Statement by Martin Regalia, Ph.D., on Corporate Inversions
Statement on Corporate Inversions for Submission to the Senate Appropriations Committee Subcommittee on Treasury and General Government on Behalf of the U.S. Chamber of Commerce presented by By Martin A. Regalia, Ph.D., Vice President and Chief Economist
October 16, 2002
My name is Dr. Martin A. Regalia, and I am Vice President and Chief Economist of the U.S. Chamber of Commerce. The U.S. Chamber is the world's largest business federation, representing more than three million businesses and organizations of every size, sector and region. This breadth of membership places the Chamber in a unique position to speak for the business community. Mr. Chairman, Senator Campbell and Members of this Subcommittee, we appreciate this opportunity to express our views on the issue of corporate inversions, and we commend you for holding these hearings.
THE IMPETUS FOR CORPORATE INVERSIONS
The United States subjects its corporations to taxation on their worldwide income, while "territorial" systems utilized by many of our trading partners and other foreign countries only tax their resident corporations on income earned within their borders. A U.S. corporation, therefore, has income from its foreign operations taxed both here and in the foreign country in which such income was earned. Double taxation may be avoided to some extent via foreign tax credits allowed, within limitations, against the U.S. tax, and by provisions of tax treaties. Typically, this credit for taxes paid to a foreign jurisdiction does not fully offset the U.S. taxes on that foreign income.
Consider a situation in which a U.S.-based multinational group produces goods and/or services in the U.S. and abroad, and a foreign-based multinational group produces exactly the same things, in the same amounts, for the same prices, in the same places as the U.S.-based group. Typically, the foreign-based group incurs a lower overall tax bill than the U.S-based group. This disparity occurs because of tax rate differentials and the fact that both the United States and the foreign jurisdiction subject the foreign-earned income of the U.S.-based multinational group to taxation. To the extent that the U.S. tax credit against taxes paid to foreign countries fails to fully alleviate this double taxation, the U.S.-based group is placed at a distinct disadvantage, as compared with the foreign-based group.
These tax disadvantages have caused some U.S.-based multinational corporations to reincorporate and relocate their domiciles abroad. These reincorporations are achieved through transactions known as corporate inversions.
Corporate inversions replace the U.S. parent of a multinational corporate group with a foreign parent, with the U.S. corporation thereby becoming its subsidiary. This has the effect of removing foreign operations income from the more onerous U.S. taxing jurisdiction, since the parent is no longer U.S.-based. The resulting tax savings help "level the playing field" for the corporate group, allowing the multinational operations to attain tax rates enjoyed by its foreign competitors.
Congress has responded to these inversions by concocting a number of schemes to penalize or otherwise discourage corporate inversions. They include tax bills that would, among other things:
- treat inverted corporations as if they were still domestic (i.e., as if the inversion transactions had not taken place);
- impose "moratoriums" on corporate inversions – in other words, disregard the tax inversion for a predetermined period of time;
- treat inverted corporations' property as being sold for fair market value on the date before the "move"; and
- deny the use of international tax treaty benefits.
Furthermore, a recent trend is for Congress to include language in non-tax legislation that would bar federal contracts to certain inverted U.S. companies (the resulting U.S. subsidiaries). Examples are the Treasury-Postal and Defense appropriations bills, and legislation to establish the Department of Homeland Security. However, some legislators from both sides of the aisle have had second thoughts about the wisdom of this tact, and stripped this provision out of the Defense appropriations bill in conference, on the rationale that some corporations are forced offshore by a U.S. tax code that puts them at a disadvantage with foreign corporations.
ASSERTED RATIONALE FOR THE CONGRESSIONAL PROPOSALS
Proponents of the foregoing assert a number of rationales in support of their proposals. They assert that corporate inversions must be thwarted, because they:
- reduce the U.S. tax base;
- demonstrate a lack of "patriotism" for the corporation's U.S. home; and
- enable escape from the corporation's obligation to pay its "fair share" of taxes for the protections, rights, and benefits of infrastructure that are accorded it in doing business within the U.S.'s borders.
