Medtronic Embarks on Self-help Tax Reform

June 16, 2014

The cost of America’s extremely high corporate tax rate continues to pile up. The Wall Street Journal reports on yet another tax “inversion” deal:

Medtronic Inc. MDT -0.77% 's agreement on Sunday to buy rival medical-device maker Covidien COV +21.12% PLC for $42.9 billion is the latest in a wave of recent moves designed—at least in part—to sidestep U.S. corporate taxes.

Covidien's U.S. headquarters are in Mansfield, Mass., where many of its executives are based. But officially it is domiciled in Ireland, which is known for having a relatively low tax rate: The main corporate rate in Ireland is 12.5%. In the U.S., home to Medtronic, the 35% tax rate is among the world's highest.

Actually it’s worse than that. The U.S. federal corporate tax rate is 35 percent, then there are state corporate taxes on top of that. Medtronic is based in Minneapolis, where the state’s corporate tax rate is 9.8 percent, making the combined U.S. corporate tax rate 41.4 percent. This is more than 3 times the tax rate in Ireland.

Plus, Medtronic apparently does some business abroad already, which means it is subject to America’s worldwide tax regime that applies the high U.S. corporate tax rate to all profits earned abroad as well. Ireland also has a worldwide tax system, but at a tax rate of 12.5 percent it essentially doesn’t matter. This is a general feature of the worldwide tax system: there is a foreign tax credit for corporate taxes paid abroad, meaning there are only additional “repatriation taxes” when the domestic corporate tax rate exceeds the foreign corporate tax rate. The only country where this applies, essentially, is the U.S. Most countries in the developed world have switched to a territorial tax system that exempts foreign profits from domestic taxation, and the remainder either have relatively low corporate tax rates (e.g. Ireland) or they have very few multinational corporations (e.g. Mexico).

And the high U.S. corporate tax rate appears to have driven this deal, according to the Journal:

Medtronic had $14 billion in cash as of April, much of it held outside the U.S. The deal would enable it to deploy that cash and help Medtronic fulfill its promise to distribute half of its free cash flow to shareholders. Indeed, a person familiar with the matter said that was one of the main reasons the company wants to do the deal.

The Journal goes on to describe how Covidien was once a division of Tyco International, which moved its corporate headquarters from New Hampshire to Bermuda in 1997. Since then, Tyco moved to Switzerland in 2009, and then finally to Ireland this May, after Switzerland introduced new rules on executive pay.

At least a dozen companies have left the U.S. in recent years using the inversion technique, which involves a U.S. company merging with a smaller company abroad and taking the foreign headquarters. After Pfizer attempted to leave earlier this year, Congress attempted to stop the wave by threatening retroactive penalties. That doesn’t seem to have worked.

Besides, corporations have many alternative and perfectly legal means of escaping high corporate tax rates, such as moving to the pass-through sector where they are taxed at individual income tax rates without further taxes on shareholders. The pass-through sector is now so big that it contains more than 90 percent of U.S. businesses, and more than half of all U.S. profits.

The high U.S. corporate tax rate is causing serious economic distortions, chasing away businesses, investment and jobs. The only way to deal with it effectively is to bring the corporate tax rate down to competitive levels, which is the path chosen by virtually every other country.

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