American companies have been steadily moving overseas for years. They have been merging with foreign firms or simply acquiring them outright. The goal has always been to decrease their tax burden and more. In 1982, an American construction company moved its base from the United States to Panama. This was done to out maneuver the Internal Revenue Service (IRS). Since that time, American corporations have found moving their operation to foreign countries a good way to save more of their earnings. It is commonly known as corporate inversion.
Successful Corporate Inversions
According to an article published in the online version of The Economist, it requires a little careful planning to be successful with corporate inversion. When an American company acquires a company overseas, the managers of the newly combined entity can determine their corporate headquarters. If they stay in the United States, the new entity could face corporate tax rates of over 38% on all profits they bring back to the United States. When they choose a foreign country, it's usually one that has a much lower tax rate on corporate profits.
Foreign Tax Credit
The United States has worldwide taxation on American corporations. This is how the IRS is able to collect taxes on corporations no matter where in the world they operate. There are many countries who only tax corporate income that is earned in that country. Corporate inversion is attractive because companies can get a tax credit that can be used to offset any taxes they pay to a foreign country. A corporation is not liable for paying taxes twice on the same income. The corporate tax rate in the United States is usually far more than what a company would pay overseas. With a foreign tax credit, corporations pay significantly less in taxes to the IRS.
Another benefit of a corporate inversion is the ability to shift income around in a way that decreases the taxes a company pays in the United States. An inverted company is able to make a loan to its subsidiaries in the United States from its foreign location. The interest payments on the loan are tax deductible. This also decreases the amount of a corporation's taxable income in the United States.
A corporate inversion also helps a company avoid paying taxes it might be required to pay on past profits. A corporation usually does not pay taxes on its foreign earnings until the money is brought back into the United States. This has resulted in corporations building up substantial amounts of money in countries around the world. The money is often then loaned to the company's United States unit for tax purposes.
Before a corporation can qualify for lower taxes after a move to a foreign country, they must do more than just open up an operation. A corporation must merge with a company actively operating in the foreign country. The newly merged entity must do a minimum of 25% of its business overseas. The other option is to provide the owners of the foreign corporation with a 20% ownership stake in the newly formed business entity. According to Congressional Research Analysis, over 28 corporations have actively participated in the inversion process during the past twenty years.
Another attractive aspect for companies to engage in corporate inversions is much lower labor costs. An American corporation will have to pay workers in places such as India and China a fraction of what they have to pay workers in the United States. Most companies are able to experience significant savings in their operating expenses when labor costs decrease.
Many American corporations feel they are seriously impacted by the number of regulations they are required to follow. When a corporation moves to a foreign country with fewer regulations, they are able to be more innovative as well as take risks that could benefit their customers. Countries that let companies operate with minimal control and influence by governments are very attractive to American corporations.
It is often more cost-effective for corporations to expand their operations in a foreign country. In many countries, land and natural resources are cheaper than those in the United States. A foreign country could also be an excellent place for a corporation to expand it product market.