Today, the Obama Administration announced a new set of anti-inversion rules. An Inversion is a transaction in which a U.S. firm merges with a foreign firm as a means to moves its legal headquarters overseas. Usually, a company inverts in order to reduce their taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. burden. The rules would both make it hard to invert and would make it less attractive to do so.
Treasury’s new rules follow a string of announced inversions by U.S. multinationals. For the past few years, several companies have moved their headquarters overseas. For example, Burger King moved its headquarters to Canada in 2014. The concern is that the string of inversions out of the U.S. could erode the corporate income tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. .
These rules will certainly make it more difficult for companies to invert. In fact, after the announcement of the new Treasury rule, Allergan’s shares, the company that Pfizer planned to acquire in an inversion transaction, dropped 22 percent. While the rules may be somewhat effective in reducing the incentive to invert, Treasury’s approach is not ideal. Treasury seems to be reacting to specific situations as they arise with targeted rules. A better approach would be to address the fundamental problems with the system by enacting broader reforms.
There is actually good international experience that the United States could learn from.
Back in 2008, the United Kingdom found itself in a similar situation. Companies were inverting from the UK to lower tax jurisdictions such as Luxembourg and Ireland. The New York Times wrote about the “exodus of British companies fleeing the tax system.”
At that time, the United Kingdom had a 28 percent corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate and a worldwide tax systemA worldwide tax system for corporations, as opposed to a territorial tax system, includes foreign-earned income in the domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. that was very similar to our own. This system allowed British multinational corporations to earn profits overseas without paying an additional tax to the United Kingdom. However, when those profits were repatriated to the UK, companies were required to pay an additional tax to the British treasury.
Companies were inverting in order to avoid the additional tax that the UK placed on their overseas earnings.
The solution that they came up with was to move to a territorial tax systemA territorial tax system for corporations, as opposed to a worldwide tax system, excludes profits multinational companies earn in foreign countries from their domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. . The system now exempts the foreign profits earned by UK multinationals from British taxation. As such, British companies no longer had the incentive to invert at all because their foreign profits were treated the same whether they were domiciled in the UK or in the Netherlands.
While there is still substantial disagreement among lawmakers over what a territorial tax system should look like here in the U.S., many lawmakers in the United States have realized that this is where the U.S. should be headed.
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