Establishing a tax domicile abroad — also known as a corporate inversion or expatriation — is a tax strategy that’s received a lot of media attention this year. The United States has the highest corporate tax rate in the industrialized world (35% before state and local taxes). And it’s the only country that taxes corporate profits earned outside its borders.
Corporate inversions are nothing new. More than 50 large companies have redomiciled over the last three decades, with several others in the works.
Here’s how it usually works. A U.S. company becomes a wholly owned subsidiary of a foreign corporation through either a merger or a sale of its assets to the foreign company. The change to foreign ownership allows the company to avoid paying U.S. tax on foreign operations and distributions to the foreign parent. But income earned domestically is still taxed at ordinary corporate rates.
Companies typically promise that corporate inversions will add value. But a recent Reuters study shows that, despite any tax savings, corporate inversions don’t necessarily translate into above-average returns for investors. Of the 52 transactions reviewed, 19 outperformed the Standard & Poor’s 500 Index and 19 underperformed it. The rest were either bought by rivals, went out of business or repatriated back to the United States. (There’s no telling how these companies would have performed if they hadn’t expatriated, however.)
A cautious approach
Remind borrowers that are large enough to consider a corporate inversion to weigh all the pros and cons. On one hand, inversions allow companies to indefinitely defer paying U.S. taxes on foreign income. They may also enable companies to access foreign cash and pursue international growth opportunities.
Conversely, most U.S. companies already have an effective tax rate below 35% due to various tax strategies, so tax savings may be lower than initially expected. Inversions may incur significant upfront tax costs, if they cause investors to recognize built-in capital gains on their stockholdings — and no company wants to upset its investors.
Inversions also require the U.S. company to operate under unfamiliar foreign laws, tax rules and cultural norms — as well as to risk being labeled as “unpatriotic,” which could create negative publicity. So, it’s imperative that there be a nontax rationale in order for an inversion to succeed. Congress is expected to consider legislation to curb the use of corporate inversions to lower taxes in the coming months. Check with your tax advisor for the latest developments.
For more information contact a member of our lender services team at 404-874-6244.