Over the past several weeks, a firestorm has exploded in Washington over the issue of corporate inversions. So just what are they?
What is it that has politicians jumping over each other, clamoring to get the latest sound bite on TV, radio and social media? Republicans blame Democrats and Democrats decry the "unpatriotic" actions of those corporations that have elected to invert. Curiously, they do not assert that these corporations have behaved illegally, just that they have shirked their patriotic duty.
If these actions aren't illegal, then what’s all the hubbub, bub?
The furor over the flipping of these corporate flapjacks reminds me of the lyrics from the song Crush, by the Dave Mathews Band:
Just knowing that the world is round
Here I'm dancing on the ground
Am I right side up or upside down
OK, this is a tax issue not choreography. Let’s dig deeper. What is a corporate inversion? Better yet, what is an inversion? According to the Merriam-Webster on-line dictionary, an inversion is
A change in the position, order, or relationship of things so that they are the opposite of what they had been
So what then is a corporate inversion? A quasi-legal definition is that a corporation inversion is the act of a parent company based in the United States switching its registration address with that of one of its offshore subsidies, usually while retaining its material operations in the U.S., in order to take advantage of lower corporation taxes.
Stated simply, a U.S. company creates, buys or otherwise merges with a corporation NOT a U.S. company. The foreign entity becomes the parent. The effect is the company essentially renounces its U.S. corporate citizenship, at least for tax purposes. Following this event, nothing really changes in the corporate universe – factories remain, sales offices remain, products and services stay the same – except that the company has a new address on its letterhead.
There is, however, one major change, at least economically. Following the inversion, the company gets a smaller income tax bill from the IRS.
Be clear, the company has, in this particular description, taken this action for the sole purpose of lowering its taxes. By becoming a “foreign” corporation, the company is no longer subject to the taxes imposed on U.S. corporations by the tax code. But it does so legally. For its efforts, for taking action that can only be described as rational, the company is excoriated. It is vilified in the hallowed halls of Congress, like nothing unpatriotic ever went on there.
But why is it that we feel compelled to call these companies traitors? Company officials have behaved rationally, lowering their cost, improving their bottom line as they are charged to do by their shareholders. They do so using the language of the tax code. A tax code, I might interject, that is impractical, inefficient, and insane beyond belief.
But who among my readers has not done so? Is there none among you who have delayed or accelerated a financial transaction specifically because doing so reduces your taxes? Really? Is that unpatriotic? I don’t think so.
In Helvering v. Gregory , Judge Learned Hand opined,
Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one's taxes.
Note he particularly stated “…not even a patriotic duty…”
Yes, these actions seem, on their face, to be wrong. Are the results distasteful? Perhaps! Are they illegal? Definitely not! Are they immoral or unethical? Not in the least. Do they make sense? Are they rational? Yes to both! It could be argued that corporate officers violate their fiduciary responsibility to their employees and shareholders if they fail to take such action.
Justice Harlan, addressed the financial impact of corporate taxes in concurring in Commissioner v. Brown.
Were it not for the tax laws, the respondent's transaction . . . would make no sense. . . . However, the tax laws exist as an economic reality in the businessman's world, much like the existence of a competitor. Businessmen plan their affairs around both, and a tax dollar is just as real as one derived from any other source.
If we listen to the political sound bites, it might be an easy mistake to conclude these companies are perverted rather than inverted. Rather than chastising the companies that invert, why don’t we address the real problem? What is that you ask? Title 26, U.S. Code – Internal Revenue Code.
James Carville, political strategist for Bill Clinton, once coined the term “it’s the economy stupid.” We can debate whether this was offensive to Americans, or to Mr. Clinton’s opponent, but it was nonetheless a succinct way to summarize the primary issue during that election. With respect to this current problem, I take the liberty to paraphrase Mr. Carville. It’s the tax code stupid!
These rather complex financial maneuvers have been around for many decades. However, the recent rush by companies to avail themselves of this benefit has provoked the Obama administration to ask Congress to close this tax loophole. Absent Congressional action, the President has promised to take administrative action, using regulations issued by the Treasury Department or the Internal Revenue Service. As an aside, with the power conveyed by our tax code, the IRS has significant leeway in issuing governing regulations, but I digress.
But let’s think this through. Do we think that Congress can address this complex, divisive issue in any meaningful way? Is it reasonable to believe that a Congress that has been locked in contentious political inaction for years can come together to truly address this matter. I think not.
But fix it they must. In undertaking this effort, they should take heed of the admonishment expressed by Warden Norton in The Shawshank Redemption, “Not Tomorrow! Not after breakfast! Now!”
Politicians on both sides of the aisle would have Americans believe this is a very complex problem. I agree only in part. While there are many different, complex issues that bear on this question, the basic problem is straightforward. Our tax code is busted. The solution is equally simple – not easy, certainly, maybe even impossibly hard – but simple. Fix the busted tax code.
In saying this, I must confess that I am concerned about the ability of our elected leaders to adequately address this matter. When Congress attempts tax reform, it generally either creates new unforeseen problems or makes the existing problem(s) worse. For example, this issue was intended to be solved by language contained in Title VIII of the American Jobs Creation Act of 2004. As an aside, how can the federal government create jobs, other than by forming something akin to Roosevelt’s Civilian Conservation Corps or by expanding the numbers of Americans in uniform in our armed forces? But again I digress.
Returning to the 2004 Act, many argue that provisions of that act made the problem of corporate inversions worse. In the least, those proponents assert, stipulations in that bill made it more lucrative for senior company officials to take steps to effect an inversion.
Treasury has already issued a ruling attempting to limit the expatriation of American companies. Yet once again, we fail to confront the real issue - Title 26 in all its confusing glory. The President is up in arms. Perhaps he should be. Members of Congress are yet again hurling barbs and epithets across the aisle at one another. Half-measures! Band-aids! Politics!
I once wrote the following regarding tax reform. I state it again here as the only true solution.
What is needed is meaningful reform – a complete do-over. Placing yet more band aids on the snafu legislation known as the Internal Revenue Code has not worked previously and will not work now. Continued attempts to do so burden our combined resources and try our collective patience. I believe that the IRC must be completely overhauled.
Billy Sunday has been quoted as saying, “The world is wrong side up. It needs to be turned upside down in order to be right side up.” In my view his comment can be expanded to aptly describe the current tax environment.
The tax code is wrong side up and wrong side out. Congress needs to turn it upside down from the inside out in order to make it right.
I have to go now. I have a headache the size of Congressional ineptitude!
Happy trails to you, until we meet again!