What is a tax inversion?
A tax inversion is a legal transaction whereby a company becomes the subsidiary of another company in another country – and, as a result, the original company becomes subject to the tax laws of the foreign country instead.
These inversions can take different forms. The first case was a cosmetics company called Helen of Troy in 1993. Incorporated in the US, it created a shell company in the tax haven of Bermuda, and made it the parent company of the US business.
However, following the deal, the US Internal Revenue Service (IRS) issued a clampdown against such transactions where they were being carried out purely to avoid US taxes. It issued the first rules against anti-inversion in 1996.
Why are we still talking about this today, then?
The IRS rules did not stop the rush of tax inversions until the US Congress took notice and tightened the rules for US companies after 2003.
The tax rules were tightened again in 2012, after another round of standalone inversions, which included the relocation of DE Master Blenders – the tea and coffee arm of Sara Lee – to the Netherlands.
Today, tax inversions are difficult to carry out – unless a very high proportion of a US company’s business is derived overseas, or a US company is involved in a merger or takeover in which it does not end up with more than 80 per cent of the shares in a new overseas company.
However, as mergers and acquisitions have started to recover in the wake of the financial crisis, tax specialists say inversions are on the rise again.
“The headline issue here for a US corporate looking at an M&A deal is that you should weigh up whether tax inversion could be part of it,” says Colin Hargreaves, tax partner at Freshfields.
Why do we care about this?
US officials are concerned that the general erosion of the US corporate tax base is leading not only to the US losing billions in tax revenue but also losing jobs.
As the US still has a relatively high corporate tax rate, compared with other countries, inversions provide US companies with a way out of the US tax jurisdiction.
In Bermuda, corporate tax rates are zero. In the US, the corporate tax rate is 35 per cent – although, because of various US tax breaks, companies in effect pay a lower rate. How much seems to vary.
Why not just change US tax rates?
This is a topic of debate in Washington. The Obama administration has already made proposals for corporate tax reform. However, there are deep political divisions on the details of any overhaul.
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