Onu Law Firm
Like a ghost from the past, corporate inversions are back and have gripped the news as there have been reports of the increased use of this thing, this tax gimmick called corporate inversion. Simply put, corporate inversion is a process whereby corporations give up their American citizenship while retaining a summer, autumn, spring and winter home in the U.S. of A. News reports continue to tell the American public of a tax gimmick that corporations are using to abandon their American passport. There was news of Pfizer attempting to become British, followed by news of Chiquita becoming Irish and of Burger King attempting to become Canadian.1

“Why?” asks the American public, “Why do you no longer want to be one of us?”

“Because, your taxes are way too high,” is the reply by the departing corporations.

Taxes. There are few citizens in any civilized country who enjoy paying taxes. That said, there is something that irritates the public about corporations emigrating simply to avoid paying taxes. This something might have something to do with the fact that corporations are not much loved right now. Ever since the last depression, that is called the great recession, the stock market has recovered beautifully and corporations are sitting on a pile of cash and yet employee’s wages has remained stagnant and many of the new jobs that are created are either part time or temporary.

“And now,” the public says, “these profitable corporations are complaining about paying taxes. And I still have to pay my taxes!!”

Needless to say, the public is upset. Corporations know this and so they turn to their PR departments who have drafted a message that they hope will calm the American public. They create a new villain.

“Hey, it’s not our faults,” the corporations say, “we would love to stay, but for your government. You, the American public, are great and we love you, but your damn government keeps getting in the way. Your government doesn’t like business and is driving us poor corporations away with their absurdly high taxes.”

Corporations argue that the U.S. corporate tax code is unfair to multinationals as it creates a burden that automatically grants their competitors an unfair advantage. In this case, competitors are foreign corporations, who the American corporations argue do not have to follow the U.S. tax code in foreign jurisdictions and as such they pay a lot less in taxes and this is unfair.

“The U.S. tax code,” the corporations say, “is unfair for two reasons. First, the U.S. corporate tax rate of 35% is the highest amongst OECD countries.2 Second, while most other countries have a territorial tax system, America follows a worldwide tax system. This means that in most countries, you only pay taxes on the income you generate in that country. While in America, U.S. citizens pay taxes on all the income they generate, no matter where in the world the income is generated. To mitigate double taxation, the U.S. tax system does allow you to offset the amount of tax that you pay to a foreign government from the amount that you owe the U.S. government, but that still means that you always pay the U.S. tax rate, which is amongst the highest in the world.3

“For example, pretend there is a foreign country, Winterfell, with a 20% corporate tax rate. All corporations doing business in Winterfell would have to pay a tax equivalent to 20% of all profits earned in Winterfell to the government of Winterfell. U.S. corporations will not only pay the 20% tax to Winterfell, but will also pay an additional tax of 15% of their profits to the U.S. government. This is because the evil U.S. government has a 35% tax rate and requires U.S. corporations to pay that rate, but in this case, since the U.S. corporations have already paid 20% to Winterfell, the U.S. government will only come for the difference of 15%. This is unfair, because while other corporations doing business in Winterfell pay 20% in taxes, the U.S. corporations have to pay 35%. So,” the corporations say, “the only reason that we dream of leaving this beautiful country is because we are being pushed away by your cruel government. The American laws that police corporations require that we protect our shareholders and so the government’s unconscionably high taxes are forcing us to consider drastic actions in order to level the playing field with our foreign competitors.”

“Nice one,” comes the public’s reply, “that is a great speech, but if the U.S. tax code is so high, how come few of you pay anything close to the 35% tax rate?”

The public has a right to be skeptical as there have also been news reports about corporations that pay few if any taxes. CEOs for corporations such as Caterpillar and Apple were criticized by some senators for using tax gimmicks that allowed them to avoid paying U.S. taxes.4 A report from the Citizens for Tax Justice shows a list of about 25 profitable U.S. corporations that did not pay any taxes over a four year period ending in 2012.5 There are news reports of Wesley Snipes going to jail for tax evasion.

“What’s with celebrities and not paying taxes?” A member of the public will ask upon hearing news of Wesley Snipes and his tax issues.

“Yeah, but at least they go to jail,” might come the reply by another member of the public.

Corporations know, or should be aware of the growing resentment that is mounting upon them. There are still those who think that they bankrupt the country and instead of being punished, they were bailed out. That said, corporations do have a valid complaint as the combination of high taxes and a worldwide tax system is blatantly unfair to multinationals. America should consider switching to a territorial tax system. There are obvious challenges associated with a territorial tax system. The first is profit-sharing, which is a technique that corporations use to transfer money from a high tax jurisdiction to a lower tax jurisdiction. Corporations do this by shifting payments between related entities within a corporate structure. A way to counter this will be to have significant anti-abuse provisions written into the tax codes.

