Tax inversions by US multinationals attempting to shift profits into lower tax jurisdictions could cost the US up to $12bn (£7.4bn) in lost corporate tax revenues by 2027, according to figures released by the US Congressional Budget Office
There were 11 major corporate inversions from 2014-2015, although two significant inversions were pulled due to a combination of commercial and government pressures – specifically Pfizer, valued at nearly $175bn and the $36bn plus Walgreens’ proposal.
The Congressional Budget Office report warned that continued inversion activity and the shifting of profits to lower-tax jurisdictions could cause the US corporate income tax base to fall by up to 2.5% by 2027, equivalent to a loss of $12bn.
Tax inversion isn used by US multinationals to move their tax residences abroad – away from the high 35% US headline federal corporate tax rate – and to release their unrepatriated earnings held offshore, even if their management and operations remain in the US.
This is typically through a merger or acquisition with a smaller entity outside the US and a change in the US company's tax residence, as attempted in the failed merger between pharma giant Pfizer and Dublin-based Allergan. With Irish corporate taxes held at 12.5% and the UK aiming for 17% by 2021, both countries offer an attractive alternative to the US corporate tax jurisdiction.
Between 1994 and 2014 companies conducting an inversion reported an average cut in corporate tax liability of $45bn a year after the completion of the tax rejig. These companies also reduced their ratio of worldwide tax expense to earnings from 29% the year before the inversion to 18% the year after.
US companies have carried out corporate inversions since 1983, effectively shifting profits offshore. In 2014 the combined assets of companies that planned to invert exceeded $319bn, more than all the previous years combined, resulting in renewed attention from the authorities.
Last October, the US Treasury watered down regulations designed to address corporate tax inversions, adopting a narrower approach after businesses launched a strong protest against its original plans, but says this will still limit the ability of companies to lower their tax bills through transactions involving debt that do not support new investment in the US.
Following an inversion-type merger, a US multinational can further reduce its exposure to US corporate tax by engaging in ‘earnings stripping’, so that the US subsidiaries borrow from their new foreign parent company (or another foreign affiliate) to increase their interest payments, reduce their taxable income, and lower their US taxes. The foreign lender then typically pays a reduced or zero tax rate on the interest income under an existing tax treaty.
While there is broad agreement across the political spectrum that large corporations should be discouraged from carrying out inversion strategies, there are stark differences in opinion over how the government and Congress should go about this.
The OECD Base Erosion and Profit Shifting (BEPS) action plan is going someway to tackling abusive tax practice with the introduction of rules to curb interest deductibility and transfer price abuse, but the US has been slow to tackle the offshore issue, which sees multinationals from Apple to Starbucks keeping funds offshore to mitigate US tax liability.
An Oxfam report released in 2016 found that the 50 biggest US companies have more than $1.4trillion (£740bn) held offshore, more than the entire GDP of countries such as Spain, Mexico or Australia. The charity’s research says these companies, which include Pfizer, Goldman Sachs, Dow Chemical, Chevron, Walmart, IBM, and Procter & Gamble, have more than 1,600 subsidiaries in tax havens.
The Congressional Budget Office report, An Analysis of Corporate Inversions, is available here
Reporting by Sara White