Tax inversion


A tax inversion or corporate tax inversion is a form of tax avoidance where a corporation restructures so that the current parent is replaced by a foreign parent, and the original parent company becomes a subsidiary of the foreign parent, thus moving its tax residence to the foreign country. Executives and operational headquarters can stay in the original country. The US definition requires that the original shareholders remain a majority control of the post-inverted company. In US federal legislation a company which has been restructured in this manner is referred to as an inverted domestic corporation, and the term "corporate expatriate" is also used, for example in the Homeland Security Act of 2002.
The majority of the less than 100 material tax inversions recorded since 1993 have been of US corporations, seeking to pay less to the US corporate tax system. The only other jurisdiction to experience a material outflow of tax inversions was the United Kingdom from 2007 to 2010 ; however, UK inversions largely ceased after the reform of the UK corporate tax code from 2009 to 2012.
The first inversion was McDermott International in 1983. Reforms by US Congress in 2004 halted "naked inversions", however, the size of individual "merger inversions" grew dramatically; in 2014 alone, they exceeded the cumulative value of all inversions since 1983. New US Treasury rules in 2014–16 blocked several major inversions, and the Tax Cuts and Jobs Act of 2017 further reduced the taxation incentives of inversions., there have been no material US inversions post-2017, and notably, two large Irish-based tax inversion targets were acquired in non-tax inversion transactions, where the acquirer remained in their higher-tax jurisdiction: Shire plc by Japanese pharma Takeda for US$63 billion, and Allergan plc by U.S. pharma AbbVie for US$64 billion ; in addition, Broadcom Inc. redomesticated to the United States.
the most popular destination in history for US corporate tax inversions is Ireland ; Ireland was also the most popular destination for UK inversions. The largest completed corporate tax inversion in history was the US$48 billion merger of Medtronic with Covidien plc in Ireland in 2015. The largest aborted tax inversion was the US$160 billion merger of Pfizer with Allergan plc in Ireland in 2016. The largest hybrid-intellectual property tax inversion was the US$300 billion acquisition of Apple Inc.'s IP by Apple Ireland in 2015.

Concept

While the legal steps taken to execute a tax inversion can be complex as the corporations need to avoid both regulatory and Internal Revenue Service hurdles in re-locating their tax residence to a lower-tax jurisdiction, simplified examples are available; such as provided in August 2014, by Bloomberg journalist Matt Levine when reporting on the Burger King tax inversion to Canada. Before the 2017 TCJA, U.S. companies paid a corporate tax rate of 35% on all income they earned in both the U.S., and abroad, but they obtained a credit against their U.S. tax liability for the amount of any foreign tax paid. Given that the U.S. tax rate of 35% was one of the highest in the world, the corporate's maximum global tax liability should, therefore, have been 35%. This pre-TCJA U.S. tax system, was referred to as a "worldwide tax system", as opposed to the "territorial tax system" used by almost all other developed countries. Levine explained:
If we're incorporated in the U.S., we'll pay 35 percent taxes on our income in the U.S. and Canada and Mexico and Ireland and Bermuda and the Cayman Islands, but if we're incorporated in Canada , we'll pay 35 percent on our income in the U.S. but 15 percent in Canada and 30 percent in Mexico and 12.5 percent in Ireland and zero percent in Bermuda and zero percent in the Cayman Islands.
By changing its headquarters to another country with a territorial tax regime, the corporation typically pays taxes on its earnings in each of those countries at the specific rates of each country. In addition, the corporation executing the tax inversion may find additional tax avoidance strategies, called tools, that can shift untaxed profits from the higher-tax locations, to the new lower-tax country to which the corporation has now inverted.

History

The following are notable events in the history of US and non-US corporate tax inversions:

