Taxes, as you might imagine, are the crux of the matter. It is true that U.S. corporations pay the highest tax rate in the world at 35 percent. It is an often-quoted statistic but not entirely accurate. The effective tax rate is more like 25 percent when all the deductions and allowances are accounted for. Nevertheless, that number is still high and many corporations fear it is going to grow larger in the years ahead.

 

The United States also insists that companies pay that same rate on income that was made overseas by its subsidiaries and repatriated home. In comparison, many countries tax only domestic profits, (those that are made in-country) while ignoring profits made overseas in countries like Ireland where tax rates are much lower.

 

As a result, some companies have resorted to a legal maneuver in which they merge with a foreign company or declare that its U.S. operations are now owned by its existing foreign subsidiary. By taking advantage of this tax loophole, a company can then shift reported foreign profits outside of American tax jurisdiction. As a result, they are only paying taxes on profits that are made in the United States. The rest of their worldwide income is repatriated to their new legal address in their new foreign domicile with little or no tax burden.

 

This is an especially appealing option to many technology and drug companies because much of their profits are derived from intellectual propriety like patents. If they transfer those patents overseas (and they do) a major portion of their profits becomes tax free. 

 

To be clear, these companies are still paying taxes here. They are not moving jobs or production overseas. They are free to keep their top executives in the United States and most do! Bottom line these so-called “inversions” are nothing more than a change of address, a new mailbox that now resides in a foreign country. 

 

Despite the furor these inversions have caused, we are not talking about many companies. Only 41 U.S. corporations have reincorporated in lower-tax countries since 1982, including 12 since 2012. Eight more are planning to do so this year. The U.S. Treasury estimates a decline in tax revenues of some $17 billion over a decade. That’s not much. What worries the politicians is that the pace may be quickening despite the Internal Revenue Service’s attempts to discourage the trend.

 

Senator Dick Durbin is working on a measure called the “No Federal Contracts for Corporate Deserters Act,” which will prevent inversion companies from benefiting from federal contracts. Others have resorted to name calling and deriding these companies as unpatriotic.

 

There is an argument that what made these corporations great was their ability to benefit from the things our government has provided - patent protection, our legal system, education, training, infrastructure, research and our ability to defend their interests from others in time of strife.  And now they are turning their back on us in the name of higher profits?

 

There was a time when we could have explained away this attitude by reminding Americans that corporations are nothing more than economic animals driven solely by the profit motive. However, the Supreme Court changed all that when they declared corporations “individuals” with the same rights and responsibilities as humans. Should we therefore expect a new level of loyalty and good citizenship from these newly-minted citizens?

 

Clearly, our tax code is a mess. In order to remain competitive in this global marketplace, this country needs to adjust corporate and individual taxes at some point. However, we all know a tax overhaul is impossible given the present state of congress. As such, we should expect more of these inversions in the future as companies fend for themselves in the absence of action by our government.

 

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.