Bogus Defenses of Tax-Dodging Corporate Inversions

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By Roger Bybee, a Milwaukee-based writer and activist who teaches Labor Studies at the University of Illinois. This is the second article in a three-part series, originally published in the May/June issue of Dollars & Sense. You can find part one here.

Why Inversions?

The crucial motive in transferring corporations’ “nationality” and official headquarters to low-tax nations is that inversions shield the “foreign” profits of U.S. corporations from federal taxation and ease access to these assets. This protects total U.S. corporate profits held outside the United States—a stunning $2.1 trillion—from any U.S. corporate taxes until they are “repatriated” back to the United States.

Major corporations benefit hugely from the infinite deferral of taxes purportedly generated by their foreign subsidiaries. “If you are a multinational corporation, the federal government turns your tax bill into an interest-free loan,” wrote David Cay Johnston, Pulitzer-Prize winning writer and author of two books on corporate tax avoidance. Thanks to this deferral, he explained, “Apple and General Electric owe at least $36 billion in taxes on profits being held tax-free offshore, Microsoft nearly $27 billion, and Pfizer $24 billion.”

Nonetheless, top CEOs and their political allies constantly reiterate the claim that the U.S. tax system “traps” U.S. corporate profits overseas and thereby block domestic investment of these funds. But these “offshore” corporate funds are anything but trapped outside the United States. “The [typical multinational] firm … chooses to keep the earnings offshore simply because it does not want to pay the U.S. income taxes it owes,” explains Thomas Hungerford of the Economic Policy Institute. “This is a very strange definition of ‘trapped’.”

In fact, these offshore profits can be, and are, routed back into the United States through the use of tax havens. (Tax havens, where corporations and super-rich individuals place an estimated $7.6 trillion, were thrust into the international spotlight with the recent release of the Panama Papers. See William K. Black, “Business Press Spins Elite Tax Fraud as ‘Good News’,” p. 5.) “‘Overseas’ profits are neither overseas nor trapped,” explained Kitty Rogers and John Craig. “It is true that for accounting purposes, multinational corporations keep these dollars off of their U.S. books. But in the real world, the money is often deposited in U.S. banks, circulating in the U.S.”

However, the “overseas” profits come with some significant constraints on their use, pointed out David Cay Johnston. “The funds can only be accessed for short-term loans back to the U.S., and are not useful for major investments like new factories or long term R&D, or for investment outside the U.S.,” said Johnston. But inversions eliminate these restrictions on how such funds can be used. “By inverting and then using a variety of tax avoidance schemes, the firms can have access to these earnings virtually free of U.S. taxes,” notes Hungerford. “This is undoubtedly the primary motivation to invert.”

The inversion route is not the only means for U.S. corporations to radically slash their U.S. taxes and gain access to offshore earnings. Any particular company’s tax-avoidance strategy is dependent on the specific conditions it faces. As tax expert Johnston notes, “Every company has its own unique issues so it will decide what works for it.”

Some giant multinational corporations, like Apple, Microsoft, and Google, have chosen to bypass inverting. Instead, they utilize immensely complex shifts of their revenue to minimize their taxes and maintain access to their offshore earnings. These maneuvers have gained exotic names like “Double Dutch Irish Sandwich,” reflecting the multiple transfers of capital that they employ. The corporations involved are able to avoid the public backlash brought on by jettisoning their U.S. nationality. On the other hand, such ploys require careful planning and execution, compared to the simple, direct step of inverting.

Corporate inversions also head off the possibility of higher rates being imposed in the United States, an idea with very broad public support as shown by polling. But in addition to the vast political resources that corporations bring to any fight in Congress on corporate taxes, inversions remind U.S. public officials that their policies can be undermined by CEOs’ unilateral decisions to relocate anywhere on the globe. Companies use this trump card to weaken the push for increases in corporate taxes and instead build momentum for further federal concessions.

Johnson Controls: The Ugly Truth

The most recent inversion deal, orchestrated by Johnson Controls—called the “latest and quite possibly the most brazen tax-dodger” in a New York Times editorial—explodes the myths underlying the standard rationale for inversions. Johnson Controls, which has been based in the Milwaukee area for 131 years, is the 66th largest firm in the United States.

Much media coverage has focused on the $149 million in annual tax savings that Johnson Controls will purportedly reap by jettisoning its U.S. identity and moving its official “domicile” to Ireland, where the tax rate is 12.5%. This is a tidy sum, but not because Johnson Controls was victimized by paying the statutory rate of 35%.

