Tax inversions, benefits and pitfalls - Term Paper Example

Tax inversions, benefits and pitfalls Tax inversion is an American term used to refer to the relocation of headquarters by corporations to nations where taxes are lower. The relocation takes place, but the corporations retain the operation materials in the original nations where taxes are high. This term is largely used in relation to corporations in the United States. Tax inversion is a recent phenomenon. Even though it is hard to be definitive, its prevalence and practice came in the 1960s when many corporations sought for tax havens such as Bermuda.

Recently, due to changes in the U.S law, publicity has aimed for corporate inversions where companies merge with those in lower-tax foreign nations. This issue was put to great publicity in April 2014 and came together with the proposed merger between two companies, AstraZeneca and Pfizer. Even though multinational public corporations have recently received more press coverage on tax inversions, middle-market and private corporations can invert and realize same tax benefits.Benefits of tax inversions A change of the legal location of the company from the United States to another nation allows the company to benefit from certain laws in that nation.

Typical benefits that make corporations in the U.S to re-incorporate in other countries include banking laws that are more flexible. In addition, they also benefit by getting friendly corporate governance rules and lower tax rates. Bermuda is one of the most common destinations for tax inversions due to several reasons. The principal driver is because Bermuda does not tax capital gains. Also, it does not have any corporate income, dividend tax or profit.Pitfalls of tax inversions Typically, shareholders of such corporations need to pay taxes from the profits realized after inversion.

Worse enough, the tax inversion transaction is mostly a stock transaction where the shareholders get no money to pay taxes on their profits in the stock. In that case, inversions are a long term play for shareholders of corporations which can bear the short term tax bite. Tax inversion also leads to unemployment in the country of origin of such corporations. The tax inversions do not typically alter the structure of operation for the company. Mostly, it means adding a smaller office in the new foreign location of the company.

Therefore, even though on rare occasions, tax inversions lead to unemployment. Pros and Cons The Bush administration passed a legislation that required corporations to continue paying taxes under current rules. Under this Act, the corporate minimum tax rules would still apply. Current rules where corporations control profits and earning would also remain in place. Corporations would still be allowed to file consolidated returns, which are steady with current law. By doing away with double taxation, the proposal can reduce tax-induced distortions.

These tax-induced distortions encourage businesses to use debt instead of equity finance in the current tax system. Since shareholders will not pay taxes only on distributions of earlier taxed corporate income, the proposal will lower incentives for some corporate tax planning. Moreover, the proposal will improve corporate governance through elimination of current bias against payment of dividends. Dividends have the ability to provide evidence concerning the financial health of a corporation.

This evidence can be used by investors to assess the financial condition of a corporation (Eicke, p. 2-15).Conclusion In summary, tax inversions are a powerful that can be used to save taxes. However, the corporations need to understand the potential pitfalls when getting involved in these transactions. In doing so, all estimated gains will be captured as expected. The future of tax inversions In the near future, inverted companies will have the ability to avoid U.S taxation in future. The proposed changes in inversion give provisions where the former U.

S shareholders have 60-80% of shares of the combined business.Works citedEicke, Rolf. Tax Planning with Holding Companies - Repatriation of US Profits from Europe: Concepts, Strategies, Structures. New York: Kluwer Law International, 2009. Print.