Tue | Dec 6, 2016

10 things to know about corporate inversions

Published:Friday | August 29, 2014 | 12:00 AM

Burger King plans to become the latest American company to shift its legal address out of the United States by merging with a foreign company. Burger King has announced plans to buy Tim Hortons, the Canadian coffee-and-doughnut chain.

Burger King's operations will stay in Miami. But the corporate headquarters of the new company will be in Canada.

The transaction is called a corporate inversion, a manoeuvre that is becoming popular among companies looking to lower their tax bills.

Burger King stressed that the deal is being driven by the international growth possibilities of Tim Hortons, not a desire to take advantage of Canada's lower tax rates.

Still, at least one senator - Democrat Sherrod Brown of Ohio - is urging fast-food patrons to take their business elsewhere, to Wendy's or White Castle, two fast-food chains that happen to be based in Ohio.

Ten things to know about corporate inversions:

1. What is a corporate inversion?

An inversion happens when a US corporation and a foreign company merge, with the new parent company based in the foreign country. For tax purposes, the US company becomes foreign-owned, even if all the executives and operations stay in the US.

2. Why invert?

There can be many business reasons for two companies to merge. The decision to incorporate the new parent company in a foreign country can generate significant tax savings over time.

The US has the highest corporate income tax rate in the industrialised world, at 35 per cent. The US is also the only developed country that taxes corporate profits earned abroad. Foreign profits are subject to US taxes once they are brought to the US, though corporations can deduct any foreign taxes paid.

Companies that become foreign-owned don't have to worry about the Internal Revenue Service trying to tax the profits they make abroad.

Most US corporations pay federal income taxes at rates much lower than 35 per cent because the tax code is filled with breaks for businesses. Inversions open the door for even more.

3. 'Stripping'

Inverted corporations must still pay US taxes on the profits they earn in the US. However, they can lower their US tax bills through a manoeuvre called 'earnings stripping'.

Here is how it works: The new foreign parent company 'lends' money to the US firm, which must pay it back. The US firm then deducts the interest payments it makes to the parent company, reducing its taxable profits - 'stripping' them from its balance sheet.

"You haven't raised any new money," said Robert Willen, a New York-based tax adviser. "All you've done is literally out of thin air, you've created a debt obligation on which the US company is the debtor and the foreign parent is the creditor."

4. 'Hopscotching'

Many US-based corporations are hoarding money overseas, either to invest abroad or to shield it from US taxes. Experts say the total amount could exceed US$2 trillion.

If a foreign subsidiary sends profits directly to a US corporation, the US firm must pay taxes on it. However, if those profits are funnelled through a foreign parent company that was formed through an inversion, the money can be invested in the US without paying US taxes.

The technique is called 'hopscotching' because the money - at least on paper - bounces from country to country while avoiding US taxes.

5. How big is the issue?

Nearly 50 US companies have inverted in the past decade, and more are considering it, according to the non-partisan Congressional Research Service.

The recent wave of inversions has been dominated by health-care companies, including drugmaker AbbVie, which has announced plans to merge with a drug company incorporated in Britain. Walgreen Company had been considering an inversion, but the nation's largest drugstore company announced in early August that it will no longer pursue one.

6. What has Congress done?

In 2004, Congress tried to curb inversions by saying US companies couldn't escape US taxes by simply reincorporating abroad, with the same shareholders and executives running the new company. Instead, Congress passed a law saying that in order to become a foreign-owned corporation, US companies must merge with a foreign partner, even if the foreign partner is much smaller.

7. Will Congress do more?

Several Democrats in Congress have announced bills to make it harder for US corporations to invert. Senator Ron Wyden (D-Oregon), chairman of the Senate Finance Committee, said he was working with key Senate Republicans in an effort to come up with a bipartisan response.

President Barack Obama included provisions in his 2015 budget request to limit inversions. The president has renewed his push in recent weeks.

But in the current political climate, it's hard to see House Republicans, Senate Democrats and the Obama White House all agreeing on a fix. We're talking about taxes, and Republicans and Democrats don't agree on much when it comes to taxes.

8. Can Obama act alone?

The US Treasury Department says it is "reviewing a broad range of authorities for possible administrative actions that could limit the ability of companies to engage in inversions, as well as approaches that could meaningfully reduce the tax benefits after inversions take place".

Experts are divided over how much Treasury can do without action by Congress.

9. What Democrats say

Obama and Democratic leaders in Congress have questioned the patriotism of corporate executives who elect to invert their companies. At the same time, they are trying to make it a political issue ahead of this year's congressional elections, accusing Republicans of protecting corporate loopholes.

"They are renouncing their citizenship even though they're keeping most of their business here," Obama said in a recent speech. "They shouldn't turn their back on the country that made their success possible."

10. What Republicans say

Key Republicans say the only way to adequately address inversions is to overhaul the tax code, making it more attractive for businesses to locate in the US.

"Anything short of that and you're not going to be able to do it," said Senator Orrin Hatch of Utah, the top Republican on the Senate Finance Committee.

Hatch and other Republicans say they could support limited efforts to fight earnings stripping, which many see as nothing more than a tax dodge. But in general, Republicans said they don't like the idea of punishing corporations for trying to lower their tax bills.

"We want to promote American competitiveness, not hurt it," said Representative Charles Boustany of Louisiana, a senior Republican on the House Ways and Means Committee.

- AP