The ongoing wave of American corporations inverting, or reincorporating as offshore companies to avoid U.S. taxes, has resulted in a bewildering variety of solutions being debated in Washington and in the editorial pages. A new report from Citizens for Tax Justice explains how these proposals differ and which are most effective.
The proposals vary in several ways. Some target inversion by stopping the IRS from recognizing the “foreign” status of a corporation that has not actually moved abroad except on paper, while others target the tax dodging practices that inversion facilitates and which provide its true motivation.
Contrary to corporate lobbyists’ claims, corporations do not seek to become foreign for tax purposes simply because other countries have lower statutory corporate tax rates. They do it because inversion makes it easier to use accounting tricks to dodge U.S. taxes. For example, an inverted company can strip earnings out of the American business by making large interest payments to the ostensible foreign company that owns it, and it can use accounting tricks to move offshore profits into the U.S. without triggering the tax normally due when U.S. companies repatriate offshore profits.
An American corporation can accomplish these feats after it creates, through inversion, the pretense that it’s owned by a foreign company, even if this change exists only on paper. So, in addition to changing the basic rules about when an American corporation will be recognized as having become a foreign one (the basic proposal to crack down on inversions), many people in Washington are also thinking about ending these two tax dodges to eliminate the incentives to invert.
Another difference between the proposals being debated is that one approach would do this through legislation while another would accomplish this through regulatory changes under existing law. The regulatory route is important in case Congress fails to provide a legislative solution — which seems increasingly likely given some of the impossible conditions key lawmakers have placed on approving any legislative solution.
There is nothing inevitable about corporate inversions. There is no fundamental reason why corporations that are American in every sense and that benefit from taxpayer-funded services should be allowed to pretend they are foreign when it comes time to pay taxes. Congress and the White House have the tools to solve this problem, and simply need to choose the right ones.