Corporate Inversions - Essay Example

CORPORATE INVERSIONS (Legal and Tax Considerations) of (affiliation) Intermediate Finance Date Submitted: Introduction The world of business is getting more complicated as competition intensifies with the continued trends towards globalization. Big corporations and giant multinationals strive to gain a permanent advantage over their competitors by finding ways to sustain such advantage and still try to maintain profitable operations. Many business decisions are made over ethical and moral considerations on which strategies to pursue that will maintain the competitive edge but at the same time will not cross the boundaries of business ethics which are often also self-imposed by these firms. What they want to do is balance profitable operations with ethical morality. There are many ways and techniques by which business firms today maintain profitable operations in the face of all this global competition. Some had tried to minimize labor costs by outsourcing non-essential business functions such as back-room operations to other countries in which labor costs are cheaper or sub-contract many manufacturing operations to reliable supplier contractors who perform the same manufacturing function but again at lower costs. While these moves are laudable by themselves, some of these business strategies had come under scrutiny as unethical business practices that damage their corporate reputations and cause a backlash. One of the latest trends that has caught the attention of top corporate executives is the use of tax minimization strategies without crossing the legal boundaries of their countries. Most of these executives view such strategies as perfectly legal because they consider such strategies as tax avoidance and not tax evasion. This paper examines and discusses the use of inversions. This is the technique of incorporating a company abroad to avail of beneficial tax laws which in turn reduce their tax burdens or obligations and many of these companies had done so lately. Discussion Big corporations and giant conglomerates today have sought and tried many ways by which to maintain their profits without necessarily violating the law. One such technique is the so-called “inversion” which is a form of tax dodging derived from the word “invert” or reverse the normal position, relationship, order, or form of two things; the one originally at the front is now placed at the back while the one in the back is now placed up front. This is the case today in inversions which can be considered as a form of tax avoidance which is perfectly legal in the sense it merely tries to minimize the taxes that will be due and has to be paid by the company. In other words, it is entirely different from tax evasion which is the illegal act of not paying taxes. It has caught the attention of many lawmakers who are now trying to implement tax reforms. Inversions are seen by lawmakers as a loophole in their tax laws which need plugging to stop this practice and raise much-needed revenues. Some countries encourage this practice by offering very low or virtually non-existent taxes on corporations which establish their domicile in their countries as an alternative to the original home country of a corporation. This move has a big effect on the decisions made by top executives on which area to establish their headquarters as it can have a very big impact on the bottom line and a painless way to boost profits. The attraction of using inversion is irresistible and today many giant corporations had opted to avail of this alternative to maintain a competitive edge. Although perfectly legal in the eyes of some corporate executives, their lawmakers and revenue people are not so happy with it. Inversions had been a primary cause in the decline of tax collections and this practice affects the economic policies of many countries as their development plans are now constrained. Process of inversion – in its simplest form, inversion involves a parent company such as a corporation based in the United States of America transferring its listed domicile or main office from America to the address of one of its offshore subsidiaries. In effect, this act of transferring the headquarters of the main company to the offshore address which is a tax haven (lower taxes) makes the main company a mere subsidiary of its original subsidiary, hence the term inversion as the business relationship is now inverted or reversed. The subsidiary is now the main company and the original main company one of the subsidiaries. At first glance, inversion defies logic as it seems to be counter-intuitive but the tax implications are huge and can produce profits. Figure 1. The illustration above shows how tax inversion is done involving several countries with low tax rates or considered as tax havens by companies (Source: Financial Times). The graphic shown in the previous page involved several countries to effectively carry out the tax avoidance process. However, inversion can involve a much simpler version involving only two countries such as a company based in America transferring its headquarters (on paper) to Bermuda and avail of its lenient tax policies and effectively reduce its U.S. tax obligations. At any rate, the process of inversion takes capital out of a country and retains the cash hoard in the new country of domicile and the repatriation of capital and profits is deferred for now. All things considered, a company that uses inversion has a definite advantage over its competitor that does not use this tax dodge because it reduces its tax payments and utilize the savings for other uses. Public policy considerations – the trend towards inversion has a negative impact on the public policies of a country. The net effect of inversion is to reduce the tax collections of the country and it impacts negatively on the rendition of vital public services such as on education, health, police forces, and many others. Budget deficits will increase if the same level of services are to be maintained but the reduction in tax revenues will constrain the flexibility of the policy makers to craft and implement new public services that will benefit everybody. In other words, a company using inversion will benefit its shareholders at the expense of the general public as the cutbacks in public services will adversely affect the overall quality of life in these