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Maarten van Swaay / September 10, 2014

Misleading Moans – and Propaganda – About ‘Inversion’

About inversion, in connection with Mr. Will’s column of 17-aug-14:

Mr. Will makes some astute observations about the asymmetry between praise for U.S. operations of foreign companies such as Toyota and BMW, and obloquy for U.S. companies that choose to establish domicile outside the U.S. Mr. Will is right: such bigotry is a hallmark for the current Administration and Senate.

It may be useful to review just what ‘inversion’ is:

Under current U.S. law, when foreign companies invest foreign profits in the U.S., that investment is not taxed by the U.S. When a U.S. company earns profits outside the U.S., those profits are taxed by the country where they are generated. But when a U.S. company ‘repatriates’ foreign profits to the U.S., that capital is additionally taxed at a rate that is the difference between the tax that was already paid abroad under the rate prevailing where it was earned, and the U.S. rate – the highest in the world.

To the best of my knowledge, the U.S. is the only major nation that taxes corporate profit without regard for where it is earned. Other nations impose a ‘territorial tax’ that is levied only on profit earned within the country.

The U.S. taxes foreign profit only when it is ‘repatriated’ to the U.S., and then allows a credit for taxes already paid outside the U.S. In effect, the U.S. imposes taxes at the U.S. corporate rate, but allows for deferral of differential tax until foreign profit is brought into the U.S. Profit from U.S. operations is taxed in the U.S. without deferral, and without regard for domicile, for both U.S. and foreign companies.

Inversion, i.e., acquisition of a U.S. company by a foreign company, such that its fiscal location will then move outside the U.S., reduces the tax on future repatriated foreign profit by making it subject only to the lower tax in its new location, rather than to the (highest in the world) U.S. corporate tax. Inversion does not affect either U.S. or foreign tax on the profit from U.S. operations. Nor does inversion shelter earned but not yet repatriated foreign profit from the (differential) U.S. corporate tax. Significantly, inversion is unlikely to reduce U.S. tax revenue: U.S. companies already can choose to leave foreign earnings outside the U.S.

The net result: as long as a U.S. company does not return foreign earnings to the U.S., inversion has no effect on U.S. tax revenue. But when a U.S. company returns foreign profit to the U.S., that returned profit is incrementally taxed in the U.S. Foreign companies are not subject to that incremental tax; they are free to invest their foreign profit here.

Consequences: Inversion makes it possible to invest (future) foreign profit in the U.S. without subjecting it to additional tax. That is likely to increase investment in the U.S., with the associated creation of U.S. jobs and associated tax revenue. The corporate interest in inversions indicates that industry is optimistic about the opportunities of future investment in the U.S.

Conclusion: the story that inversions amount to ‘unpatriotic’ tax avoidance, let alone evasion, is thick and smelly snake oil. The same legal tax avoidance is already available and widely used in the form of leaving foreign profit outside the U.S., i.e., ‘exporting jobs’. But reinvestment of that profit in the U.S. is severely hampered by current U.S. corporate tax law.

Professor Maarten van Swaay retired from Kansas State University in 1995. He can be reached at [email protected]

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