Aaron Brooks: The Political Aversion To Corporate Inversions

Editor’s note: Aaron Brooks is an attorney with Little Rock-based Wright, Lindsey & Jennings, LLP.  A graduate of the University of Central Arkansas and Harvard Law School, his practice focuses primarily on mergers and acquisitions, corporate finance and securities law.

2014 has been a banner year for corporate mergers and acquisitions. A combination of favorable conditions, including increased corporate cash and historically low interest rates, have caused M&A volume for the first half of the year to surge to a seven-year high, with approximately $1.8 trillion in announced transactions.

The most significant (and controversial) trend to emerge from this booming market has been the rise of so-called tax “inversions.” Put simply, inversions are cross-border mergers in which a larger company purchases a smaller company in a more tax-friendly country, and then declares itself to be domiciled in the low-tax jurisdiction. This maneuver can sharply reduce a company’s tax bill, even though in the vast majority of cases, the company’s mailing address (and not its operations or physical location) is the only thing that moves.

Because the United States has the highest corporate tax rate in the developed world, it comes as no surprise that inversions are particularly attractive to American corporations; since 2013, at least 19 U.S. companies have announced such moves, and researchers from the congressional Joint Commission on Taxation estimate that inversions will cost the federal government almost $20 billion in lost revenue over the next decade.

This flurry of activity has recently received widespread attention in business and political circles: President Obama denounced inversions as unpatriotic in a weekly radio address and has referred elsewhere to inverting companies as “corporate deserters”, the Wall Street Journal has extensively covered the subject, and Treasury Secretary Jack Lew penned an op-ed in the Washington Post asserting that inversions (while legal) shift a greater share of the tax burden from participating companies to American small businesses and individuals.

In the same op-ed, Lew urged Congress to enact legislation to address the practice, and his is far from the only voice calling for action. Lawmakers on both sides of the aisle, from Senator Orrin Hatch (R-UT) to Senator Ron Wyden (D-OR), have expressed a desire to explore a legislative fix. Many discussions coalescing around a two-step solution: inversion-specific legislation in the short term and, in the long term, much needed comprehensive tax reform aimed at lowering the corporate tax rate and creating a more competitive system to reduce the appeal of foreign incorporation.

While such bipartisan interest is as encouraging as it is rare, observers remain skeptical that it will lead to the passage of any legislation, and indeed there are a host of specific questions that must be resolved before the framework of a viable proposal can emerge. For its part, the Obama administration (with the encouragement of some congressional Democrats) is reviewing an assortment of potential administrative actions, like banning inversions among companies with federal contracts and revising the tax code to eliminate the economic incentives that drive companies to invert, in case Congress fails to act.

Notably, this issue is not new. In 1996, the Treasury issued Treas. Reg. § 1.367(a)-3(c), and in 2004, a Republican Congress passed the American Jobs Creation Act, each containing anti-inversion provisions that ultimately failed to deter these transactions. As a result of these experiences, some believe that even if further reforms are enacted, creative lawyers and accountants will continue to facilitate overseas repatriation in some form as long as foreign tax regimes remain attractive.

There is also an argument to be made that the negative attention focused on the inversion trend, while a public relations nightmare, exaggerates both its prevalence and impact. Post-inversion, companies continue to pay U.S. corporate taxes – anticipated tax savings are largely confined to their foreign profits. And assuming that inversions in fact cost the Treasury $20 billion over the next 10 years, that amount would equal less than 1 percent of all estimated corporate taxes for the same period.

Perhaps most significantly, Walgreen Co. recently illustrated that inverting is not always a no-brainer for company management. The massive pharmacy chain recently surprised investors by announcing that its $15 billion acquisition of German company Alliance Boots would not be structured as an inversion; on a conference call explaining the company’s reasoning, CEO Gregory Wasson cited the possibility of a protracted legal battle with the IRS, and potential consumer backlash and political ramifications. If other companies reach the same conclusion as Walgreen, the collective outcry and momentum for government intervention could fade.

In any event, the likelihood of Congress passing meaningful legislation in the foreseeable future (on this issue or any other) seems low, and the Obama administration’s appetite for taking executive action on this front remains to be seen. But until either the rules of the game or the economic incentives change, it’s a safe bet that corporations will consider using inversions as a means to minimize their cost of doing business and maximize the return to their shareholders.