What is tax inversion?
A tax inversion happens when a corporation relocates its headquarters from a high-tax country to a low-tax country. The company doesn’t change where it makes and sells its products, just where the head office sits. It’s a way for companies to reduce their tax bill. The practice has gotten into the news lately because some prominent US firms have acquired foreign firms, and one financial incentive has been reducing their taxes through corporate restructuring.
Recent examples include Chiquita bananas moving to Ireland, Walgreens moving to Switzerland, and drug-maker Mylan moving to the Netherlands. One major impetus for these deals is the US corporate tax code, which has both a higher rate than every other county, and is a worldwide system, rather than a territorial system. Under current law, if California-based Apple builds iPhones in China and sells them in Japan, the Federal government claims 35% of the profit. But Apple only has to pay these taxes if they bring this cash home to pay US-based expenses. So Apple’s cash-hoard remains domiciled overseas. Only the US and Eritria have worldwide systems.
Taxes motivate all kinds of un-economic behavior. In the opening scene of Henry V, two church prelates agree between themselves that the best way to discourage a proposed levy on the church is to urge the king to undertake a foreign war. Closer to home, tax systems affect corporate investment, marketing, and production decisions, usually reducing earnings and efficiency. Our high corporate tax rates combined with targeted exemptions penalizes efficient companies and subsidizes politically favored firms.
Death and taxes are certain. But since companies don’t die, they just have to worry about the IRS. If the government doesn’t reform its code, more tax-driven deals—and lower tax revenue—are inevitable.
Douglas R. Tengdin, CFA
Chief Investment Officer
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