. corporate income tax. The transaction was conceived by McDermott's lawyers at Davis Polk & Wardwell, especially John P. Carroll, and by the company's tax director, Charles Kraus.

After the transaction was completed, the IRS challenged it by arguing that shareholders of McDermott were liable for a hefty tax bill on the deal. The company defended the shareholders in U.S. Tax Court, and in 1987, in Bhada v. Commissioner, the company prevailed. It also prevailed on appeal to a federal circuit court.

Congress attacked the McDermott transaction in 1984 by adding Section 1248(i) to the Internal Revenue Code. The measure narrowly prevented future deals along the lines of McDermott and left open the possibility of other inversion structures.

Helen of Troy and government response[edit]

The second inversion took place in 1994 and also provoked a sharp response from the government. Rather than raise up an existing foreign subsidiary to become a parent, Helen of Troy, of El Paso, Texas, created a new subsidiary in Bermuda and then flipped it to become the parent.

The so-called "Helen of Troy rules" followed. The Treasury Department, under the authority of Section 367 of the tax code, wrote regulations that imposed a shareholder-level tax on inversions.

Turn-of-century wave of inversions and crackdown[edit]

The end of the decade and the beginning of the next saw several large and well-known companies invert, mostly to the island tax havens of Bermuda and the Cayman Islands, neither of which impose corporate income tax. The departed included Ingersoll-Rand, Tyco International, and Fruit of the Loom. In 2002, Stanley Works' proposal to invert to Bermuda provoked a storm of media reports and Congressional discussions. The top Democrat and Republican on the Senate Finance Committee jointly pledged to enact legislation to prevent inversions and to make it retroactive to 2002. Since no company wanted to risk having a transaction unwound by subsequent legislation, the pledge became a de facto moratorium on inversions. The anti-inversion bill finally became law in 2004, and it was made retroactive to 2003.

At the same time some lawmakers were weighing tax-code revisions to attack inversions, others were using the federal government's contracting heft to discourage the deals. A 2002 law creating the Department of Homeland Security forbid the new agency from signing contracts with inverted companies; the same language was later added to temporary spending bills across the federal government.

The second inversion wave[edit]

The 2004 law effectively banned inversions, but its definition contained some notable exceptions. It allowed companies to adopt the foreign address of a merger partner as long as the partner was at least one-fourth the size of the U.S. firm. Eventually, a new wave of inversion deals arose, many of them involving pharmaceutical companies, in which they assumed the foreign address of an acquisition target.

Treasury Department responses[edit]

In early 2014, a series of high-profile potential inversions were under consideration, including those of Pfizer, Walgreen, and Medtronic. Concerns about an accelerating exodus prompted a round of proposals in Washington. One group of Congressional Democrats proposed a measure to disallow inversions involving a smaller merger partner; another group proposed tightening rules on government contracts with inverted companies. As the bills had little chance of clearing a divided Congress, the Obama administration acted administratively to discourage inversions. On September 22, 2014 the Treasury Department issued a notice that reduced some of the tax benefits of inversions completed after that date, and barred companies from manipulating their capital structure to take advantage of inversion rules.[23] The September 22, 2014, Notice describes future regulations that can be separated into two categories: (i) special rules regarding ownership threshold requirements (ii) rules targeting certain tax planning after an inversion, primarily to access foreign earnings of the US acquired corporation.[24]

In early 2015, the Financial Times reported that the new regulations imposed by Congress to prevent tax inversions had left American companies vulnerable to foreign takeovers, and had led to a wave of foreign corporate takeovers.[25]

Notable inversions[edit]

See also[edit]


