Since the United States’ foundation as a country it has stood as a robust believer in the triumph of capitalism and the free market. However, in recent years these values have been challenged by the increasing trend of tax inversion by U.S. companies. Tax inversion is a corporate strategy that involves a corporation moving its tax domicile to a different country to bear a lower corporate tax. In the American example, this is normally achieved through a U.S. company merging with or acquiring a rival foreign firm, enabling the company to incorporate abroad and benefit from a lower tax burden.
The US corporate tax rate currently rests at 35 per cent, while in contrast the estimated average of all OECD member states stands at roughly 24 per cent.. The United States is also unique with respect to its counterparts in the developed world by taxing U.S. headquartered companies’ foreign revenues. Naturally, if one believes in the fundamental economic principle that corporations will seek to maximise their profits, it explains the increasing trend for American companies to engage in merger & acquisition (M&A) activity with foreign firms to avoid such high tax burdens.
This building tension between business and government came to a head when the Treasury Department announced on 24 September a set of rules aimed at curbing tax inversion. Some of these new provisions include: restricting US firms from utilising ‘creative’ means of transferring money or foreign profits into the U.S. without paying taxes; using ‘hopscotch’ loans, which allow companies to avoid tax dividends when accessing tax-deferred foreign profits; and making it more difficult to shift the address of administrative headquarters for tax purposes. For instance, even if a U.S. company mergers with a foreign entity and establishes headquarters abroad, it will still face being treated as domestic company if U.S. shareholders still own more than 80 per cent of the newly formed entity. In an effort to further minimise inversions, the Obama administration is seeking to eventually lower this condition to only a 50 per cent stake and prevent firms from ‘skinnying down’, which includes making special dividends to get below this benchmark percentage. If the Obama administration can successfully pass new tax legislation through Congress, it estimates that this will bring in approximately $20 billion over the next 10 years.
These new rules will have consequences for the eight inversions currently underway. A notable case includes Medtronic’s purchase of Irish-based Covidien Plc., which includes in the contract a clause that lets either company walk from the deal if Congress approves legislation to change U.S. tax law. Another inversion case garnering perhaps the most media attention is Burger King’s impending merger with Canadian coffee & doughnut giant Tim Hortons, valued at $11.5 billion, which would place the newly merged entity’s headquarters in Canada. Despite both parties claiming that the merger is motivated by “long-term growth and not tax benefits,” this move, though still holding the new firm responsible for paying taxes on burgers purchased within the U.S., would absolve non-American Burger King profits from the high U.S. corporate tax rate . For the companies involved in the eight planned inversions, share prices declined as the market adjusted to the Treasury’s announcement.
American opinion regarding tax inversion is divided roughly along party lines. Democrats have moralised the issue, painting inversion as a national betrayal of sorts. President Obama has forcefully espoused the notion that ‘economic patriotism’ should discourage U.S. companies from moving their headquarters abroad, declaring in July, “I don’t care if it’s legal. It’s wrong”. The American public has likewise expressed mistrust at this corporate strategy, asserting that the country is being cheated out of the tax revenue these corporations would normally bring in.
This intermingling of business strategy combined with a supposed mandate to also promote national loyalty and interests (in terms of tax revenue) is a unique political spin on what is fundamentally an economic issue. The Obama administration’s position to merely criticise U.S. corporations on a moral level and spitefully tighten tax regulations is a counterproductive response to an issue that has emerged as a result of policies that undermine the competiveness of American businesses. Rather than the President and Congress acknowledging the greater issue of a desperate need to reform the American tax system, the government is discouraging the very free-market principles at the core of its liberal philosophy. Is it really fair of the Obama administration to penalise and bash U.S. corporations for doing smart business? Rather than tighten regulations, should Congress not seek to instead make America a more attractive place to do business?
A company has an obligation to act in a manner that above all enhances value for shareholders through generating maximum profits. The success of America as a global economic leader can be partially credited to the historical independent success of ambitious businesses that were able to flourish under an America that encouraged an entrepreneurial spirit and attracted innovators from across the world. Today, the U.S. government looks towards policies that will continue to cause well-performing companies to move elsewhere, whilst using patriotism and a nationalist sentiment to defend uncompetitive economic strategies.
Ultimately, if the U.S. corporate tax rate stays at its current level, businesses are will look to establish themselves abroad, while anti-inversion regulations will merely decelerate, but not completely eliminate M&A activity between American and foreign companies. Current rhetoric linking corporate loyalty to a nation does not make sense in the context of traditional American liberal market ideals. The campaign for ‘economic patriotism’ touted by the Obama administration clouds the serious problem of a deeply broken tax system that will continue to harm the nation until it is addressed.