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The crisis of corporate inversions remains unresolved in Congress, but some new proposals could set the stage for a resolution.
An August report from CTJ explained that the inversion crisis really consists of three related problems. The first is that American corporations are able to use mergers with smaller foreign corporations to claim a foreign address for tax purposes even though almost nothing has changed about their business, management, or ownership. This problem would be addressed by the Stop Corporate Inversions Act introduced by Rep. Sander Levin and Sen. Carl Levin in May.
The second problem is that those corporations claiming to be based abroad (and corporations that really are based abroad) are able to use “earnings stripping” to make profits earned in the United States appear to be earned in countries where they will be taxed more lightly or not at all. This problem would be addressed very effectively by a new proposal from Congressman Mark Pocan of Wisconsin, and less effectively addressed by a proposal introduced by Senator Charles Schumer last week.
The third problem is that profits American corporations earn offshore through their subsidiaries are supposed to be taxed by the U.S. when they are brought to the United States, but after becoming “foreign,” corporations are able to use accounting tricks to escape that rule. An op-ed from Citizens for Tax Justice and Americans for Tax Fairness explains how this problem can be resolved by requiring corporations that give up their American citizenship to pay taxes they have deferred on these profits, just as individuals who give up their American citizenship must pay any tax on capital gains they have deferred. A CTJ report also explains this idea in detail.
The following describes these proposals in more detail.
As CTJ’s August report explained, earnings are stripped out of the U.S. when a U.S. corporation (which after inversion is technically the subsidiary of a foreign parent corporation) borrows money from its foreign parent corporation, to which it makes large interest payments that wipe out U.S. income for tax purposes. The loan is really an accounting gimmick, since all the related corporations involved are really one company that is simply shifting money from one part to the other.
The August report explained that the strongest proposal to address this is the one President Obama proposed as part of his fiscal year 2015 budget plan — which has now been introduced as legislation for the first time by Rep. Pocan. When the President proposed this provision, the Joint Committee on Taxation estimated that it would raise $41 billion over a decade.
It would, with good reason, apply to all corporations, not just those that have inverted. It would allow a multinational corporation doing business in the U.S. to take deductions for interest payments to its foreign affiliates only to the extent that the U.S. entity’s share of the interest expenses of the entire corporate group (the entire group of corporations owned by the same parent corporation) is proportionate to its share of the corporate group’s earnings (calculated by adding back interest deductions and certain other deductible items). A corporation doing business in the U.S. could choose instead to be subject to a different rule, limiting deductions for interest payments to ten percent of its income.
Sen. Schumer’s proposal is much more similar to the one that President Obama included in his previous budget plans, which is much weaker. Schumer’s proposal only applies to inverted corporations. Most importantly, it would bar an inverted American corporation from taking deductions for interest payments to a foreign parent company in excess of 25 percent of its income. The current rule sets the limit at 50 percent.
Accumulated Offshore Profits
The U.S. theoretically taxes all the profits of American corporations, including the profits earned by their offshore subsidiaries. (The U.S. corporate income tax is reduced by whatever corporate income tax has been paid on these profits to foreign governments.) But U.S. corporations are allowed to defer paying U.S. tax until these profits are officially brought to the U.S., which may never happen. As a result, one of the key questions is what will become of the offshore profits that American corporations’ subsidiaries have accumulated offshore after they invert.
In The Hill, CTJ and ATF point out that deferral is a break we give American corporations, supposedly to help them compete with corporations based in other countries. It therefore makes no sense to continue giving corporations this break once they declare that they are no longer American. In other words, the profits held offshore by a corporation that announces a new foreign address should be subject to U.S. taxes as if they are repatriated to the U.S. at that point. This would only be fair, and would certainly discourage inversions.