If you can't beat them, join them: the U.S. solution to the issue of corporate inversions.

• Author: DeAngelis, Scott

ABSTRACT

There is an old proverb, "If you can't beat them, join them," that suggests that those who cannot win against some group should stop fighting and instead band together with them. It seems clear that when it comes to corporate inversions, the United States cannot win. Instead, countries overseas have taken advantage of tax break schemes to lure multinational companies away from the United States. This Note suggests that to prevent further foreign inversions, the United States should join these foreign countries in two ways. First, the United States should put its support behind the OECD's plan of a multilateral instrument that would eliminate some of the unfair tax practices that facilitate controversial inversions. Second, the United States should implement its own patent box policy immediately, as there is no guarantee that the OECD's multilateral instrument will come to fruition.

TABLE OF CONTENTS I. INTRODUCTION II. CORPORATE TAXATION AND CORPORATE INVERSIONS A. Worldwide vs. Territorial Tax Regimes B. Corporate Taxation in the United States C. The Corporate Inversion Transaction D. Reasons For Inverting E. Prior Waves of Inversions 1. The McDermott Transaction 2. The Helen of Troy Transaction 3. Late 1990s and Early 2000s Wave III. THE RECENT WAVE OF INVERSIONS AND PATENT BOXES AS A TOOL FOR COMPETITION A. Overview of Patent Boxes B. Ireland C. Luxembourg D. The Netherlands E. The United Kingdom IV. RESPONSES TO INVERSIONS A. Political Pressures From the United States 1. Concerns From the U.S. Perspective 2. Proposed U.S. Legislation B. European Investigations Into Illegal State Aid C. The OECD's Proposed Plan V. THE U.S. SOLUTION TO CORPORATE INVERSIONS A. Support the Multilateral Instrument Proposed by the OECD B. Create a U.S. Patent Box VI. CONCLUSION I. INTRODUCTION

Corporate inversions have once again gained the attention of both the media and politicians. This is not surprising, as there have been a surge of inversions in the past decade. (1) Not only has the quantity of inversions warranted notice, but the size of these transactions and the highly recognizable companies that have either inverted recently or plan to invert in the coming years have also been noteworthy. (2) Among some of the more well known corporations to invert are those in the technology and pharmaceutical industries that hold large amounts of intellectual property. (3) Presumably this is in part due to favorable tax incentive policies, such as the patent box, that have become popular in recent years. Among some of the popular destinations for these multinational companies are Ireland, Luxembourg, the Netherlands, and the United Kingdom--all of which have developed patent box devices within the last eight years in their own efforts to forestall companies from inverting in foreign locations. (4)

Corporate inversions have not been accomplished without criticism. Both the United States and the Organization for Economic Cooperation and Development (OECD) (5) have been critical of such policies. (6) The United States has proposed legislation to counter these corporate inversions; however, as in the past, these provisions are reactive in nature and are destined to fail again. (7) On the other hand, the OECD has proposed a seemingly promising plan that deals with some of the most concerning tax issues. (8)

This Note focuses on corporate inversions from the perspective of the United States, with special attention given to inversions involving technology and pharmaceutical firms since the most recent wave of inversions has been motivated by tax incentives concerning intellectual property. Part II provides background on corporate taxation and the inversion process. Part III explores the recent wave of inversions and why certain countries have benefited more than others. Ireland, Luxembourg, the Netherlands, and the United Kingdom are examined specifically because the United States can borrow the tax strategies of these countries when developing a plan to address corporate inversions. Part IV discusses current responses to corporate inversions. Part V suggests that to begin benefitting from corporate inversions, the United States should join forces with countries to support the OECD plan and also follow the movement of certain European countries that have already implemented a patent box regime.

2. CORPORATE TAXATION AND CORPORATE INVERSIONS

   Before delving into a discussion on corporate inversions, it is useful to briefly examine the background of corporate taxation. The tax system in the United States differs from tax systems found throughout the rest of the world. These differences illustrate some of the motivations behind the corporate inversion movement. Corporate inversions can be accomplished in a variety of ways, each with the goal of escaping the reach of U.S. taxation. While the most recent wave of global corporate inversions has gained much attention, this trend is certainly not the first of its kind.

