Corporate inversion planning strategies.

• Author: Melnik, Steven V.

In aiming to reduce their worldwide tax burden, an increasing number of U.S. multinational corporations (MNCs) are undergoing (or considering) a corporate inversion. This tax planning strategy, however, carries tremendous tax and nontax consequences, some of which are not always apparent.

Background

Countries throughout the world use two main types of jurisdictional bases when asserting their right to assess and collect taxes--a residence and a source. Under a pure residence system of taxation, they assert their right to tax their residents' worldwide income. Under a pure source system, however, they exercise their right to tax all income generated within their boarders, whether or not earned by residents.

To alleviate the hardship of potential double taxation, which may result when two countries assess income tax on the same income, residence countries generally yield to source countries in the taxation of the income derived in the source country. This "yielding" is generally achieved either through exemption of foreign income from the residence country's tax base, use of foreign tax credits (FTCs) or a combination of both. Most countries use both systems, with one system dominating.

The U.S. generally follows a residence-based tax system under Sec. 61, with offsetting FTCs authorized under Sec. 901. Most of its trading partners, however, use a source-based system. U.S. MNCs term this disparity a competitive disadvantage.

Example: USA, Inc., a U.S. MNC, and D, a German MNC, each earns $100 in country Z, which assesses a 20% corporate income tax. Both companies pay $20 of income taxes to Z. USA pays an additional $15 to the U.S. (which assesses a 35% tax on the $100 and then allows a $20 FTC). Because Germany follows a source-based system of taxation, it does not assess any additional income taxes on D. As a result, USA pays more taxes on its worldwide income than D, making it less competitive.

What Is Corporate Inversion?

An "inversion" is a process that enables an MNC to change its country of residence. Specifically, it removes the ultimate parent from the U.S and places it abroad. Although an inversion, in itself, is not a new phenomenon, use of it has been increasing significantly. To date, corporate inversions have mainly taken three forms.

"Stock-for-stock" transaction. In this transaction, a new foreign parent is formed overseas. Shareholders of the old U.S. parent exchange their shares for the overseas parent's shares. The result is...