US Politics: Tax Inversions are a result of Political Gridlock

[TerraPrime]

Solo, what is this shit?! I blame you. :-p

[Mlle. Zabzie]

Ok, the whole inversion topic basically made this thread a "summon Zabzie" moment. As you might guess, this is a topic that I know a little something about and have strong view on. Given my time, I think I'll break up my views into multiple posts on some slightly different topics. None of this, obviously is advice or anything like it. So where to start. To take Maria von Trapp's advice, I'll start at the very beginning.

1. Are the transactions currently being described as "inversions" actually inversions? Well, no, actually. Inversions, in the classic sense, were so-called "naked inversions", where a US company would form a non-US subsidiary, typically in an offshore jurisdiction and merge into that entity. There have been several waves of inversions, beginning many, many moons ago with the Helen of Troy company. There was another wave when Tyco, Fruit of the Loom and others (including Accenture, when it spun out of Anderson) went off shore. There have been several responses to them. Originally, Congress acted and made the transactions taxable to US shareholders. This is, by the way, generally true for any outbound business combination unless in the combination the shareholders of the foreign party end up with > 50%. This failed to stop inversions because, quite frankly, shareholders don't care. They are either tax exempt (e.g., pension funds), mark to market (hedge funds), or tax-indifferent (mutual funds). After tinkering that direction failed to stop inversion activity, Congress passed Section 7874, that tried to define whether a real business combination was occurring or not. It laid a benchmark of <80% continuing ownership by the US company's historic shareholders (with complicated counting rules) as that definition.

2. Why invert? You'll hear a lot of noise about how our worldwide tax system + high corporate rate basically creates irresistible incentives to invert. You'll hear about how inverted companies are no longer going to pay US corporate tax and are renouncing their corporate citizenship (whatever the eff that means). You'll hear about how US parented corporations are not competitive with their foreign parented competitors. It's all so much hooey. Ed Kleinbard said it better than I can here but what's really going on is (1) base erosion and earnings stripping, (2) access to foreign cash that has been stockpiled because of the way the GAAP rules work with our subpart F anti-abuse system, (3) the creation of "stateless income" and (4) the lemming effect. What do I mean? Well, base erosion and earnings stripping means that these deals can allow the historic US parent ALL OF WHOSE OPERATIONS, INCLUDING ITS CURRENT FOREIGN SUBSIDIARIES REMAIN IN THE US SUBJECT TO US TAX to move income, through deductible interest payments or otherwise, to a low(er) tax jurisdiction. That erodes the US tax base. There are limits, even under current law, on the ability to do this, but the incentives are very much there EVEN WHERE THERE ISN'T AN INVERSION. See, Hewlett Packard, Apple. Successful world-wide base erosion can lead to the creation of "stateless income" - that is income that is basically taxable nowhere. See, Apple. This is why the OECD is currently engaged in a massive project (the so-called base erosion and profit stripping (or BEPS) project) to coordinate a global response to the problem. The US system is unique in that it has a territorial system with respect to foreign entities under a lot of circumstances unless the entities earnings are actually or constructively repatriated, at which time they are taxed, and taxed A LOT (this is in contrast to European jurisdictions, e.g., who have generous participation exemptions allowing entities resident in their jurisdiction to exclude dividends and capital gains from certain subsidiaries). US GAAP is a funny creature, so that so long as the company is willing to swear that it has no plans to repatriate foreign cash, the repatriation costs aren't included in the calculation of the effective tax rate. So there's this huge incentive for the cash just to sit offshore, doing nothing [the US P may well have to include the interest on the cash in income, but that's a small (relative) price to pay]. But these entities want to use the cash, so how? Well, there was a tax holiday last decade where billions were brought back, but weren't reinvested but instead used for dividends and share buybacks - Congress felt betrayed. So now the cash is just sitting there and in a foreign parented structure, it may well be possible for that cash to be lent from the foreign subs of the US entity up to the foreign parent without US tax. Voila. Cash.

More later.. . . . . . . .

[TerraPrime]

(smartness)

Yay, Summon Zabz worked!

I think I understood the first answer but only 50% of the second answer. Not the fault of the person explaining, just a lack of general concepts for fiannce related terms.

[MerenthaClone]

Yeah OK, you have an ax to grind.

The ad was condemning Obama's propensity for frequent rounds of golf whilst the middle east burns. That's the point it was making, now you might disagree with that, which is fine, but to condemn as some kind of sleazy snuff flick is taking a step beyond partisan la la land IMO. How would the director be expected to show the middle east crisis? Clips from Disney's Aladdin perhaps?

That's be cool if you had a good working definition for "frequent." Is it equal to "any"?

[aceluby]

So what happens if you jaywalk with a brandished gun, point it indiscriminately, curse, and make vulgar gestures to police?

http://www.dailykos.com/story/2014/08/31/1324831/-White-man-jaywalks-with-gun-guess-what-happens#

Apparently you get a strong warning, no arrest, and you are told to move along... if you're white.

