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Congressional Research Service (CRS)

 

Corporate Expatriation, Inversions, and Mergers: Tax Issues

Donald J. Marples, Specialist in Public Finance

Jane G. Gravelle, Senior Specialist in Economic Policy

September 3, 2014

http://fas.org/sgp/crs/misc/R43568.pdf?

[full-text, 17 pages]

 

Summary

News reports in the late 1990s and early 2000s drew attention to a phenomenon sometimes called

corporate “inversions” or “expatriations”: instances where U.S. firms reorganize their structure so

that the “parent” element of the group is a foreign corporation rather than a corporation chartered

in the United States. The main objective of these transactions was tax savings and they involved

little to no shift in actual economic activity. Bermuda and the Cayman Islands (countries with no

corporate income tax) were the location of many of the newly created parent corporations.

 

These types of inversions largely ended with the enactment of the American Jobs Creation Act of

2004 (JOBS Act, P.L. 108-357), which denied the tax benefits of an inversion if the original U.S.

stockholders owned 80% or more of the new firm. The Act effectively ended shifts to tax havens

where no real business activity took place.

 

However, two avenues for inverting remained. The Act allowed a firm to invert if it has

substantial business operations in the country where the new parent was to be located; the

regulations at one point set a 10% level of these business operations. Several inversions using the

business activity test resulted in Treasury regulations in 2012 that increased the activity

requirement to 25%, effectively closing off this method. Firms could also invert by merging with

a foreign company if the original U.S. stockholders owned less than 80% of the new firm.

 

Two features made a country an attractive destination: a low corporate tax rate and a territorial tax

system that did not tax foreign source income. Recently, the UK joined countries such as Ireland,

Switzerland, and Canada as targets for inverting when it adopted a territorial tax. At the same

time the UK also lowered its rate (from 25% to 20% by 2015).

 

Several high profile companies have more recently indicated an interest in merging or plans to

merge with a non-U.S. headquartered company, including Pfizer, Chiquita, AbbVie, and Burger

King. For Pfizer, which has accumulated substantial profits in subsidiaries in low tax foreign

countries that would be taxed if paid to the U.S. parent, the territorial tax system is likely the most

important tax benefit from such a merger. This “second wave” of inversions again raises concerns

about an erosion of the U.S. tax base.

 

Two policy options have been discussed in response: a general reform of the U.S. corporate tax

and specific provisions to deal with tax-motivated international mergers. Some have suggested

that lowering the corporate tax rate as part of broader tax reform would slow the rate of

inversions. Although a lower rate would reduce the incentives to invert, it would be difficult to

reduce the rate to the level needed to stop inversions, especially given the effect of the revenue

loss on the budget. Other tax reform proposals suggest that if the United States moved to a

territorial tax, the incentive to invert would be eliminated. There are concerns that a territorial tax

could worsen the profit-shifting that already exists among multinational firms.

 

The second option is to directly target the merger inversions. H.R. 4679, S. 2360, and the

President’s FY2015 budget proposal would treat all mergers as U.S. firms if the U.S. shareholders

maintain control of the merged company. H.R. 1554, H.R. 3666, and S. 268 are among the

proposals that would limit the tax benefits of an inversion if the merged company is managed and

controlled from the United States, while H.R. 694 and S. 250 would, in addition to limiting tax

benefits for merged firms, eliminate deferral. H.R. 5278 and S. 2704 would disallow awarding

federal contracts to inverted firms. Other legislative and administrative proposals to reduce the

benefits of inversions have been proposed.

 

Contents

Introduction ...................................................................................................................................... 1

U.S. International Tax System ......................................................................................................... 2

Anatomy of an Inversion ................................................................................................................. 3

Substantial Business Presence ................................................................................................... 3

U.S. Corporation Acquired by a Larger Foreign Corporation ................................................... 4

A Smaller Foreign Corporation Acquired by a U.S. Corporation .............................................. 4

Response to Initial Inversions: The American Jobs Creation Act .................................................... 5

Post-2004 Inversions and Treasury Regulations .............................................................................. 6

Policy Options ................................................................................................................................. 9

U.S. Corporate Tax Reform ....................................................................................................... 9

Lower the Corporate Tax Rate ............................................................................................ 9

Adopt a Territorial Tax System ......................................................................................... 10

Tax Reform Proposals ....................................................................................................... 11

Targeted Approaches ............................................................................................................... 11

Legislative Proposal .......................................................................................................... 11

Administrative Changes .................................................................................................... 13

Concluding Thoughts .............................................................................................................. 14

 

Contacts

Author Contact Information........................................................................................................... 14

 

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