On the contrary, Johnson Controls has already been benefitting handsomely from a U.S. tax system that is remarkably generous to major corporations. As Matthew Gardner of the Institute on Tax and Economic Policy pointed out, “Between 2010 and 2014, Johnson Controls reported just over $6 billion in U.S. pretax income, and it paid a federal income tax rate averaging just 12.2 percent over this period.” Significantly, “This is actually lower than the 12.5 percent tax rate Ireland applies to most corporate profits.”

Far more central to Johnson Controls’ inversion is the virtually tax-free status that it will gain over its vast pile of profits accumulated offshore, Gardner argues. Digging beneath the surface, Gardner found, “At the end of 2014, Johnson Controls disclosed holding $8.1 billion of its profits as permanently reinvested foreign income, profits it has declared it intends to keep offshore indefinitely.”

The tax stakes for Johnson Controls are therefore much higher than the annual savings so often cited. “Reincorporating abroad would allow Johnson Controls to avoid ever paying a dime in U.S. income tax on profits currently stashed in tax havens,” Gardner stated.

Johnson Controls is using the common inversion strategy of arranging for a smaller corporation based in a low-tax nation to purchase a much larger firm operating in the United States. In this case, the Ireland-based Tyco International (itself an inverted firm which had long been based in the United States) is buying Johnson Controls. Tax expert Edward Kleinbard describes this as a “minnow swallowing a whale” scenario that characterizes many inversions.

The Johnson Controls-Tyco deal qualifies as a so-called “super inversion,” as Fortune put it, because it evades a number of new ownership regulations set by the U.S. Treasury Department to discourage inversions. “Tyco shareholders will own 44% of the deal after it is done, avoiding any penalties the Treasury Department has tried to impose on these deals,” Fortune reported. “The Treasury Department had set an ownership requirement in 2014 of 40% for foreign firms involved in inversion deals with U.S. corporations, in an effort to discourage inversions.”

The deal with Tyco will change virtually nothing for Johnson Controls International except for its slightly modified name—“Johnson Controls plc.”—and its ability to manipulate the U.S. tax system. The company’s new domicile will officially be Cork, Ireland, but it will retain its real operating headquarters in its present site near Milwaukee. It will continue to be listed on the S&P 500 stock index. Johnson Controls will still be protected by the vast legal architecture safeguarding U.S. firms, like those on securities, intellectual property, and patents.

The corporation’s CEO Alex Molinaroli insists that the firm is simply acting to best serve its shareholders: “It would be irresponsible for us as a company to not take advantage of the opportunities that come along.” The inversion will also provide some advantages to the CEO himself, with Fortune observing, “Molinaroli will receive at least $20.5 million and as much as $79.6 million for doing the deal over the next 18 months.”

Johnson Controls also stands to retain other advantages. It will remain eligible for U.S. government and state contracts under current law, as have Accenture and other firms which have staged inversions. Between 2010 and 2014, Johnson and its subsidiaries received more than $1 billion in federal contracts—more than $210 million a year, according to ITEP’s Gardner. Furthermore, Johnson Controls’ ability to gain federal and state tax incentives for job creation will apparently continue.

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  1. TheCatSaid

    Countries could easily stop this kind of thing if they wanted to. But they don’t want to. Governments have become completely captured by corporations and are afraid to rock the boat. At state and local levels they tighten the screws further to get sweetheart deals on state and local taxes. This transfers more of the cost for providing local services and infrastructure on small businesses and workers, who don’t have the same tax avoidance options as large corporation.

    Something omitted from this discussion is whether corruption and revolving doors are factors in understanding why governments do not take action.

    How will this all end? What remedies are politically feasible, whether at local, state or federal level?

    This post does a great job describing many of the problems. We need an expanded mindview to perceive solutions not yet in our awareness.

    1. twisted

      I’ll bet it wouldn’t be hard to find a strong correlation between politicians who:
      a) don’t pursue making corporations pay tax.
      b) receive donations from corporations who aren’t being taxed and thus happen to have a lot of cash to donate.

      It looks to me like a vicious circle. The politicians who don’t play the game don’t get enough ‘donations’ to get themselves elected.

    2. JD

      I posted a thought on this below. Definitely in your camp as a general matter, but recent events have opened my eyes to perhaps another conflict playing out before us.

  2. ke

    Wolf provided the boycott list. Silicon Valley is no 1. How can a global city stealing Americans and the rest of the world blind be the example for others to emulate without destroying the global economy?

    And the majority is funding the construction of its own prison, real inflation far surpassing pensions, upon the mistaken assumption that some future generation will pay. The future is here.

    If you are a young person, you owe us nothing, and your children the opportunity to marry, have children and pursue their dreams, in a world where work is money.