If you're black you can't even be in the toy section with a toy gun and you have a chance of being gunned down in the store.

[Mudguard]

Zabzie, thanks for the detailed background. If I'm understanding you correctly, you are saying that inversion isn't really the problem but that the real problems are (1) base erosion and earnings stripping, which can create stateless income that isn't taxed anywhere, and (2) stockpiling of foreign profits due to incentives/penalties in the tax code. Regarding base erosion and earnings stripping, is this the technical name used to describe how Starbucks managed to avoid paying taxes in the UK by setting up an entity in a low tax rate jurisdiction to hold various assets (like intangible IP assets) and then have the UK group pay the low tax rate entity for the use of those assets so that profits are essentially shifted from the UK to the low tax rate entity? Or is this something else?

The only proposal I've seen so far to address inversion was from the White House, and it was very underwhelming to me, partly because the more I think about it, the less of a problem inversion appears to be. If the company wasn't going to bring the foreign profits back anyway, there really isn't a loss of tax revenue, right? You might as well let them bring the money home then...Anyway, I think the proposal was to change the limit of the combined entity to less than 50% US ownership. Is this pretty pointless, or am I off base here? Shouldn't they be proposing legislation to fix the other problems first? Is there a realistic chance that the US actually passes new legislation to address the real problems?

[awesome possum]

So what happens if you jaywalk with a brandished gun, point it indiscriminately, curse, and make vulgar gestures to police?

http://www.dailykos.com/story/2014/08/31/1324831/-White-man-jaywalks-with-gun-guess-what-happens#

Apparently you get a strong warning, no arrest, and you are told to move along... if you're white.

If you're black you can't even be in the toy section with a toy gun and you have a chance of being gunned down in the store.

Want gun control enacted in the quickest way possible? Have a bunch of black people show up in public armed to the teeth.

[DanteGabriel]

Want gun control enacted in the quickest way possible? Have a bunch of black people show up in public armed to the teeth.

No, it just causes governments to double down on their already-stringent Black People Control policies.

[aceluby]

Want gun control enacted in the quickest way possible? Have a bunch of black people show up in public armed to the teeth.

The Black Panthers policing the police are what caused the huge amount of gun control pushed by conservatives in the 80's. So unfortunately, you're right, but at the expense of A LOT (more) black people dying from police violence.

[MerenthaClone]

No, it just causes governments to double down on their already-stringent Black People Control policies.

Or...gets us California's current gun laws, as passed by St. Reagan.

[Mlle. Zabzie]

So let's talk base erosion for a minute:

In the US, corporate tax is levied on "taxable income". What is that income? Well, you can think of it as revenue (turnover/whatever) less deductions for certain allowed items (e.g., expenses incurred in producing the revenue (e.g., COGS), and importantly interest expense, royalty expense, etc.). This is true in most jurisdictions I've run across, in very broad terms. Some expenses are easy to follow - interest payments to a 3rd party lender are pretty easy to see and understand. Though they erode the taxable base, they are payments that reduce the overall whole - that is to the extent the payments are made out of one of a group of corporations, they reduce the overall value of the group insofar as they are cash outflows to the lender from the paying entity (and then reduce the equity value up chain). (The name of the game with external leverage is to get a better return on your use of the proceeds than you pay in interest. . . .). Ok, so what's going on within multinationals? Well, remember that each entity within an overall structure is treated as a separate entity for tax purposes unless the entity and other entities in the same jurisdiction qualify to consolidate (or for group relief, or whatever the local concept is). Therefore, you look at payments among the entities and to the extent that there would otherwise be a deduction in the jurisdiction of the payor if the payment were made to a third party, the payor gets a deduction for the payment to the related entity. (This third party concept is important - we'll come back to that). So, for instance, if US company A borrows money from related Luxembourg Finco Company B, the interest US Company A pays to Company B may well be deductible by Company A, provided that it is on arm's length terms and subject to some anti-abuse rules. The arbitrage opportunities are obvious. So what are the constraints? Well, for one, "transfer pricing". This is a concept that says that payments between related parties need to be on arms' length terms. Most non-haven countries have this concept, and some even require that you get a an advance ruling from the government that your transfer pricing is good. There are whole industries (principally in accounting firms) filled with economists (you were wondering what to do with your economics phd?) who help multinationals figure out their transfer pricing. And then there are the anti abuse rules. E.g., the US imposes various restrictions on the ability to deduct payments made to related foreign parties. The US subpart F rules require income inclusion (as dividends) to the extent a foreign controlled subsidiary loans money to its controlling US parent. Debt isn't just debt because you call it debt. Many/most jurisdictions have limitations on the amount of debt that a company can have (whether internal or external), either through explicit thin capitalization rules or through common law rules defining what can be debt within a capital structure.

