We’re sure you’ve heard the phrase “I’m moving to Canada” recently. But corporations have been pulling this move—called a tax inversion—for decades, at least on paper. But rather than a political statement—or a fondness for poutine—heading abroad helped corporations avoid billions in taxes.
Bear with us, because explaining how it works can be a mouthful. A tax inversion is a loophole in which a US-based company merges with, or acquires, a foreign company in a lower corporate tax jurisdiction and then claims to be a subsidiary of the foreign company in order to avoid paying higher US taxes.
By shifting its headquarters to another country, a business still has some US tax liability, but companies can significantly reduce their tax bills by shifting profits abroad or borrowing from the foreign parent and deducting interest payments to offset profits. According to a 2017 Congressional Budget Office (CBO) analysis, 60 corporations completed inversions between 1983 and 2015.
And the practice was growing: In 2014, the combined assets of companies announcing plans for inversions was $319 billion, “more than the combined assets of all of the corporations that had inverted over the previous 30 years,” according to the CBO. The Obama administration estimated that the US stood to lose tens of billions in tax revenue as the practice increased.
“The feeling in Washington, among the lawmakers and among Treasury people, was this may be technically legal, but it shouldn’t be allowed,” Alistair Nevius, former editor in chief of tax at AICPA’s magazines and newsletters in 2014, told CFO Brew.
As more companies looked to inversions to reduce their tax bills, in September 2014, the Obama administration took action to close the inversion loophole by implementing regulations that made the practice much more difficult, and less advantageous.
“I think the regs were fairly successful in at least slowing down corporate inversions,” Nevius said. “Certainly the attention to them really went away.”
Within a few short years, the Obama-era regulations on tax inversions seriously curtailed the practice, and the Trump administration would later pass legislation that essentially ended inversions.
How they stopped it. In part, the 2014 Treasury regulations changed the ownership requirements of inversion transactions. The new regulations mandated that a company was still liable for American taxes if “less than 25 percent of the new multinational entity’s business activity is in the home country of the new foreign parent,” and the shareholders of the American corporation owned 60% or more of the foreign company. In 2016, new regulations also changed how organizations could account for intra-company debt, further weakening the advantages of tax inversions.
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“[Tax inversion regulations] gave companies a lot more hoops that they had to jump through in order to do it successfully,” Nevius said.
In other words, if the company is doing business in the US and is owned by American shareholders, the new entity is considered an American corporation, no matter how it moves money around. Voilà, loophole closed.
“It was a bold step by the Treasury and we encouraged them,” Steve Rosenthal, former senior fellow at the Urban-Brookings Tax Policy Center, who was also an advisor to the Obama Treasury Department at the time, told us.
But companies weren’t happy about it. According to Rosenthal, there was backlash from some in the business community and Congress that argued the regulations went beyond the Treasury’s authority. And while there was a threat to take the administration to court, that challenge didn’t make it far.
Did it work? In 2018, data from the Commerce Department found that the Obama-era anti-inversion rules led to a decline in foreign direct investment in the US, suggesting that tax-driven mergers and acquisitions had indeed slowed.
But the real nail in the coffin of tax inversions was the first Trump administration’s 2017 Tax Cuts and Jobs Act, which brought the corporate tax rate down from 35% to 21%. According to Nevius, bringing the corporate tax rate more in line with other countries took away a big incentive to find creative ways of avoiding taxes, and put corporate inversions on the back burner.
“I don’t think there’s been a real big name corporate inversion since then,” he said.
Even though the Trump administration’s business tax cut curtailed most corporate inversions, Trump considered doing away with Obama’s Treasury rules on inversions. But ultimately they were largely left intact.
“What I took from that was that even the Trump administration, a business-oriented administration, appreciated the fact that these regulations were both effective to stop the abuse, and not too burdensome,” Rosenthal said.