Tax inversion

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Tax inversion, or corporate inversion, is the practice of relocating a corporation's legal domicile to a lower-tax nation, or tax haven, usually while retaining its material operations in its higher-tax country of origin.[1][2]

The first inversion in the United States took place in 1982, but the practice became common only in the late 1990s, with U.S. corporations seeking to relocate to tax havens such as Bermuda.[3] More recently, because of changes in U.S. 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 UK 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 the law of most other developed nations, the U.S. Internal Revenue Code imposes income tax on the profits of American corporations' foreign subsidiaries.[3] This creates a strong incentive for American companies with large overseas markets to seek to recharacterize themselves as a foreign corporation.[6]

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. Internal Revenue Code § 7874 (Rules relating to expatriated entities and their foreign parents) contains the tax rules related to inversions.


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 UK, 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.

Earnings stripping[edit]

Earnings stripping is a commonly used technique in United States domestic tax avoidance in which a U.S. corporation uses loans between different divisions of the same company to shift profits out of high-tax jurisdictions and into lower-tax ones. According to the New York Times, a multinational could reduce its "American tax bill by having its American subsidiary borrow money from a foreign parent company and then deduct the interest on that loan against its earnings."[7] Earnings stripping is one of the most common tax avoidance techniques facilitated by tax inversions. In addition to allowing U.S. companies 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 study of four inverted companies in 2004 found that most tax saving was generated by earnings stripping, not by avoiding tax on genuinely foreign profits.[8]

In April 2016, new Treasury Department rules were introduced by the Obama administration to narrow the loopholes used for corporate tax avoidance that "will fight earnings stripping by treating the loan in the transaction as equity, which removes the debt-based tax benefit."[7]


In the United States taxation can be imposed as a statutory corporate income tax as well as a taxation on the profits that domestic corporations collect from their subsidiaries abroad.[9][10] 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:[11]

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.

The Economist explains:[12]

The incentive is simple. America taxes profits no matter where they are earned, at a rate of 39% — higher than in any other rich country. When a company becomes foreign through a merger, or “inverts”, it no longer owes American tax on its foreign profit. It still owes American tax on its American profit.

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.[11]

The Congressional Budget Office also described how tax inversions work in a January 2013 report.[13]


1980s–90s: McDermott Inc. and Helen of Troy[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.

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.

1990s–2000s: Turn-of-century wave 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 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.

2010s: Executive action[edit]

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

In early 2014, Pfizer (inverting to the UK by taking over AstraZeneca),[4][14] Walgreen, and Medtronic had each proposed high-profile inversions. Concerns about an accelerating exodus prompted a round of public policy proposals in Congress.[citation needed] 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; both groups were blocked by Republicans.[citation needed] The two parties also split over whether to enact short-term measures to discourage inversions.[citation needed] President Barack Obama called the maneuvers "unpatriotic" during a speech in July 2014.[citation needed] The Economist responded to the 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.[3]

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 had several proposals that could possibly address the issue.[15] 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.[16]

Expecting the likelihood of the proposals passing through Congress to be low, 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.[17] 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 U.S. acquired corporation.[18]

In early 2015, the Financial Times reported that the new regulations to prevent tax inversions had the "perverse effect" of a "sharp increase" in tax inversion deals.[19]

In November 2015, the U.S. 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."[20] The Wall Street Journal reported subsequently 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."[21] The article described how,[21]

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

In early April 2016, the Obama administration introduced new rules that would "limit the ability of American companies to shift their home overseas simply to lower their tax bills." In response Pfizer and Allergan ended their $152 billion merger.[22]

Diana Furcht-Roth of the Manhattan Institute for Policy Research—who is critical of the U.S. Treasury Department's new rules— explained that "Under the old rules, Pfizer shareholders would have owned 56 percent of the combined company, enough to substantially lower its United States taxes. Under the new rules, Pfizer would own between 60 and 80 percent, subjecting it to much higher United States taxes."[23] She argues that companies need lower taxes so they can "grow their businesses."[23]

Paul Krugman coined the term "leprechaun economics" in 2016 for Ireland's illusory economic boom after multinational corporations made use of Ireland's tax regime for tax inversion purposes.[24]

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. ^ a b c "How to stop the inversion perversion". The Economist. 26 July 2014. 
  4. ^ a b "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. ^ Worstall, Tim (30 April 2013). "With All Of Apple's Cash, Why Is It Issuing Bonds?". Forbes. 
  7. ^ a b "A Corporate Tax Dodge Gets Harder". The New York Times. 6 April 2016. Retrieved 7 April 2016. 
  8. ^ "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" (PDF). National Tax Journal. December 2004. 
  9. ^
  10. ^
  11. ^ a b Levine, Matt (25 August 2014). "Burger King May Move to Canada for the Donuts". Bloomberg View. 
  12. ^ "Inverse logic". The Economist. Washington, D.C. 20 September 2014. 
  13. ^ "Options for Taxing U.S. Multinational Corporations" (PDF). Congressional Budget Office. January 2013. 
  14. ^ Levin, Sander (22 July 2014). "Inversions Highlight Unfairness of the Tax Code". New York Times. Retrieved 20 November 2015. 
  15. ^ Stephenson, Emily (19 September 2014). "U.S. Senate Democrats propose exit tax for inverting companies". Reuters. Retrieved 19 September 2014. 
  16. ^ Halper, Jason. "Assessing Retroactive Inversion Legislation and Its Risks". Transaction Advisors. ISSN 2329-9134. 
  17. ^ Drawbaugh, Kevin (23 September 2014). "U.S. Treasury moves against tax-avoidance 'inversion' deals". Reuters. Retrieved 22 September 2014. 
  18. ^ 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. 
  19. ^ "Tax inversion curb turns tables on US". Financial Times. 15 March 2015. A crackdown by the Obama administration on 'tax inversion' deals, which allowed U.S. companies to slash their tax bills, has had the perverse effect of prompting a sharp increase in foreign takeovers of American groups. 
  20. ^ 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. 
  21. ^ a b Rockoff, Jonathan; Cimilluca, Dana; Mattioli, Dana (19 November 2015). "Allergan-Pfizer Talks Include Allergan as Possible Buyer". Wall Street Journal. Retrieved 20 November 2015. 
  22. ^ Bray, Chad (6 April 2016). "Pfizer and Allergan Call Off Merger After Tax-Rule Changes". New York Times. Retrieved 6 April 2016. 
  23. ^ a b Furchtgoot-Roth, Diana (7 April 2016). "Free Pfizer! Why Inversions Are Good for the U.S.". The New York Times. Retrieved 8 April 2016. 
  24. ^
  25. ^ Daurat, Cecile (22 April 2015). "Pace Soars as Arris Agrees to $2.1 Billion Inversion Deal". Bloomberg. 
  26. ^ "The overseas tax tactic is back". Yahoo Finance. 23 April 2015. 
  27. ^ Gilbert, Craig (27 January 2016). "Hillary Clinton slams Johnson Controls-Tyco deal". Milwaukee Journal Sentinel. 

Additional reading[edit]