  3. alex

    Almost never mentioned in these articles is that the US is the only G20 country to tax active business income in foreign subsidiaries when repatriated – the alternative chosen by everyone else is not to tax it at all. Similar to how the US is unique in taxing the income of US citizen nonresidents. If the argument against inversion is moral suasion, then it has to engage with the question as to why it’s appropriate for the US to be different in this way. Also whether that difference (and the very high US corporate rate) will become more of a problem as American economic dominance wanes.

    A rebuttal to this might be that the US is a relatively tolerant jurisdiction with respect to international tax planning, which allows companies to lower their effective rates of tax pretty effectively. And I think its stance on this is a political compromise between doing nothing and normalizing its tax system (eg making it more like the UK, with a 50 percent lower tax rate and a participation exemption). But that compromise leads to the US facilitating the base erosion of other countries as a side effect, among other issues.

    1. inode_buddha

      *sigh* and I’ve been saying for years now, that one thing we can do is do away altogether with taxing foreign income, and corporate taxes, *IF* we harmonize capital gains with labor permanently, and also institute re-tarriffs — similar to the way things were before income tax was invented. Basically a quid pro quo trade policy. That’s without even touching the spending side of things —

  4. bkrasting

    Inversions are not ‘tax dodging”, they are tax avoidance – they are legal.

    Sadly, the only voice making any sense of this is Donny Trump. Inversions could be ended forever, and in the process the US Treasury would collect $500 Billion.

    The problem is not “bad” companies like Apple and Microsoft – it’s a stupid tax policy in the US. Want to end inversions, bring home trillions, create more jobs at home? Then fix the tax code. It ain’t that hard.

    That this insanity has gone on for so long is the reason that guys like Trump have a chance to win.

    1. Yves Smith Post author

      Stop propagating inaccurate information. These are book profits. They have nothing to do with where cash sits, which is typically in US banks. Apple runs its cash horde as a hedge fund out of Nevada. US companies do not incur a tax cost if they want to invest in the US. The only thing this affects is the ability to pay dividends.

      1. alex

        The whole point of a well-developed body of law around this issue is to prevent US companies from investing their offshore earnings in the US without bearing US tax. Yes, bank deposits or short-term loans are OK, but not anything that looks like a long-term investment, such as a facility in the US or patent rights to a US product. has an overview.

        So the three main things companies can’t fund with offshore earnings are dividends, stock buybacks and long-term US investments. It might well be that companies are inverting out of concern for the first two uses rather than the latter, but at the margins the rules definitely affect corporate decision making around investment decisions as well.

  5. JD

    The approach of a business-minded government agent seeking to recoup lost tax revenue would be to focus on the core value offered by “access to your economy”. Once you identify that value, all you need to do is charge the market clearing price for that access. In doing this, you are able to convert a “tax” into “fair compensation” or simply a “price”.

    Though its easy to want to pin the immense levels of corruption on some grand conspiracy between government and big business, I’m starting more and more to wonder whether we really just have an immense imbalance in intelligence between “government officials” and “those capable of making profit in the private sector.” Though one might ordinarily expect the smarter and far more capable private sector folks to easily overpower government — the government has lots and lots of weaponry as well as incredible means of acquiring information and making “justice” bend to their needs.

    Thus, it is very likely that what we are seeing now happen is the private sector seeking ever more creative means to avoid the “tyranny of the stupid”, which is at the same time, becoming ever more stupid and (as a direct result) in financial trouble (debt). Though perhaps a trivial distinction, it may actually be quite important in determining how best to dig us out of this mess. After all, if its treasonous selling out of the citizenry — we’re in a different kind of trouble than if its merely one rational actor and one irrational actor — well lets inject some rationality into the second half of the equation.

    There is of course also the important fact that many people have created jobs and even entire industries based upon the need to both comply with government regulations and, at times, evade them. To the extent this is playing a role, I think that these folks likely fall in the “intelligent, but doing their best in a stupidly designed system” category. Thus, they would likely be able to easily adapt their efforts to more productive — but better aligned — aims.

    Just a few thoughts

  6. ke

    Funny, Silicon Valley sells debt, and collects cash, which really isn’t cash. Whatt next, a gold fort for paper gold as a diversion for real gold, in an arbitrary money system.

    The irony. If people spent half as much time working as opposed to pretending to work to avoid work…The RE ponzi called government wouldn’t exist.

  7. nat scientist

    How would Boobus Publicus know an Inversion from a Conversion when the language is 24/7 mangled by impromptu narratives from the lips of the Media brides of Frankenstein? People go mad in droves, but recover one by one, putting thinking before needing, rather than the reverse with sudden delivery and true cost unknown.

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