Another problem is a potential loss in domestic investments. The fear is that a territorial tax system will lower the cost to invest abroad and corporations might chose to replace their American investments with investments in foreign countries with lower tax rates. This might be true, but this writer hopes that a territorial tax system will encourage corporations to bring back the mountains of cash that they have stored in foreign jurisdictions. Under the current, U.S. worldwide tax system, corporations’ foreign earnings are not taxed until the monies are brought back to America.6 For this reason, corporations keep most of their foreign earnings in low tax foreign jurisdictions. So, the hope is that under a territorial tax system, corporations will bring some of their foreign cash back to America. The hope is that the combination of the cash that is brought back to America and the fact that multinationals will have to maintain some American investments for the sake of public relations or goodwill, will offset the potential increase in foreign investments.

However, the biggest problem with a switch to a territorial tax system is the loss of tax revenue. For this reason, this writer humbly suggests that all loop holes be removed and the tax rate be kept high. This writer suggests a tax rate that moves within a range of 20% to 30%. Corporations that maintain high average median wages will be rewarded with a lower tax rate. The hope is that a tax policy that incentives higher median wages will hopefully lead to a rise in wages paid to the majority of American workers. The other reason for a high tax rate of 30% is that no matter how low the tax rate, corporations will always find ways to legally cheat on their taxes. Therefore, a tax rate of 30% will cause corporations to cheat and, if the public is lucky, end up paying taxes at a rate between 20-25%.

Corporations are creative and will always find creative ways to evade paying taxes. Corporations, like the public, do not enjoy paying taxes. Corporations, unlike the public, can spend the money to find the legal ways to get away with not paying taxes. For example, the use of corporate inversions first exploded during the late 1990s and early 2000s. In response congress passed the American Jobs Creation Act of 2004 as a way to stop the inversions.7 A losing battle as corporations found creative ways to perform the now current version of corporate inversions. A better example of corporate ingenuity can be found in Britain. England is known to have favorable tax codes that corporations would consider fair, and yet Starbucks got into trouble when it became known that Starbucks had paid no tax on £1.2 billion in sales and claimed to have no profit in 14 years of operations.8 Corporations will always find creative ways to avoid taxes and so taxes should be kept relatively high. This is especially true when there are no better alternative sources for tax revenue. Someone has to pay the taxes and the public will gladly say, “not me.”

It should be stressed that a territorial tax system will not completely stop the use of corporate inversions. Corporations have one other reason to burn their passports that have little to do with taxes. Corporations have been complaining about the regulatory burdens imposed on them by the U.S. government. There is the Sarbanes-Oxley Act of 2002, the Foreign Corrupt Practices Act of 1977 (scarcely enforced for its first 20 years of existence), and the Dodd-Frank Act of 2010. Corporations complain that these laws place huge burdens on them by requiring them to spend millions just to provide the paper work that shows that they are in compliance—some state that the hidden annual cost of compliance with U.S. regulations is $1.75 trillion.9 So, even with tax reform, corporations will still have at least one reason to want to renounce their citizenship.

A territorial tax system won’t stop all tax gimmicks but it is still a good idea because there is something inherently disagreeable with being required to pay taxes on monies made in foreign lands. America is supposed to represent the principle of “no taxation without representation,” and America doesn’t really provide representation to Americans who are abroad. Seriously, it is the policy of the U.S. government not to pay ransom money to free Americans kidnapped in foreign lands. Therefore, there is no American representation on foreign soils, and so there should be no American taxation.

1Donald J. Marples & Jane G. Gravelle, Congress Research Service, R43568, Corporate Expatriation, Inversions, and Mergers: Tax Issues (2014), at summary, available at http://fas.org/sgp/crs/misc/R43568.pdf [hereinafter CRS Report 1]
2Simpson, Joshua. “Analyzing Corporate Inversions And Proposed Changes To The Repatriation Rule.” 2013. PDF file, at 718. Available at http://www.law.nyu.edu/sites/default/files/upload_documents/NYU-Annual-Survey-68-3-Simpson.pdf [hereinafter NYU pdf 1]
3See CRS Report 1, supra note 1, at 3.
4Neuman, Scott. “Senate Democrats Say Caterpillar Avoided $2.4 Billion In Taxes.” NPR, 01 April 2014. Web. 16 Oct. 2014. http://www.npr.org/blogs/thetwo-way/2014/04/01/297867382/senate-democrats-say-caterpillar-avoided-2-4-billion-in-taxes
5Strachan, Maxwell. “These 26 Companies Pay No Federal Income Tax.” The Huffington Post, 26 Feb. 2014. Web, 16 Oct. 2014. http://www.huffingtonpost.com/2014/02/25/corporation-tax-rate_n_4855763.html
6See CRS Report 1, supra note 1, at 2.
7See CRS Report 1, supra note 1, at summary.
8Pease, Martha. “You pay taxes, and rich corporations don’t.” CNN, 16 July 2014. Web. 16 Nov. 2014. http://www.cnn.com/2014/07/16/opinion/pease-tax-avoidance/
9See NYU pdf 1, supra note 1, at 688.