Obama’s tax inversion reforms – “antiquated” approach to tax policy continues
The Obama administration yesterday announced sweeping reforms to tackle companies engaged in tax inversions - a transaction whereby a foreign corporation acquires a US company so as to remove overseas business expansion from the reach of the US corporate tax system.
Under the new rules, it will be harder for companies to meet the strict requirements for an inversion deal, while those companies that have an inverted structure, will now struggle to access their overseas cash piles without paying US taxes when they move cash between foreign jurisdictions.
With a federal tax rate of 35% and an overall rate that can be close to 40% including state and local taxes, the US has the highest corporate tax rate among major world economies. On top of this, unlike many other jurisdictions, US corporations are also taxed on their worldwide income.
This scale of taxation is at odds with a number of other jurisdictions across the globe who are taking steps to make their tax environments more attractive to multinational companies, recognising the investment and employment benefits they bring.
As a result, countries such as Ireland have become popular locations for corporate inversions, where companies benefit from a corporation tax rate of just 12.5% on trading profits and 25% on passive income. The rationale for inversions is not simply on a reduction in the overall corporate tax rate, but also to escape the burden of complex US tax rules that add to compliance costs, such as the controlled foreign corporation (CFC) legislation, and to satisfy longer term business objectives in relation to overseas expansion. One recent example was Burger King which subsequently came under fire for using a tax inversion following its merger with Canadian coffee shop Tim Hortons.
The new rules would forbid non-US subsidiaries of inverted companies from providing a loan to their foreign parent company as a means to circumvent paying US tax. They will also stop new parent companies from buying subsidiaries overseas to free up cash from their balance sheets as a way to evade paying US tax.
The publicity associated with the US government’s aversion to inversions could be compounding the issue, as we are already seeing evidence that media coverage has sufficiently raised alarms at start-ups, so much so that they are avoiding establishing their parent companies in the US.
The announced changes around inversions only highlights the impending storm which is likely to surround the current lack of wider corporate tax reform in the US. At present the change to inversion rules is not legislative and only removes some of the advantages of an inversion. The continued approach of the US on this issue is yet another example of antiquated tax policy which fails to create a pro-business environment. Combined with its approach towards offshore cash, the country is creating an uneven playing field and is losing out to those jurisdictions who recognise the benefits of a forward looking tax policy.
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