“Nothing is certain but death and taxes.” We all have almost certainly heard this phrase before and most often remember it as a witty adage about the obscurity of life with only two exceptions: everyone at some point will move on (die) and everyone will have to pay taxes. And while I am forced by nature to maintain the truth of the former part of this saying, the latter is a bit more involved. Yes, we may all have to pay taxes, but there is a sizeable difference as to how much we will pay and to whom will we pay those taxes to.

A lot of talk has been passed around lately about the on going corporate inversions that a lot of U.S. corporations are seeking to undergo. An inversion is the process that a domestic firm (in our case a U.S. company) undergoes when they merge with a foreign company and reincorporates themselves in the foreign country in order to reduce the amount of taxes it would pay on its earnings. While this behavior is not exactly new, it has been pushed to the forefront of today’s debate floor and leaves the rest of us asking what to do about it.

The world of corporate tax law is more complex and twisted then just about any other area of government regulation. Corporations are taxed on their earnings made here at home and abroad. Tax credit is often awarded to companies on earnings that are acquired and already taxed abroad, so double taxation is limited. Also, earnings made abroad are only taxed after they are brought home to the U.S. parent company, repatriated earnings. If the earnings on not brought home immediately, they become deferred earnings.

The problem lies in that those foreign earnings do not need to be brought home to the U.S. parent company, and therefore are never taxed by the U.S. Apple and G.E. are two good examples of this. “Bloomberg estimated in March that the foreign cash hoard of American companies had reached $1.95 trillion,” Jeff Sommer wrote in his New York Times article Jeers and Cheers Over Tax Inversion.  One problem with deferred earnings is that all the money is tied up in corporate accounts abroad and cannot be readily used. Inversion can help with that.

Corporate inversion allows a company to save a large amount of money, often millions of dollars – as most of the firms that are inverting are large multinational, multimillion/billion dollar companies – that would have otherwise been paid in taxes. The United States has the highest corporate tax rate among developed nations at about 35 percent. By reincorporating under the newly acquired business in a foreign nation, these companies can drop that down to 25 percent, as it is in the Neherlands, or even 12 percent, as it is in Ireland.  Also, by inverting to reincorporate in a new country, companies can tap into all their offshore money without fear of taxation because everything is run through their foreign subsidiaries and the foreign parent company.

All this does not mean that these companies no longer pay taxes on their earnings. Just that the amount of taxes paid is significantly less (only the earnings made in the U.S.). Add the fact that the earnings of the U.S parent company is flooded with their foreign subsidiaries’ debt to make it seem as though their earnings were significantly less than they really were, resulting in lower taxable earnings. Also, the new foreign parent company tends to buy the controlling stake of the foreign subsidiaries in order to access the deferred earnings in their accounts and avoid paying taxes on it.

Are these companies cheats? Are they unethical? Are they ripping off the public? The answer is no. All businesses look to reduce their spending and retain more earnings. Individuals are just as guilty of this.

What this means, is that America – more specifically Congress – needs to address the failings of our tax system. And we, as citizens, need to watch this because even though what these businesses are doing is not technically illegal, they are skipping out on their portion of the check. This could leave it up to the rest of us to pick up the tab or we could see a reduction in government services. Worst of all, it could potentially lead to more governmental borrowing of money (Sommer).

The U.S. Treasury department has recently taken steps to curb the number of inversions. Last week they outlined new policies that they hope will make inversion deals less economically appealing. One of the rules under this new policy says that any stock that the foreign parent buys, even if it is of the subsidiaries, will be considered owning stock in the former U.S. parent company, thus allowing the deferred income to be taxable again. Also, loan or stock investment between the subsidiary and the foreign parent will now be considered U.S. property and taxable. (These are only a few things that this new policy will do. For a complete explanation see the link below.)

So the certainty of taxes remains. Through inversions corporations are finding ways to minimize their tax burden and they always will. That is a correlation of people and money. Everyone should be thinking about this too. Investors with money in companies that are thinking about inverting are bound to see a rise in stock value, but will be taxed on their capital gains. The negative spotlight the inversion brings may hurt the inverting companies stock value through consumer backlash (look at Burger King). And finally fact that if corporations are not paying enough in taxes and the government begins to lose money, then it could fall to the individual to make up the difference.

Chadd Brown
Super Tool, Inc.