  1. ^ Corporate Inversion
  2. ^ Subcommittee on Select Revenue Measures of the House Committee on Ways and Means (June 25, 2002). Statement of the Hon. Richard Blumenthal, Attorney General, Connecticut Attorney General's Office, Hearing on Corporate Inversions. Retrieved September 5, 2004.
  3. ^ "Twenty years ago inversions were rare. But as other countries chopped their rates and America’s stayed the same, the incentive to flee grew. Until a decade ago Bermuda and other tax havens were the destination of choice". "How to stop the inversion perversion". The Economist. 26 July 2014. 
  4. ^ "Pfizer Ends AstraZeneca Bid But The Tax Issues It Raised Live On". Forbes. 26 May 2014. 
  5. ^ Sander Levin (22 July 2014). "Inversions Highlight Unfairness of the Tax Code". New York Times. 
  6. ^ "America levies tax on a company’s income no matter where in the world it is earned. In contrast, every other large rich country taxes only income earned within its borders." "How to stop the inversion perversion". The Economist. 26 July 2014. 
  7. ^ Worstall, Tim (30 April 2013). "With All Of Apple's Cash, Why Is It Issuing Bonds?". Forbes. 
  8. ^ Corporate Inversions
  9. ^ Corporate inversion transactions: Tax policy implications
  10. ^ Eicke, Rolf (2009). Tax Planning with Holding Companies. The Netherlands: Kluwer Law International. pp. 23–29. ISBN 978-90-411-2794-5. Retrieved 27 July 2014. 
  11. ^ "Developments in the law: jobs and borders". Harvard Law Review 118 (7): 2270. May 2005. 
  12. ^ "How to stop the inversion perversion". The Economist. 26 July 2014. 
  13. ^ Stephenson, Emily (19 September 2014). "U.S. Senate Democrats propose exit tax for inverting companies". Reuters. Retrieved 19 September 2014. 
  14. ^ Halper, Jason. "Assessing Retroactive Inversion Legislation and Its Risks". Transaction Advisors. ISSN 2329-9134. 
  15. ^ Pfizer Ends AstraZeneca Bid But The Tax Issues It Raised Live On, Forbes, 26 May 2014 
  16. ^ Sander Levin (22 July 2014), Inversions Highlight Unfairness of the Tax Code, New York Times, retrieved 20 November 2015 
  17. ^ Rubin, Richard (19 November 2015). "U.S. Unveils Rules to Make Corporate Inversions More Difficult Move intended to stop American companies from putting their addresses in foreign countries to reduce tax bills". Wall Street Journal. Retrieved 20 November 2015. 
  18. ^ a b Jonathan Rockoff; Dana Cimilluca; Dana Mattioli (19 November 2015). "Allergan-Pfizer Talks Include Allergan as Possible Buyer". Wall Street Journal. Retrieved 20 November 2015. 
  19. ^ a b Matt Levine (25 August 2014). "Burger King May Move to Canada for the Donuts". Bloomberg View. 
  20. ^ "Inverse logic". The Economist. 20 September 2014. 
  21. ^ "Despite managements’ claims that inversion–related tax savings will be due to the avoidance of U.S. tax on foreign earnings, we conclude... that most of the tax savings is attributable to the avoidance of U.S. tax on U.S. earnings." "Effective Tax Rate Changes and Earnings Stripping Following Corporate Inversion" (PDF). National Tax Journal. December 2004. 
  22. ^ CBO-Options for Taxing U.S. Multinational Corporations-January 2013
  23. ^ Drawbaugh, Kevin (23 September 2014). "U.S. Treasury moves against tax-avoidance 'inversion' deals". Reuters. Retrieved 22 September 2014. 
  24. ^ DeNovio, Nicholas; Stein, Laurence; Doyle, Diana; Murphey, Lauren. "Treasury Announces Inversion Regulations; Reach Extends to Other Cross-Border M&A". Transaction Advisors. ISSN 2329-9134. 
  25. ^ "Tax inversion curb turns tables on US". Financial Times. 15 March 2015. A crackdown by the Obama administration on 'tax inversion' deals, which allowed US companies to slash their tax bills, has had the perverse effect of prompting a sharp increase in foreign takeovers of American groups. 
  26. ^ Daurat, Cecile (22 April 2015). "Pace Soars as Arris Agrees to $2.1 Billion Inversion Deal". Bloomberg. 
  27. ^

Additional reading[edit]