US experience

  • 1983. The first officially recognized US corporate tax inversion was of McDermott International from Texas to Panama. Academics refer to it as a first-generation inversion.
  • 1990. The relocation of Flextronics from California to Singapore; however it is not considered as a full tax inversion.
  • 1994. The second officially recognized US corporate tax inversion was of Helen of Troy Limited from Texas to Bermuda. Academics refer to it as a second-generation inversion.
  • 1994. James R. Hines Jr. publishes the important Hines–Rice paper, which shows that many US corporations had chosen to shift profits to tax havens, instead of using tax inversions.
  • 1996–2004. The first major wave of US tax inversions mainly to Caribbean tax havens such as Bermuda and Cayman Islands; these inversions were mostly "naked inversions" where the corporate re-domiciled to a tax haven in which they had no existing business, and included: Ingersoll-Rand, Accenture, Seagate, Cooper, and Tyco. Academics refer to them as third-generation inversions.
  • 2004. US Congress passes the American Jobs Creation Act of 2004 with IRS Section 7874 that requires existing shareholders to own less than 80% of the new entity, and introduces a "substantial business activities" test in the new foreign location; AJCA ends "naked inversions" to Caribbean-type tax havens.
  • 2009–2012. Several US inversions from the first wave to the Caribbean-type tax havens relocate to OECD tax havens, such as Ireland, and Switzerland, fearing a backlash from a new Democratic administration.
  • 2012–2016. The second major wave of US tax inversions use mergers to meet the "substantial business activities" of IRS 7874; Ireland and the UK are main destinations and the size of these inversions are much larger than the first wave, and included: Medtronic, Liberty Global, Eaton Corporation, Johnson Controls, and Perrigo. Academics refer to them as fourth-generation inversions.
  • 2012. The US Treasury issues T.D. 9592 increasing the "substantial business activities" threshold in the foreign destination from 10% to over 25%.
  • 2014. The value of new proposed US tax inversions in 2014 alone exceeds the cumulative value of all previous US tax inversions in history.
  • 2014. The US Treasury further tightens the regulations around the existing AJCA/TD 9592 thresholds; AbbVie cancels a US$54 billion inversion to Ireland with Shire plc.
  • 2015. Medtronic completes the largest tax inversion in history in a US$48 billion merger with Covidien plc in Ireland.
  • 2015. Apple Inc. completes the largest hybrid IP-inversion in history by moving US$300 billion of IP to Ireland.
  • 2015. Two previous US tax inversions to Ireland, Actavis plc and Allergan plc, execute a US$70 billion merger to prepare for a tax inversion with Pfizer.
  • 2016. The US Treasury tightens, and introduces new regulations around the existing AJCA/T.D. 9592 thresholds which blocks the US$160 billion merger of Pfizer with Allergan plc in Ireland.
  • 2017. The US Congressional Budget Office forecasts a 2.5% permanent reduction in annual US corporate tax revenues from inversions.
  • 2017. The US Tax Cuts and Jobs Act reforms US tax code and introduces a lower 21% headline tax rate and moves to a hybrid–"territorial tax system".
  • 2019. AbbVie announced an agreement to acquire Allergan plc for $US63 billion; however the acquisition would not be structured as a tax inversion, and that the group would be domiciled in the U.S. for tax purposes. AbbVie announced that post the 2017 TCJA, its effective tax rate was already lower than that of Irish-based Allergan plc at 9%, and that post the acquisition, it would rise to 13%.

    UK experience

  • 2007–2010. The United Kingdom loses a wave of tax inversions mainly to Ireland including: Experian plc, WPP plc, United Business Media plc, Henderson Group plc, Shire plc, and Charter.
  • 2009–2012. The United Kingdom reforms its corporate tax code introducing a lower 19% corporate tax rate and moves to a full "territorial tax system".
  • 2013. Liberty Global completes the second largest US tax inversion in history in a US$24 billion merger with Virgin Media in the UK.
  • 2015. The UK HMRC reports many UK inversions to Ireland returned ; and that the UK was a major destination for US inversions.
  • 2016. The UK becomes the third most popular destination in history for US tax inversions with 11 inversions.

    Other experience

  • 2014. Irish International Financial Services Centre tax-law firms sometimes list Pentair in their brochures as a Swiss tax inversion to Ireland; however Pentair was really a 2012 US tax inversion to Switzerland, who then used Ireland as a base for two years, before moving to the UK in 2016.
  • 2018. The Japanese Takeda Pharmaceutical Company announced that it was merging with Irish-based Shire plc ; however, after some initial confusion, Takeda clarified that it was not executing an inversion to Ireland and that its legal headquarters would remain in Japan.

    Drivers

Reduced taxes

While corporates who execute inversions downplay taxation in their rationale for the transaction, and instead emphasise strategic rationale, research is unanimous that tax was the driver for most US tax inversions from 1983 to 2016.

Types of tax saving

US research on US tax inversions breaks down the tax savings into three areas:
  • Tax on US income. Before the 2017 TCJA, the US corporate tax rate was one of the highest rates in the developed world at 35%. The development of that could shift or earnings strip US-sourced profits to other jurisdictions without incurring US taxes, created an incentive for US corporates to execute tax inversions to lower tax jurisdictions. The "first wave" of US inversions from 1996 to 2004 focused on debt-based tools, however, the significantly larger "second wave" of US inversions from 2012 to 2016 also made use of IP-based BEPS tools.
  • Tax on non-US income. Before the 2017 TCJA, the US corporate tax code applied the 35% rate of taxation to all worldwide corporate profits. The US was one of only eight jurisdictions using a "worldwide tax system". All other jurisdictions used a "territorial tax system" where very low rates of taxation are applied to foreign-sourced profits. US tax academics noted this was the reason why non-US corporations made limited use of tax havens; in contrast, US corporations have been shown to be the largest global users of tax havens.
  • Tax on offshore reserves. Tax academics have shown that the dominance of US corporations in using tax havens was driven by strategies to shield non-US income from US taxation. BEPS tools such as the "Double Irish", enabled US corporations to build up untaxed offshore cash reserves estimated at US$1–2 trillion in 2017. Ensuring that such reserves would be protected from any initiatives by Congress to subject them to US taxes required an inversion to another jurisdiction. Medtronic's US$20 billion in untaxed offshore reserves was noted as a driver for their 2015 inversion.
In 2015, the UK HMRC identified high corporate taxes and a "worldwide tax system" for the wave of UK tax inversions to Ireland in 2007–2010.