It isn't complicated and it's not rocket science. The thievery underway in the form of corporate tax inversions can be stopped if there was a will to do so. It's a problem with three easy-to-describe pieces--and some pretty straightforward solutions. The issue is: does the White House, beyond an election-year messaging stunt, really want to stop the robbery of the American taxpayer?
Citizens for Tax Justice has really done a great service by describing, in very clear language in a new report, how corporations, using so-called "inversions", are ripping off the people, running away and trying to hide hundreds of billions of dollars from a legitimate tax, and what can be done (if I ever get rich--ha!--I'd write a big fat check to CTJ which, to my mind, does an astounding public service by banging away at the daily corporate tax rip-off...and while I'm on the topic, donate here).
It's simple, and I'll summarize the CTJ report (there is a lot more detail in the report):
The inversion crisis actually consists of three related problems which each call for specific solutions. First, loopholes in our tax law allow American corporations to pretend they are based abroad. Second, those corporations claiming to be based abroad (and corporations that really are based abroad) are able to use “earnings stripping” techniques to make profits earned in the U.S. appear to be earned in countries where they will be taxed more lightly or not at all. Third, the profits that American corporations earn offshore are supposed to be taxed by the U.S. when they are brought to the U.S., but after inverting corporations are able to use accounting tricks to escape that rule.I wrote about Kleinbard's argument here--which eviscerates the bullshit "competitiveness" argument.
The first problem is simply the absurdity that American corporations can pretend to be foreign corporations, while the second and third problems are the benefits they obtain by doing so. As Edward Kleinbard, former director of the Joint Committee on Taxation (JCT) argues, these benefits, rather than any attempt to enhance “competitiveness,” are the true goals of inversions
Step Number One:Loopholes allowing inversions must be closed.
The straightforward solution is to treat the company that results from this arrangement as American if the majority of it is owned by the former shareholders of the American company, and to treat is as American if it is managed in the U.S.The Levin brothers--Carl in the Senate, Sander in the House--have proposed exactly that (here is my May piece on that). A tiny step, while the fight is on to pass that bill, is to bar these tax-dodgers the right to federal contacts.
Step Number Two: Earnings stripping must be stopped.
The second problem is that once a corporation has inverted, it has opportunities to use “earnings stripping” to make profits earned in the U.S. appear to be earned in other countries where they will be taxed more lightly or not at all. In theory, any profits earned in the U.S. are subject to U.S. taxes, whether they are earned by an American-owned company or a foreign-owned company (which an inverted corporation is, technically). But earnings are stripped out of the U.S. when a U.S. corporation (which after inversion is technically the subsidiary of a foreign parent corporation) borrows money from its foreign parent corporation, to which it makes large interest payments that wipe out U.S. income for tax purposes. The loan is really an accounting gimmick, since all the related corporations involved are really one company that is simply shifting money from one part to the other. The interest payments made by the American corporation in effect shift the profits that are really earned in the U.S. to the foreign country for tax purposes.Step Number Three: American corporations must not be allowed to avoid the U.S. tax normally due on offshore profits upon repatriation to the U.S.
Restrictions on earnings stripping can take several forms, any of which can be weak or strong depending on how strict the limits are. One approach is to limit the amount of interest that can be deducted for tax purposes to some percentage of income or revenue. Another approach is to limit the deductions to the extent that the American subsidiary’s ratio of debt to equity (loans taken to stock issued) exceeds some set limit. The current (very weak) rule uses these approaches, and some reform proposals would simply lower the percentage of income or revenue that the deductable interest cannot exceed. Another approach would be to limit the interest deductions to the extent that the American subsidiary’s indebtedness is disproportionate relative to the rest of the corporate group (the group of corporations owned by the same foreign parent company). This is the approach taken in the earnings stripping proposal in President Obama’s most recent budget plan, which may be the strongest proposal to stop earnings stripping.[emphasis added]
The third problem is that the profits that American corporations earn offshore are supposed to be taxed by the U.S. when they are officially brought to the U.S. But after inverting, corporations are able to use accounting tricks to escape this rule.And they do this by shifting around money, particularly in the form of loans to the new sham corporate shell offshore:
But the inversion allows for the use of loans (as an accounting gimmick) to move the money into the U.S. for that purpose while avoiding the tax.That could be ended by closing a loophole in the tax code (in Section 956...yeah, it gets a bit technical but not that hard understand).
Last point: this really does end up in the lap of the president who, at least rhetorically, jumped into the debate recently. If Congress does not act, he can end this theft by executive regulatory action, per CTJ:
Former Treasury official Stephen Shay has argued that this problem (along with earnings stripping) can be resolved through administrative action if Congress fails to act. He cites several sections of the tax code, including 956(e) which says the “Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this section, including regulations to prevent the avoidance of the provisions of this section through reorganizations or otherwise.” The mergers that corporations use in inversions to claim to be restructured as foreign companies would seem to be such “reorganizations.”Bottom line:
Another section of the law cited by Shay is even more straightforward in providing this authority to the President. Section 7701(1), provides that the “Secretary may prescribe regulations recharacterizing any multiple-party financing transaction as a transaction directly among any 2 or more of such parties where the Secretary determines that such recharacterization is appropriate to prevent avoidance of any tax imposed by this title.”
If Congress fails to act and the administration addresses the crisis with regulations, there is no doubt that some members of Congress will accuse it of overstepping its authority, even if that is factually not true. Does the administration have the will to act despite that inevitable backlash? A lot may depend on how that question is answered.