Monday, September 1, 2014

What is a "tax inversion"?

"Tax inversion", also known as a "corporate inversion" is one of the ways corporations reduce their tax burden.  The long made short - a company based in a country with a high tax rate merges with a company that's in a country with a lower tax rate, then moves the headquarters of their newly formed company to the country with the lower tax rate, essentially "renouncing" their citizenship.

This has been making quite a bit of news lately as US corporations are looking at any and all ways to increase profits.  The US has the highest corporate tax rate of any western nation at 35% (well, highest of those in the OECD).  Of course, we all know that no corporation actually pays taxes; they pass the cost of taxes along to the consumer in the form of higher prices.  However, taxes still come off their bottom line so if they can find a way to get the cost of taxes down, then the bottom line retains more profits.  This makes investors happy, but hurts the previous host nation (in this case, the US).

Another benefit to corporations, besides the obviously lower rate, is not paying taxes on out-of-country profits.  US based corporations pay 35% whether the money is made in the US or elsewhere; they're merely credited what they paid outside the US.  For example, if a US corporation paid 20% in taxes in another country, then they'd pay an additional 15% when they brought their remaining profits back home.  Most countries only tax profits made within their individual country; this means the money made outside the host country are not taxed any more than what the other country requires.

Anything that's good for a corporation must be bad for the people, right?  Well...that's up for debate.

First and foremost, shareholders take a bit of a hit when the inversion occurs as their shares will be traded out for shares in the new company...and subject to capital gains tax.  Secondly, corporate profits made within the US will remain the same.  So we're really just talking about the loss of a small percentage on foreign investments.  True, there are some pretty big multinational companies (like Burger King) talking about making the jump, but even the US Treasury is only estimating a loss of $20 billion over the next DECADE.  That's right - a paltry $2 billion a year.  For a country which has budgets in the trillions of dollars, $20 billion over ten years is a drop in the well.

What about the little know, the thousands of employees the company has here in the US?  Truth is...they're not even going to notice.  So long as business in the US continues to be profitable, these companies are going to continue to do business in the US.  The one exception here...employees with company shares would feel the pinch as capital gains tax.  Even that's just an impact to the middle class and wealthy who hold long term positions; individuals making less than $37k and couples making less than $78k do not have to pay capital gains.  And anyone who has these stocks in a Roth IRA, 401k, or other tax deferred account.  (Investment advisers may also recommend selling some other stocks for a loss to offset the capital gains, or even gifting a portion of stocks to someone else.)

According to the Ways and Means Committee of the US House of Representatives, 76 companies have completed corporate inversions since 1983; 19 have announced plans to do so in the last 18 months alone, with 14 having completed their plans already.  In fact, since President Obama took office, 25 companies have chosen to change their addresses.  The pundits, of course, blame this on the Obama administration and their aggressive rhetoric/policies; the reality is more that we're a global marketplace now and corporations are under heavy pressure to reduce tax burden.  This is just one of many tactics to do so.

The companies completing tax inversions are varied and several you've heard of, maybe even buy from regularly.  Medtronic, a manufacture of durable medical goods, just moved to Ireland.  Most pacemaker recipients will have heard of this company.  Pfizer has been in on-again/off-again talks to buy Britain's AstraZeneca.  Liberty Global, formerly of Colorado, bought Virgin Media and made the jump across the pond.  Chiquita bought Fyffes and moved to Ireland.  Forest Labs bought Dublin's Activis and is reincorporating there.  You may notice these companies are all moving to the UK...that's because the government there taxes at 13% and only taxes domestic profits.

Burger King and Walgreen's have been hot in the news lately.  Walgreen's was considering a move to Switzerland; for what can only be described as patriotic reasons (i.e., heavy PR fallout), they reconsidered and will remain a US firm for the present.  Burger King, though, is merging with Tim Hortons of Canada and the move is underway.  Some argue this was for the brand value of Tim Hortons; it's practically a household name in Canada, so headquartering it here might damage the brand.  The tax benefits are only around 10% so although there are some financial benefits, it's not as massive as some other inversions.  Money is money, though, and that will allow the new company to expand as they pull on each other's considerable experience and menus.  (Let's face it - Burger King makes some great sandwiches, but their breakfast is terrible; Tim Hortons is the breakfast king in Canada.)

So...that's the story on corporate/tax inversions.  The media is making a big deal out of it; the Democrats think it is the end of the world; the Republicans are all about it.  For the rest of us, it's good to understand all the hoopla.

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