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A new report from Citizens for Tax Justice explains that Congress should change our tax laws to require inverting corporations to pay the taxes they owe, but have deferred paying, on profits they accumulated offshore before inverting. As the report explains, requiring inverting corporations to pay taxes they have deferred on offshore profits would be akin to the existing rule that individuals who renounce their citizenship must pay taxes they have deferred on unrealized capital gains (on appreciation of assets they have not sold). This reform would complement others that have been introduced in Congress to address inversions.
Americans and their lawmakers are increasingly alarmed by corporate inversions, in which an American corporation merges with a smaller foreign one and then claims the foreign country as its address for tax purposes even though little or nothing has changed about where the business is conducted or managed. Burger King’s plans to declare itself Canadian and Pfizer’s stated commitment to pursuing an inversion are only the latest evidence of the crisis.
Under current law, both individuals and corporations are allowed to defer paying U.S. taxes on key parts of their income, but wealthy individuals are required to give up this benefit when they renounce their American citizenship, while corporations are not. Individuals are allowed to defer paying income taxes on capital gains until they sell their assets. But upon renouncing their U.S. citizenship, wealthy individuals are required to give up that benefit and must pay tax on their unrealized capital gains.
Corporations, on the other hand, are allowed to defer paying income taxes on their offshore profits until those profits are officially brought to the United States, and continue to enjoy this benefit even after renouncing their U.S. citizenship. After becoming a foreign company for tax purposes, a corporation is likely to use accounting tricks to ensure those profits are never subject to U.S. taxes.
The CTJ report explains there is no reason to continue granting this tax break to corporations that declare they are no longer American. This is especially true given that after inverting a corporation can often route these offshore profits through its new foreign parent company to get them into the hands of U.S. shareholders without triggering the U.S. taxes that would normally be due upon repatriation.
The most straightforward solution is to change the tax code so that these offshore profits are taxed as if they are repatriated at the point when the company inverts.
This is the one part of the inversion crisis that, so far, is not addressed by any legislation before Congress. A bill introduced in May by Rep. Sander Levin and Sen. Carl Levin would stop inverted companies from being treated as foreign for tax purposes. Legislation introduced this week by Sens. Charles Schumer and Richard Durbin would prevent inverted companies from dodging taxes on future profits through the practice called earnings stripping.
Left unaddressed is the part of the problem described in CTJ’s report — the ability of inverted companies to avoid taxes on the profits they have already earned and hold (at least as an accounting matter) offshore. Edward Kleinbard, former chief of staff to the Joint Committee on Taxation, argues that avoiding U.S. taxes on these profits is one of the major reasons why corporations invert.