Are corporate tax inversions ‘unpatriotic’?

Moving overseas to cut tax burden remains a viable option for some firms, though the presidential candidates may have other plans.

With the long haul of a presidential election campaign just beginning, companies that leave the U.S. to lower their tax bills are once again political targets. Donald Trump this week introduced a tax plan that would cut the corporate tax rate so low that so-called corporate inversions would become unnecessary.

But the rhetoric won’t prevent some firms from trying to move offshore to cut their tax bill. Here’s why.

Last year, President Barack Obama called corporate tax inversions “unpatriotic” after several high-profile companies, such as Medtronics and Burger King, acquired smaller foreign companies and reincorporated in more tax-friendly countries. The lost tax revenue from inversion transactions is estimated at a relatively modest $20 billion over the next 10 years by the congressional Joint Committee on Taxation, but it’s easier for politicians to demonize companies that leave than to lower taxes for those that stay behind.

“Inversions are still a hot-button issue in Washington,” said Joseph Falbo, a partner at CPA firm Tronconi Segarra & Associates and president of the New York State Society of CPAs. “There are plenty of areas involving more egregious [tax avoidance], but a lot of legislators will continue to chase this issue down.”

Even after the Obama administration did everything it could to discourage inversions—including a host of new rules by the Treasury Department that make it harder for inverted companies to evade U.S. taxes—they are still happening.

Recently announced deals include Steris Corp. with U.K.-based Synergy Health, Cyberonics with Italy-based Sorin Group, and Arris Group with U.K.-based Pace. Accountants say corporate clients can and should still investigate options—including inversions—to lower their tax burdens.

“The driver for inversions is high corporate-tax rates in the U.S.,” said Ryan Dudley, a partner with Friedman, an accounting firm. “The new Treasury rules make inversions less attractive and more difficult to execute, but they are still a viable option for many companies.”

There have not yet been any New York City- or state-based companies to execute an inversion, but as home to a large number of Fortune 500 firms with global operations that would find inversions attractive, the city and state are vulnerable to losing high-profile taxpayers. Pfizer, for example, planned an inversion as part of its bid for the U.K.’s AstraZeneca last year (see sidebar below). Although the British company nixed the deal, Pfizer executives are reportedly still interested in moving elsewhere for tax purposes.

The incentives to invert are substantial. The U.S. is an outlier on the international corporate-tax scale. The combined federal and state corporate rate is approximately 40%, compared with the 25% average among member countries of the Organization for Economic Co—operation and Development. Despite Gov. Andrew Cuomo’s proposed cut in the state corporate-tax rate to 6.5% this year, companies headquartered in New York City have a combined rate of more than 40%.

‘Obligated to consider them’

The rest of the world, meanwhile, has been rapidly reducing its corporate-tax rates to attract investment. The U.K., a formerly high-tax jurisdiction, has cut its business tariff to 20% and is deliberating on reducing it further. The rate in the U.S. has been at 35% since 1993. Although companies make effective use of loopholes in the tax code, the lower that rates go elsewhere, the more attractive an inversion looks.

“Inversions are not unpatriotic,” said Paul Dailey, a partner with CPA firm Citrin Cooperman. “If the rules are there, corporate taxpayers are obligated to consider them.”

Mr. Dailey works predominantly with smaller companies that he said were largely scared off inversions by last year’s rhetoric. Some big firms have also been hesitant to make the move for fear of the political cost. Walgreens and Stanley Works, for example, abandoned plans to invert after facing intense criticism.

Mr. Dailey nevertheless expects that large and small companies with significant foreign operations will continue to look at the inversion option despite the bad PR. “The hysteria affected many of my smaller clients,” he said, “but once they see that inversions are still viable, they’ll get back into the game.”

With every session of Congress that ends without corporate-tax reform, the charge that inverting companies are unpatriotic tax cheats rings a little more hollow. The U.S. not only has a very high statutory rate, but it also has a worldwide system of taxation, meaning it imposes a levy on foreign profits at the same 35% rate, minus taxes paid in those jurisdictions. It doesn’t apply the tax until profits are repatriated to the U.S., which leads companies to hoard foreign income overseas.

The estimate of profits now held offshore by U.S. companies surpasses $2 trillion. When a company inverts by acquiring a smaller business in a lower-tax jurisdiction, future foreign profits are taxed at the lower rate. Until recently, access to accumulated profits not yet repatriated to the U.S. could also be more easily gained after inversions by using intercompany loans between subsidiaries and the new foreign parent.

The rules passed by the Treasury Department last year to stem inversions made those so-called hopscotch loans harder to execute. It also tightened the rules requiring at least 20% foreign ownership in the new entity—one reason the U.K. has become a favorite destination for U.S. company inversions. U.S. multinationals typically already have significant operations in the U.K., and a merger with a British company carries less stigma than one executed in Ireland or an even smaller offshore tax haven.

If Congress continues to put off corporate-tax reform, new administrative rules aren’t likely to keep companies from inverting for long, suggested Mr. Falbo. “Other strategies will be employed within the rules to help companies achieve a lower tax rate,” he said. “U.S. companies are trying to level the playing field with competitors.”

Who needs inversions? Manhattan-based drug company Pfizer was one of the highest-profile companies in the U.S. to attempt a corporate-tax inversion when it made a bid for U.K.-based AstraZeneca last year. The deal fell through, but Pfizer is reportedly still on the prowl for one that helps it find a more tax-friendly home.

Pfizer, however, has done a stellar job at managing its tax burden. Like most pharmaceutical (and many technology) companies, it has shifted intellectual-property assets and the income they produce to offshore jurisdictions, where they are taxed at much lower rates.

Although Pfizer and other drug firms charge much more for their products in the U.S. than in countries where prices are regulated, it usually reports losses in the U.S. for tax purposes. Between 2008 and 2012, Pfizer booked net losses of $15 billion in the U.S. versus foreign profits of $69 billion, according to TaxAnalyst chief economist Martin Sullivan. It reported an effective tax rate of 21.2% in 2012, but if the deferred taxes recognized (but not paid) on foreign earnings were excluded, the level would have been 3%. Pfizer is at constant war with the Internal Revenue Service over its tax returns, but with results like that, it might as well stay in New York City.

Correction: Paul Dailey, a partner with CPA firm Citrin Cooperman, was incorrectly referred to as Mr. Cooperman in an earlier version of this article originally published online Sept. 28, 2015.