Over the past few months, corporate inversions have been getting a lot of press. Although not new, momentum has propelled this technique into the foreground, particularly with a spate of large acquisition transactions that have been announced in the past few months. Although there have been only approximately 80 such transactions in the past 25 years, about 15 of these have occurred in the past year.
The U.S. tax system has long been at odds with that of many of our trading partners. The U.S. taxes worldwide income of its residents while most nations only tax income earned in country. Additionally, the U.S. maximum corporate statutory tax rate is 35%, one of the highest in the world. To combat the tax cost, many companies have turned to the use of hybrid entities, debt structures and inversion transactions.
Inversions occur when a U.S. company, typically a large public multinational company with significant intellectual property, is effectively acquired by a foreign entity (this can happen even when the U.S. company is the buyer). In most cases, the owners of the U.S. company remain intact, with some dilution for the incoming foreign acquired or acquirer corporation. When properly structured, this type of transaction can reduce U.S. cash tax expense, as well as the tax expense reported in the financial statements.
What to do. Anti-inversion tax rules have been in place for some time, creating an “exit tax” for inverting companies, unless certain exceptions are met. Although it can be somewhat costly, if properly structured, an inversion will result in reduced future U.S. tax. Even with a current tax cost to the U.S. shareholders, the expected long term tax savings is often attractive, as is the impact on the effective tax rate in the financial statements.
There’s growing sentiment among political leaders that the anti-inversion rules need to be tightened. Several bills have been introduced which address the matter. Perhaps this is leading to rewrite of the international tax provisions of the U.S. tax code. Likely, nothing will happen until after the November elections, but as has been done before, there is potential for a temporary “quick fix” with a reduced tax on repatriated earnings. This may slow the pace of inversions by reducing the U.S. tax cost on repatriation of foreign earnings and many companies would likely bring back excess cash to the U.S. to be used for additional investment, acquisitions and dividends. And it would bring in some tax revenue. While not quite “problem solved”, it may be a reachable short term compromise.
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