Firms That Incorporate Abroad for Tax Purposes: Corporate "Inversions" and "Expatriation"
Publication Date: March 2007
Publisher: Library of Congress. Congressional Research Service
Author(s):
Research Area: Banking and finance
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Abstract:
Over the past several years, reports indicate that an increasing number of U.S. firms have altered their structure by substituting a foreign parent corporation for a domestic one. Such "inversions" typically involve creation of a new foreign corporation in a country with low tax rates (a "tax haven") that becomes the parent of the firm's foreign and U.S. component corporations. A chief motive for inversions is apparently savings by firms on their U.S. corporate income tax. One source of savings is tax on a firm's foreign income: the United States taxes corporations chartered in the United States on both U.S. and foreign income but taxes foreign chartered corporations only on their U.S.-source income. An inversion can thus potentially reduce a firm's U.S. taxes on foreign income. Other tax savings apparently result from "earnings stripping," or the shifting of U.S.-source income from taxable U.S. components of the firm to the tax-exempt foreign parts.
In the long run, inversions may be accompanied by some increased level of U.S. investment abroad; a firm that inverts reduces its tax burden on foreign investment. However, any such shift may be small, and the recent corporate inversions do not appear to be accompanied by substantive shifts of economic activity from the United States. This leaves the impact of inversions on tax revenues as probably the leading near-term economic effect. As a consequence, one policy issue inversions present is that of tax equity: unless offset by spending cuts or larger budget deficits, the lost revenue is made up with higher taxes on other U.S. taxpayers. Several bills introduced in the 108th Congress appear to have had the revenue losses and tax equity as their primary concern, and tax legislation aimed at restricting inversions was included in the American Jobs Creation Act of 2004 (P.L. 108-357), an omnibus tax bill addressing business and international tax issues. In 2006, additional tax restrictions were proposed in the Senate-passed version of the Tax Increase Prevention and Reconciliation Act (TIPRA; P.L. 109-222) but were not contained in the final act. At the outset of the 110th Congress, there are indications that Congress may look to the corporate income tax as one area where revenue-raising measures might be found to offset tax cuts provided elsewhere. Given the inclusion of inversion restrictions in early versions of TIPRA, congressional attention may return to inversions in 2007.
Some have viewed inversions as symptomatic of a burden they believe the U.S. tax system places on the international competitiveness of U.S. firms. A May 2002 U.S. Treasury report saw inversions as just one result of competitive problems posed by U.S. taxes and called for a more general reexamination of the U.S. international tax system. The report's near-term recommendations for more stringent tax rules are confined to changes aimed at protecting the domestic tax base rather than U.S. tax revenue from foreign income. Recent policy discussions of the U.S. international tax system have included calls by some for adoption of a "territorial" tax system, under which U.S. taxes would not longer apply to foreign-source income. Inversions can be viewed in this larger context; they have been described as "do-it-yourself" territoriality and present many of the same policy issues. This report will be updated as events in Congress and elsewhere occur.