countries. So in essence, a tax inversion has moral implications as well if a corporation will take a serious look at its corporate social responsibility (CSR). A company is supposed to contribute to the community where it makes its profits and give back to the public in the form of social duties such as donating to charitable organizations or help the government by paying its taxes honestly. Inversion is like business process outsourcing (BPO) that may be legal but morally incorrect. Legal implications – various tax laws and tax treaties allow for any company to choose its domicile or main office location. Globalization and competition made tax inversion a very attractive option for big companies but the growing trend has drawn the attention of lawmakers. For example, back in 1960, the United States was home to 17 of the 20 largest corporations in the world and yet five decades later, only six such multinationals have headquarters in the U.S. It has raised the concern of lawmakers who are trying to balance the need for these companies to stay competitive but also implement corporate tax reforms (The Financial Times, n.d., para. 4). Globalization has contributed to the growing attraction of using inversion because it is one way to stay competitive. If one company uses it but another competitor in the same industry did not avail of the tax benefits of inversion (all things being equal), the former has a definite advantage because of its reduced tax liabilities. The tax savings can be used for other productive investments to enhance its competitiveness further while the latter will be saddled with an avoidable tax liability. There is a moral obligation involved in tax inversion but ultimately it is a matter of survival where a company needs to produce profits in face of intense competition. American corporate tax rates are considered one of the highest in the developed world. It involved federal, most state, and some local taxation on income earned by business entities that are considered under American laws as corporations. This triple taxation is a disincentive for most corporations domiciled in America because these firms think the tax laws are regressive by penalizing profitable operations. High tax rates, together with globalization, has contributed to a growing use of inversions today. Tax rates can vary from 15% to as high as 39% of income. The graph below illustrates the comparative tax rates of various countries in the Western world. Figure 2: The high rates of taxation in the United States effectively reduces productive forms of investments such as capital expenditures to maintain competitiveness and at the same time reduces the number of jobs that will be generated and reduces further the tax revenues on income in a never-ending downward cycle (Source: The Heritage Foundation). The United States Congress has held several committee hearings to try to resolve issues with its tax system and at the same time address the concerns of American corporations. This practice of allowing corporations to move their assets and revenues offshore has implications for the entire U.S. economy and has created a new set of problems (U.S. Congress, 2003, p. 39). It is the consensus among lawmakers to amend certain tax laws because inversion as of now is not an illegal accounting scheme to avoid payment of taxes because of several tax treaties with other countries of the world with regards to the treatment and repatriation of overseas profits. Taxation accounting – the benefits of inversion include the non-remittance of income earned abroad by most U.S. corporations and another way is to lend their big cash hoards to their own subsidiaries in America. This loans create a further tax shield as loan interest payments are tax deductible under current U.S. tax laws. This accounting practice can mean huge savings as it effectively reduces the tax rate to a mere 6% instead of the usual 39% tax rate imposed. By using these schemes, foreign income escapes taxation as it is not repatriated (Romano, 2002, p. 268). Prominent examples – the U.S. cable group of Liberty Global has adopted tax inversion by buying out the Virgin Media group of the United Kingdom in a $23 billion acquisition and its transfer of domicile or principal place of business to the U.K. (The Financial Times, n.d., para. 8) and pay a lower corporate tax rate of only 21%. The U.S. pharmaceutical giant Pfizer planned to avail of this tax scheme with its proposed purchase of Astra-Zeneca of the U.K. (ibid.). Perhaps the most famous example of inversion is Apple, Incorporated because of its huge foreign income and Apple uses a variety of accounting techniques such that its income tax payments are small in comparison to its huge income by setting up representative sales offices using anonymous post office boxes abroad in many tax haven countries (Duhigg & Kocieniewski, 2012, p. 1). Conclusion Lawmakers themselves often put tax incentives into the laws to encourage new firms to put up new ventures or expand existing ones. These incentives include tax holidays for capital expenditures (CAPEX) and tax laws like the Economic Recovery Tax Act of 1981 (ERTA) that promotes new depreciation rules (Kolb, 2007, p. 649) but corporate inversions involve moral issues and require a more complex response because it also involves international tax treaties. References Duhigg, C. & Kocieniewski, D. (2012, April 28). “How Apple sidesteps billions in taxes.” New York Times. Retrieved from http://www.nytimes.com/2012/04/29/business/apples-tax-strategy-aims-at-low-tax-states-and-nations.html?pagewanted=all Kolb, R. W. (2007). Encyclopedia of business ethics and society. Thousand Oaks, CA, USA: Sage Publications. Romano, C. (2002). Advance tax rulings and principles of law: Towards a European tax rulings system? Amsterdam, The Netherlands: IBFD Publications. The Financial Times (n.d.). “Definition of tax inversion.” Retrieved November 30, 2014 from http://lexicon.ft.com/Term?term=tax-inversion The Heritage Foundation (2014). “U.S. corporate tax rates are the highest in the developed world.” Retrieved November 29, 2014 from http://www.heritage.org/federalbudget/corporate-tax-rate U.S. Congress (2003). Corporate inversion: Hearing before a subcommittee of the committee on appropriations. University Park, PA, USA: Pennsylvania State University Press. Due: November 30, 2014 @ 11:44 p.m. Read More