RESPONSE TO CONGRESSIONAL RATIONALE
The often-quoted and esteemed Judge Learned Hand had something to say about the propriety of planning to minimize one's tax burden. Hand wrote, "Over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demand: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant." Commissioner v. Newman, 159 F.2d 848 (2d Cir., 1947, dissenting opinion).
Not only is it permissible for a corporation to plan to minimize its taxes – and thereby reduce the U.S. tax base – but it is a matter of fiduciary obligation for a corporation's managers to do so, in order to maximize corporate competitiveness and value for its shareholders. It is important to keep in mind that corporate inversions result in permissible tax avoidance under the Internal Revenue Code – not tax evasion. It is a perfectly legal and valid strategy.
Nor do corporate inversions demonstrate a lack of "patriotism" for the United States. Tax planning is merely a function of business decision-making. Taxes are levied by the tax code and are measured by its provisions, not by the depth of sentiment for our country.
Indeed, imposing and retaining punitive levels of taxation that place U.S. corporations at a competitive disadvantage when compared to their foreign rivals is unpatriotic. Denying government contracting opportunities to U.S. corporations that take steps to achieve tax parity with their foreign competitors is unpatriotic. Either way, the corporation is harmed. This double-edged sword of loss of tax dollars versus loss of business revenue penalizes the U.S. corporation by depriving it of vital sources of revenue, with the attendant loss of jobs and restriction on ability to fund growth and attract future business opportunities – while penalizing the investor through the resulting drag on the value of the corporation's stock and the U.S. economy. True patriotism would be demonstrated by steps our government could – and should – take to enable our corporations to thrive internationally in the global economy.
It is important to keep in mind that a corporate inversion does not excuse the U.S. corporation from paying taxes on its domestic operations. In fact, it remains legally obligated to do so. Payment of these taxes continues to support the functions and operations of our government, and compensate it for the protections, rights, and benefits of infrastructure that are bestowed upon corporations operating here – whether the corporation is a product of an inversion, a company acquired by a foreign corporation, or merely a domestic corporation that has no foreign operations. At the state level, property, sales, and income taxes continue to be levied on plants and facilities, and on domestic business operations.
A MORE APPROPRIATE AND BENEFICIAL SOLUTION
The U.S. Chamber urges Congress to reject the short-term and counterproductive legislative measures previously discussed. We believe that corporations should be free to incorporate where they choose, without the federal government imposing economic penalties upon their free exercise of prudent business decision-making, and assert that the U.S. Congress certainly should not favor foreign firms over U.S. firms in the tax code. These measures are a poor substitute for needed systemic reform of the U.S. tax code's archaic international provisions which currently put our corporations at a competitive disadvantage internationally and provide great incentive for them to leave this country. In addition, our tax structure also has the deleterious consequences of:
- encouraging takeovers of our corporations by foreign interests; or
- providing new businesses with the motivation to initially incorporate in countries other than the United States.
Congress's varied plans to stem the tide of corporate inversions have in common one glaring, critical flaw. In each case, enactment of the previously discussed legislative proposals would perpetuate the inequality between the U.S. worldwide tax system and its foreign territorial counterparts, leaving U.S. multinational corporations disadvantaged vis-à-vis their foreign multinational competitors. While this disparity remains in effect, we can expect to see a continuing increase in mergers and acquisitions that place foreign interests in functional control of our U.S. businesses.
We believe that the proper response should be the undertaking of serious and overdue tax reform through restructuring the international provisions of the U.S. tax code, such as conversion of the U.S. tax system to one based on territoriality. This would help achieve much-needed parity between U.S. and foreign corporations and simplify our tax structure. It is only fair that foreign operations of a U.S.-based company not be subject to a burden not borne by its competitors.
Undertaking the task of formulating a more appropriate international tax structure would have significant beneficial effects on the U.S. economy, through its ability to attract and retain corporate parents of multinational groups. When the resulting decisions affecting the future location of new investment, operations and facilities, and employment opportunities are made by U.S.-based companies, U.S. interests will be promoted. In sum, our overriding goal should be to fashion a tax system that will attract businesses to the United States, rather than drive them away.