   1. Worldwide Versus Territorial Tax Regimes

      One of the biggest differences between the tax systems of the United States and those of other countries is worldwide taxation versus territorial taxation. A worldwide tax regime taxes a domestic corporation on all of its income, whether the income is generated domestically or abroad. (9) This tax system, though not the most common, is used by the United States. (10) This means that income earned by a U.S. corporation from foreign transactions is subject to taxation both in the United States, the residence country, and in the source country where the transaction took place. (11) Usually corporations are not taxed on income earned abroad in foreign subsidiaries until it is paid, or repatriated, to the U.S. parent company--usually done in the form of dividends. (12) Foreign tax credits are usually allowed to offset some of the U.S. tax that a corporation would otherwise have to pay when a corporation chooses to repatriate earnings. (13) Many multinational corporations defer this income indefinitely by leaving their profits abroad, allowing them to escape U.S. taxation. (14) In a country with a worldwide tax system, foreign corporations are taxed only to the extent they earn income that originated in that country.

      A more popular tax regime used by foreign countries is a territorial tax regime that imposes tax only on income derived within the geographical boundaries of that country. This system usually exempts income that is generated from outside of the home country's geographical boundaries from being taxed. (15) Although many foreign countries operate under a territorial tax regime, these systems have strong provisions designed to prevent the shifting of income out of the country to evade being taxed domestically. (16) Such provisions make territorial tax systems less appealing to corporations than they otherwise would be, though this is not to say that they are less appealing than a worldwide tax system.

   2. Corporate Taxation in the United States

      As previously noted, the United States uses a worldwide tax system. (17) The current statutory corporate tax rate in the United States is 35 percent, among the highest in the world. (18) Although the U.S. statutory corporate tax rate of 35 percent is quite high when compared to other companies, the effective rate is well below 35 percent--sometimes as low as 13 to 17 percent due to certain available tax breaks. (19) For instance, research and experimentation tax credits are highly beneficial to technology and pharmaceutical companies. (20)

      Being subject to a worldwide taxation scheme may be extremely disadvantageous to corporations competing globally. The United States has chosen to provide foreign tax credits as a way to alleviate some of the competitive disadvantage that companies incorporated in the United States may experience--foreign income taxes paid or accrued are credited against U.S. income taxes. (21) This credit alleviates the double taxation of foreign-source income without eliminating the tax on domestic-source income. (22) This foreign tax credit is limited to the amount of U.S. tax liability on foreign-source income, which is determined by U.S. tax law. (23) Although these tax credits prevent double taxation, the overall tax paid on foreign investments may still be higher for U.S. corporations when compared to that of their competitors. (24)

      To illustrate, let us assume that there is a multinational corporation, A-Corp, incorporated in the United States, that generates $100 million from its operations in Ireland. Under the worldwide tax regime, A-Corp will be subject to Irish taxation (12.5 percent) as well as U.S. corporate taxation (35 percent) minus any foreign credits received for the initial Irish taxation for any income derived in Ireland. Therefore, A-Corp would owe $12.5 million (12.5 percent x $100 million) in taxes to the Irish government. The U.S. government would then credit A-Corp for this amount and collect the difference between the taxable amount under the U.S. tax rate of 35 percent and the amount credited. Thus, A-Corp would owe the U.S. government $22.5 million ((35 percent x $100 million)--$12.5 million) in taxes. This does not include the corporate tax that this corporation would owe the state in which it is incorporated. Assuming the average state corporate tax rate in the United States of 4.1 percent, another $4.1 million (4.1 percent x $100 million) in state corporate tax would be owed. This results in a grand total of $39.1 million in taxes from the A-Corp's $100 million worth of operations in Ireland.

      Now let us assume there is another multinational corporation, B-Corp, incorporated in a territorial tax jurisdiction that also generates $100 million from its operations in Ireland. B-Corp would only have to pay 12.5 percent of the $100 million of income, resulting in a total amount of tax paid of $12.5 million. Through this simplified example, it is easy to recognize the advantage that...