New Study Debunks Big Corporations' Argument About Taxes

A bunch of Fyffes bananas, grown by Fyffes Plc, left, sits with bunches of Chiquita bananas, grown by Chiquita Brands Interna
A bunch of Fyffes bananas, grown by Fyffes Plc, left, sits with bunches of Chiquita bananas, grown by Chiquita Brands International Inc., in this arranged photograph taken at a fruit and vegetable stall at an outdoor market in the Lewisham district of London, U.K., on Friday, Aug. 15, 2014. Chiquita, owner of the namesake banana label, said it will continue with its planned purchase of Irish competitor Fyffes after rejecting an unsolicited $611 million takeover proposal from Cutrale Group and Safra Group. Photographer: Simon Dawson/Bloomberg via Getty Images

Not long ago, the top executive at a large American drug company said that her company would be planting its corporate flag in the Netherlands, because the U.S. tax code is just so darn unfair.

Heather Bresch, the CEO of Mylan, told a New York Times columnist that her bid to acquire a smaller Dutch company and move ownership abroad through a controversial tactic known as an inversion was forced by Congress, which has refused to lower corporate tax rates and make U.S. businesses "more competitive."

As a patriot, she resisted until it was clear she had no other choice, she said.

“You know what makes me want to cry?" she said. "I think whoever the next Facebook is, why would you ever start that company here in the United States?”

But a new paper by a leading critic of inversions strongly refutes this narrative, arguing that instead of disadvantaged left-behinds struggling to compete against foreign competitors with lower tax bills, large American companies are gaming international and domestic tax rules better than anyone else.

"U.S.-based multinationals that are pursuing inversion transactions have been quick to wrap themselves in a mantle of simple virtue, forced to take the unpalatable step of inverting into Irish, U.K. or Swiss public companies because their love goes unrequited by a country that cruelly saddles them with both the highest corporate tax rate in the world, and a uniquely punitive worldwide tax base," writes Edward Kleinbard, a law professor at the University of Southern California, and a former chief of staff for Congress's Joint Committee on Taxation. This argument, he writes, "is almost entirely fact-free." (The New York Times' Andrew Ross Sorkin was first to write about Kleinbard's new paper, in his Tuesday column for the New York Times).

Large American companies are so clever at scoping out loopholes and finding ways to shift earnings to low-tax jurisdictions that most never pay anything close to the top 35 percent U.S. corporate rate that the complain about so loudly, Kleinbard writes.

In 2010, profitable U.S. corporations paid an effective rate of less than 13 percent, according to the Government Accounting Office, a nonpartisan arm of Congress. Citizens for Tax Justice, a tax reform advocacy group, recently determined that most U.S. multinationals pay a higher foreign rate than they do abroad.

Mylan, the drug company with the CEO that might cry over U.S. tax rates, paid a 16.2 percent domestic tax rate in 2013, company filings show. (The company did not immediately respond to a request for comment).

This isn't Kleinbard's first broadside against inversions, nor is he the only economist to point out that U.S. multinationals routinely play three-card monte with their cash piles in order to avoid taxes. But his paper is especially timely: it lands in the midst of a public relations brawl between U.S. companies, who argue they have been forced by onerous tax rules to find overseas partners, and critics who decry the tactic as nothing but a cynical tax dodge.

In an inversion, a U.S. company buys a smaller foreign business and then the new company reincorporates abroad. In most cases this is little more than window-dressing from an operations standpoint: the headquarters and top executives remain in the U.S. But the tax savings can be substantial, which is why so many companies are now considering such a maneuver.

In recent months, the drugstore giant Walgreen considered, then abandoned a plan to invert as part of its acquisition of the Swiss company Alliance Boots. Such a deal could have lowered the company's tax bill to 20 percent from 35 percent, costing the U.S. Treasury as much as $4 billion, according to some estimates.

Banana giant Chiquita may be the next big company to invert, last week the company said it would move forward with a plan to merge with an Irish company.

The Treasury Department has said it is reviewing inversions. President Obama's proposed new budget would essentially eliminate inversions.

The looming crackdown -- if it comes -- has U.S. businesses scrambling to find foreign targets. Not any company will do: it must be smaller, but not too small. Shareholders of the acquired company must receive stock amounting to 20 percent of the new combined entity. But the tax savings can be huge. Transocean, owner of the Deepwater Horizon platform that dumped oil into the Gulf of Mexico after an explosion, saved $1.9 billion over a decade, according to Tax Analysts, a nonprofit.

Kleinbard doesn't dispute that U.S. companies can save Scrooge McDuck quantities of money by exploiting the inversion loophole, and repatriating overseas. He is instead pushing back at the assertion that current U.S. tax policy leaves companies at a disadvantage relative to their overseas competition, and that fleeing for Ireland or the Netherlands is somehow the only option to level the field.

Understanding his argument requires a basic understanding of how the the U.S. collects taxes on profits earned abroad, and how pretty much everyone else does it.

Technically, the U.S. operates on something called a "worldwide" system. This system requires domestic companies to pay taxes on profits earned overseas in excess of what they have already paid in those nations. So, for example, if an American company doing business in Ireland were to earn a dollar in profit from selling a widget, the company would owe the Irish government 12.5 cents. It would then owe the U.S. government the difference between the Irish and American tax rates -- or, an additional 22.5 cents.

Most other countries operate instead under a "territorial" system, where companies operating abroad are only on the hook for the host nation's tax bill, provided they follow certain guidelines.

U.S. multinationals despise the worldwide system, and have lobbied aggressively to change it. They argue -- probably rightly, Kleinbard notes -- that the top U.S. rate of 35 percent is too high.

But the reality is almost no domestic company pays taxes on profits earned abroad. That's because Congress has repeatedly extended a law that allows them to hold onto that cash indefinitely, as long as they don't try to bring it home. As a result, U.S. companies have about $1 trillion that they can't fully access.

U.S. companies are also the world leaders in figuring out ways to "earn" those profits in jurisdictions that charge little, or no taxes. Google, for example, used accounting techniques nicknamed the “Double Irish” and the “Dutch Sandwich,” involving two Irish subsidiaries and one in Bermuda, to help shrink its tax bill by $3.1 billion from 2008 to 2010, according to Citizens for Tax Justice, a tax reform advocacy group.

Multinationals have also become incredibly sophisticated at figuring out how to shift profits earned domestically to foreign subsidiaries where they pay little or no taxes, and reduce their domestic bill. Drug companies, for example, often sell patents on profitable medicines to overseas shell companies in places like the Cayman Islands. The U.S. operation then pays a royalty to the shell company to produce the drug, thus lowering their domestic bill.

So why invert? Kleinbard says doing so makes it much easier for companies to spend those piles of cash that they currently can't bring back home without paying a tax bill. Some companies, like Apple, have found workarounds -- such as borrowing money to fund domestic purchases, using the offshore cash as effective collateral. But unfettered access to that cash, as an inversion will allow, is much better from a corporation's point of view.

An inverted company can also more easily shift profits earned in the U.S. to its lower-tax, overseas "owner," Kleinbard writes.

"In the international arena, U.S. multinational firms have established themselves as world leaders in global tax avoidance strategies," he writes.

Inversions are just the latest evidence.