Inverting corporations should pay what they owe when they go

If the all-American fast food chain Burger King, with its thousands of restaurants in the United States, can claim to be a foreign company for tax purposes, our corporate tax system is in real trouble.

The crisis of corporate inversions is now apparent even to those who aren’t connected to the boring details of tax policy. The specifics of inversions are clear to everyone: A U.S. corporation merges with a smaller foreign company and claims the foreign country as its address, even though the vast majority of the business continues to be carried out and managed in the U.S. The public outrage is so apparent that Walgreen Co. backed off its plans to invert.

This ire stems from the justified belief that there’s a separate set of rules for powerful corporations. So here’s a thought. To restore some level of fairness to the system, require corporations that declare they are no longer American to pay the U.S. taxes that they have put off, just as we do to individuals who renounce their U.S. citizenship.

Specifically, Congress should require that any corporation that becomes a foreign company must pay U.S. taxes it has deferred on profits it has accumulated offshore.

This measure would not be a new tax but merely the elimination of a special tax break (the ability to defer paying taxes on profits earned offshore) for companies that say they are no longer American.

American multinational corporations are given this tax break supposedly to help them compete with multinational corporations based in other countries. Questions of whether this tax break makes sense aside, we shouldn’t offer this break to corporations that declare themselves no longer American..

Right now our tax laws give corporations a better deal than individuals when it comes to expatriation. Corporations and individuals are both allowed to defer paying income taxes on key parts of their income, but only individuals are required under current law to give up that benefit when they renounce their U.S. citizenship.

Individuals are allowed to defer paying income taxes on their capital gains (appreciation of assets) until they sell their assets. But when wealthy individuals renounce their U.S. citizenship, they are required to pay income tax on unrealized capital gains (appreciation on assets they have not sold).

Corporations are allowed to defer paying income taxes on the profits they earn offshore until repatriating them to the U.S. Unlike individuals, corporations do not lose this key tax break when they become foreign. Congress should change that, meaning these offshore profits should be subject to U.S. corporate income taxes as if they were repatriated to the U.S. at the point when the company inverts.

This could dramatically reduce incentives for certain corporations to invert. For example, the medical device maker Medtronic, which is merging with Covidien and plans to change its corporate address to Ireland, has $20.5 billion in permanently reinvested earnings offshore, and $13.9 billion of that is cash or cash equivalents (the profits the company is most likely to repatriate to the U.S.). Medtronic acknowledges that if it repatriates these profits it would pay U.S. income taxes on them at an effective rate in the range of 25 to 30 percent. Given that the U.S. tax on offshore profits is reduced by whatever tax has been paid to foreign governments, this suggests that Medtronic books a lot of profits in very low-tax countries that normal people call tax havens.

After inverting, Medtronic will technically be the subsidiary of a foreign company. It could route these offshore profits through its ostensible foreign parent company, or one of that company’s subsidiaries, to get this money into the hands of shareholders without triggering the 25 to 30 percent U.S. income tax that would normally be due upon repatriation.

If these offshore profits were taxed as if repatriated at the point of inversion, this tax dodge would be stopped and Medtronic would likely decide that inversion is not in its interest after all.

To be clear, this proposal would complement others already on the table. A bill introduced by Rep. Sander Levin (D-Mich.) and Sen. Carl Levin (D-Mich.) in May would prevent inverted corporations from being treated as foreign companies for tax purposes. A bill introduced by Sen. Charles Schumer (D-N.Y.) last week would stop inverted corporations from dodging taxes on future profits through the practice called earnings stripping. Congress should enact these reforms immediately. A third part of the problem is the ability of inverted corporations to dodge taxes on profits they accumulated offshore before inverting, which can be solved by taxing offshore profits as if they are repatriated at the point of inversion.

Inverted corporations are American companies pretending to be foreign even as they benefit from public investments financed by U.S. taxes. The reform described here would make corporations much less likely to use this tax dodge and more likely to pay their fair share. And our tax code would move one step closer to something resembling common sense.

Wamhoff is legislative director of Citizens for Tax Justice. Clemente is executive director of Americans for Tax Fairness.