Corporate Inversions, Profits and Taxes

How many of you vote yes for inversions? What? What the hell is an inversion? I looked at Wikipedia and found that inversions occur in music, arts, natural sciences, mathematics, and just about everything. Typically it means you have turned things backwards or stood things on their heads. For example, the air nearest to the earth’s surface is warmer because solar radiation warms the earth’s surface. In a temperature inversion the air gets warmer, instead, at higher levels. When temperature inversions occur we get a lot of awful things like smog entrapment and freezing rain.

As such it seems almost obvious that the President would want to halt business inversions going on today. In a business inversion a successful domestic company decides it wants to move its headquarters to a foreign country. Imagine if GM decided it wanted to move its headquarters to Cuba! Now that would be an inversion! One way to conduct an inversion is to merge or be acquired by a foreign company. Suppose Toyota bought GM. In that case GM’s productive and other activities would continue in America – but GM America would become a subsidiary of a Japanese company.

Why would a US company do such a thing? According to the President the reason is taxes. Where a company like GM pays its taxes is an important issue. Many American companies are global and increasingly so. This means they have international activities all over the world. Important for the inversion issue is where they sell their goods. If GM sells cars in Hungary – then the sales revenue flows directly to a GM subsidiary in Hungary. The subsidiary is technically a Hungarian company because the Hungarian government licenses it to do business within Hungarian borders – but it is run by GM.

So American companies have sales in many different countries. The sales revenue goes to pay for business costs. Typically the American companies will report and pay profits taxes in those countries. If there is anything remaining after all that the rest of the revenue flows back to America. When and if it flows back, it is taxed again by the USA. According to an Economist Magazine article (http://www.economist.com/news/leaders/21608751-restricting-companies-moving-abroad-no-substitute-corporate-tax-reform-how-stop ) , the US is the only large rich country to tax these repatriated earnings. And since the US has the highest corporate tax rates of most major countries, US companies feel put upon and dislike the extra taxes they have to pay. An inversion, accordingly, feels good to these companies. Becoming a foreign company means they no longer have to pay the extra taxes. According to the article, most large countries have gone to a territorial tax system and few pay double taxes as in the USA.

Please notice one thing that is often not said or written adequately in inversion discussions. This has nothing to do with corporate taxes paid or earned on sales within the USA. With or without an inversion, US sales and operations will be taxed as usual. Inversions only have to do with repatriations of the already-taxed profits in other countries.

Still, the President and others do not want to reverse these tax laws. They want US companies to pay significant tax rates on repatriated earning despite being taxed once already in other countries. Instead they prefer to introduce new and more stringent regulations on how and where US companies can merge or be acquired by other companies. Interesting is the signal sent by these new regulations. The US government proposes to allow inversions in cases where real managerial control is NOT kept by the US company. That is, if the foreign merger results in the US company losing control to a larger foreign entity over its decisions, then that is okay. Talk about perverse! This is a true inversion in logic. Okay US company – we do not want you to control your operations. Let’s let the foreign company really take you over. All that risk is incurred so that the government gets a little more from the repatriated foreign earnings. Wow – now that is really backward and dangerous. You put at risk ALL the earnings and taxes of the US companies for the sake of chicken feed.

One more thing. Most mergers and acquisitions are notoriously difficult, complicated, and uncertain endeavors for large corporations. Most of them fail. Companies spend huge sums of money trying to predict the many impacts of corporate marriages. Just like in human marriages much is unknown about your partner in a corporate marriage. Despite sometimes spending billions most of these corporate marriages fail. It is not reasonable to conclude that any of the high profile large company inversions causing the President’s concern were solely done to reduce US taxes. Taxes might matter, yes, but the overwhelming reasons for inversions are for strategic reasons.

And why not for strategic reasons? It is no secret that business is increasingly global. As the President acknowledges, he would love to increase US export sales. This is because few serious companies can be profitable without taking advantage of a huge world marketplace. He wants to find ways to encourage US companies to seek out and successfully enter these international markets. He wants to do this because more profitable US companies hire more workers, pay better wages, give more to charity, and more. So why does he say he wants to motivate more exports one day and then the next day penalize the profits of these same companies with an extraordinary corporate tax system?

I vote for inversions. If the President wants more tax revenues, let him try another way that doesn’t damage the competitiveness of US companies and US exports in general. Focusing on tax loopholes and tax reform might be a place to get started.