[TerraPrime]

I get that the interest your left hand pays to your right hand is deductible and thus not taxed, saving you money, but wouldn't that increase the tax burden on your right hand as that's a form of income (the interest you charge on a loan you issued)? I suppose the trick is to have your right hand be in a different jurisdiction where the tax rate on that interest is less than the tax rate would have been on your left hand as profit?

[lokisnow]

Uncle Joe is running! Gates of HELL, lmao, hillary v joe is gonna be epic

[aceluby]

Uncle Joe is running! Gates of HELL, lmao, hillary v joe is gonna be epic

What? LOL!

[TrackerNeil]

Claire McCaskill may just have saved the Democratic Senate majority. I seem to recall that, back in 2012, she helped engineer Todd Akin's path to the nomination, and if so she's much shrewder than her opponents realize.

[Sci-2]

Who Goes to Jail? Matt Taibbi on American Injustice Gap from Wall Street to Main Street

'Well, this book grew out of my experience covering Wall Street. I’ve obviously been doing it since the crash in 2008. And over and over again, I would cover these very complex and often very socially destructive capers committed by white-collar criminals. And the punchline to all of the stories were basically the same: Nobody would get indicted; nobody went to jail. And after a while, I started to become interested specifically in that phenomenon. Why was there no enforcement of any of this? And around the time of the Occupy protest, I decided to write this book, and then I shifted my focus to try to learn a lot more for myself about who does go to jail in this country, because I thought you really can’t make this comparison accurately until you learn about both sides of the equation, because it’s actually much more grotesque to consider the non-enforcement of white-collar criminals when you do consider how incredibly aggressive law enforcement is with regard to everybody else.'

[lokisnow]

It's disappointing and frustrating that in the above mentioned new Hampshire gates of hell speech that Biden is staking out a more hawkish than Clinton position. That loses my support, I'll vote for the least hawkish.

[Shryke]

Claire McCaskill may just have saved the Democratic Senate majority. I seem to recall that, back in 2012, she helped engineer Todd Akin's path to the nomination, and if so she's much shrewder than her opponents realize.

Not really.

The 3rd party candidate says he will "caucus with whoever has a clear majority".

And he's a former-Democrat and wealthy businessman.

These are not positive signs. Though I guess it's better then a Republican. But not by alot.

[NestorMakhnosLovechild]

Not really.

The 3rd party candidate says he will "caucus with whoever has a clear majority".

And he's a former-Democrat and wealthy businessman.

These are not positive signs. Though I guess it's better then a Republican. But not by alot.

Clearly, a man of strong principles.

[Mlle. Zabzie]

I get that the interest your left hand pays to your right hand is deductible and thus not taxed, saving you money, but wouldn't that increase the tax burden on your right hand as that's a form of income (the interest you charge on a loan you issued)? I suppose the trick is to have your right hand be in a different jurisdiction where the tax rate on that interest is less than the tax rate would have been on your left hand as profit?

Yes (or have your right hand be a haven).

So today I thought I'd write a little bit about what current anti-inversion legislation does.

Basic rule - if a non-US corporation acquires a US corporation and the former shareholders of US corp hold 80%+ of the non-US corp after the transaction, then the non-US corp will be taxed as if it were a US corp (this, btw, is a pretty crappy answer for the non-US corp if it's actually a business). If the former shareholders of US corp hold bn 60%-80% then two things happen (I) the US corp can't use it's tax attributes (like net operating losses, tax credits, etc.) to shelter gain on the the movement of property of the US corp (including stock of foreign subsidiaries, IP etc.) off shore for 10 years and (II) executives pay a 15% excise tax on their deferred comp. If the former shareholders hold < 60%, then these rules don't apply. There is an exception to these rules if 25% of the foreign corporation's sales, employees (by headcount and comp) and assets (by value) are in the foreign jurisdiction in which the foreign corporation is organized.

This set of rules, plus the rule I mentioned yesterday that US shareholders of the US corp will pay tax on the transaction all sound pretty gnarly, so why do it? Well, the "out from under" planning isn't what's driving these deals (absent a strategic rationale). It's base erosion and/or access to foreign cash. Just another word on the access to foreign cash. If these cash stockpiles were brought back now, the US multinationals' effective tax rate would skyrocket because the cash would attract a 35% actual cash tax rate. Note that this shows how artificial the GAAP effective tax rate actually is. The executives aren't deterred by the excise tax - I mean they are nervous about it, but they can always be grossed up by the company (though the company would lose the tax deduction for the grossup - which is no great loss because it might not be deductible anyway) or there's an exception if they cash out at close so long as there are no regrants for 6 months. The 6 months they miss can be later made up to them. . . .it's just math.

So query whether the focus should be on continuing to tax the foreign corporation as a US corporation to prevent "economic traitorism" whatever that means, or rather focusing on the base erosion/earnings stripping planning and something regarding the taxation of the large stockpiles of cash accumulated by foreign subsidiaries. This is a broader conversation which I will address in a different post.