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If a group of Walgreens shareholders get their way, the drug retailer will restructure itself to become — on paper — a foreign company for tax purposes. It’s likely that nothing would actually change in terms of Walgreen’s business or management. The scheme is a simply a gimmick to avoid taxes. The bad news is that the laws that are supposed to to prevent this kind of tax avoidance are weak, and Congress, particularly its Grover Norquist-directed contingent, has shown no inclination to address this sort of problem. The good news is that the Obama administration has at least proposed a reform that probably would prevent this sort of corporate tax avoidance.

In some parts of the United States, there is a Walgreens every few miles or even every few
blocks, and it’s difficult to think of a company that seems more American. But tax rules don’t always conform with common sense.

Walgreens recently acquired nearly half of the Swiss-based pharmacy chain Alliance Boots, and could acquire a majority of the company. A group of hedge funds that own almost 5 percent of Walgreens’s stock demand that it use the merger to officially become a “foreign” corporation for tax purposes. This type of maneuver is often referred to as a corporate “inversion.”

When a corporation renounces its Americanism, little or nothing about the way the company does business or is managed changes, and yet the company can claim to be a brand new entity incorporated in another country. For example, a U.S. corporation can merge with a foreign corporation resulting in a new company that is 80 percent owned by shareholders of the original U.S. corporation and still be treated as a foreign corporation for tax purposes. This is true even if the new company is managed and controlled in the United States.

Some anti-tax types argue that the problem facing Walgreens and other American corporations is that the United States taxes both domestic and offshore profits, and that this is unfair. But that’s neither true nor the real motivation behind corporate inversions.

U.S. taxes levied on American corporations’ offshore profits are extremely minimal or non-existent in practice. One reason for this is that American corporations get a tax credit equal to any taxes they pay to foreign governments. Another reason is that companies are allowed to “defer” U.S. taxes until they officially bring their offshore profits to the U.S.

The real reason American corporations sometimes invert is that it makes it easier to avoid U.S. taxes on their U.S. profits. Corporate inversions are often followed by “earnings-stripping,” which makes U.S. profits appear, on paper, to be earned offshore. The American part of the company is loaded up with debt that is owed to the foreign part of the company, so that interest payments officially reduce the American profits, which are effectively shifted to the foreign part of the company.

Congress can tighten up rules to prevent all this from happening. As CTJ has explained, under a reform included in President Obama’s most recent budget plan, a company that results from the merger of a U.S. corporation and a foreign corporation will be taxed as an American company if more than half its voting stock is owned by shareholders of the original U.S. corporation. That’s far more reasonable than the current rule, which would allow the resulting company to pretend that it’s a “foreign” corporation for tax purposes even if 80 percent of its voting stock is still owned by the shareholders of the original U.S. corporation.

Under another part of the Obama proposal, the resulting company would be taxed as an American corporation (regardless of how much the ownership has or has not changed) if it has substantial business in the U.S. and is managed and controlled in the U.S.

The President’s budget also includes a proposal to make it more difficult for all U.S. corporations (not just those involved in inversions) to engage in earnings stripping.

It’s impossible to know what Walgreens will do. Maybe it will be too ashamed to renounce its ties to the U.S., or fear customer blow back. But Congress should enact common sense reforms to ensure that it and other American corporations don’t avoid U.S. taxes simply by pretending to be foreign companies.

Photo via Kai Morgener Creative Commons Attribution License 2.0