With a U.S. corporate tax rate of 39 percent - the highest in the developed world - many large corporations with their headquarters in the United States have considered a "tax inversion" also known as a "corporate inversion" as a way to reduce their tax burden. The concept is simple: find or establish a company in a country with a lower tax rate, relocate the U.S. company to the country where the merged or newly established company is located and save a large percentage of profits which would otherwise go towards paying taxes in the United States.
While tax inversions have recently been in the news, the practice first became prevalent in the 1990s, when a cosmetics company, Helen of Troy founded a shell corporation in Bermuda in 1993. The company then made the Bermuda firm its parent company effectively "inverting" its domicile to Bermuda.
The U.S. Internal Revenue Service became aware of the transaction and took measures against tax inversions in 1996. Rules were written against companies that could be shown to be making transactions with the specific intention of avoiding U.S. taxes.
Tax Inversions in 2014
Tax inversions became popular this year with several large transactions which ultimately fell through due in large part to changes the U.S. Treasury made on the rules for inversions. The changes essentially made inversions significantly less advantageous for large U.S. corporations.
The first attempted inversion was the Omnicom merger with UK based Publicis, which fell through because of differences between the two companies over who would end up controlling what would have become the largest advertising agency in the world. The merger fell through last May.
Two other large transactions which were originally intended as inversions were the AbbVie takeover of UK based Shire Pharmaceuticals, and the Pfizer attempt at taking over UK based AstraZeneca.
AbbVie's $54 billion takeover of Shire was terminated directly due to the new rules which were "designed specifically to destroy the financial benefits of these types of transactions." AbbVie will pay Shire a $1.635 billion breakup fee. The $118 billion Pfizer deal was terminated after AstraZeneca's board rejected Pfizer's proposal. Pfizer announced it did not intend to make another offer for AstraZeneca. New Rules for Tax Inversions
Basically, the new rules, which became effective on September 22nd, will:
- Prevent inverted companies from accessing a foreign subsidiary's earnings while deferring U.S. tax through the use of creative loans otherwise known as "hopscotch" loans.
- Prevent inverted companies from restructuring a foreign subsidiary with the purpose of accessing the subsidiary's earnings tax-free.
- Close a loophole to prevent inverted companies from transferring cash or property from a Controlled Foreign Company or CFC to the new parent company to completely avoid paying U.S. taxes.
- Make it more difficult for U.S. companies to invert by strengthening the requirement that the former owners of the U.S. entity own less than 80 percent of the new combined entity.