Tuesday, December 15, 2015

Three analyses of corporate inversions

Martin Sullivan has a good article in this week's Tax Notes, called "A Middle Path for Stopping Inversions.  Here is the link, but it may not work for non-subscribers.

Sullivan notes that the main issue posed by inversions such as that by Pfizer and Allergan "involves a loss of revenue, not employment .... Pfizer's operational headquarters will remain in Manhattan - just as the operational headquarters of Allergan, legally resident in Ireland, has remained in Parsippany, New Jersey."

A revenue issue arises for two reasons. Pfizer-Allergan will now find it easier to strip profits out of the United States through intra-group debt, and it will now have an easier time doing what it likes with the "trapped earnings" that it has given itself abroad, mainly through tax planning, without a taxable U.S. repatriation.

Sullivan, like me, believes that these issues are best addressed in a broader context than just anti-inversion rules.  Thus, he proposes improving our earnings-stripping rules - which, unlike our controlled foreign corporation (CFC) rules, need not be aimed disproportionately at U.S. as compared to non-U.S. companies - and enacting a one-time tax (in effect, a deemed repatriation) on the existing stock of unrepatriated earnings.

Less good, though not wholly devoid of merit, was Carl Icahn's op-ed in the New York Times yesterday. Icahn appears to have a couple of basic misunderstandings of how our international tax rules actually work.  For example, he claims that we impose "double taxation" upon U.S. companies' foreign earnings - apparently not understanding that we have a foreign tax credit. (Indeed, he expressly refers to the "foreign tax deduction.")  He also repeatedly says that the problem is our "uncompetitive" tax system, an annoying cliche that rests on assuming that U.S. multinationals face unusually high tax burdens by global standards. Researchers have tried to study this, and it is probably false. The motivation for inversions rests in their capacity to reduce the companies' tax burdens - which is distinct from the question of whether these burdens are high or low to begin with. 

Icahn does, however, note the importance of earnings-stripping. He also gives props to a bipartisan tax legislative proposal (Schumer-Portman) that would use deemed repatriation (at a reduced rate) to address trapped earnings, although he appears to misunderstand it as allowing voluntary repatriation.

I am perhaps least happy with a Business Insider op-ed by Glenn Hubbard. I don't really disagree with Hubbard's opening claim, which is that, if the deal benefits Pfizer's shareholders, there is good reason for management to want to do it. I am surprised, however, that Hubbard seems to think the main motivation for inversions is that the U.S. corporate tax rate is too high.

Now, it's true that a higher corporate rate raises the tax savings per dollar of earnings-stripping, as well as the tax charge associated with a taxable repatriation.  But for U.S. source activity that yields U.S. taxable income, the corporate tax rate, whatever it is, applies alike to U.S. and foreign multinationals. So it is not directly affected by inversions.

By all means, let's debate how low or high the U.S. corporate tax rate should be. But whether it's lowered significantly or not, let's also strengthen our earnings-stripping rules (so the rate will apply more uniformly to U.S. economic activity).  Also, Hubbard should know that it's not generally efficient to hand transitional windfalls to taxpayers, by wiping out deferred taxes that pertain to profits generated in the past.

And finally, calling the Pfizer deal (as Hubbard does) "self-help tax reform" is a bit gag-worthy.  Agreed that it's self-help, and that we should expect self-help. But preparing for greater earnings-stripping, and wiping out deferred taxes on profits that to a considerable extent may have been placed abroad, as an artificial accounting matter, through tax planning, falls somewhat short of what I would call "tax reform."

If I may deliberately (and egregiously) mix my metaphors, Hubbard's op-ed barks up the wrong tree regarding inversions because he has other fish to fry.  When you have a position, it's tempting to use everything out there as evidence in its favor, but inversions operate mainly at different margins than that posed by the choice of domestic U.S. corporate tax rate.

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