What is Corporate Inversion?

Corporate inversion is a process employed by big companies that are based in the U.S., in an attempt to reduce the tax burden on income or gains. Basically, the company seeks to allocate income away from the country of incorporation to a foreign country. In most cases, companies pick a nation with a lower tax burden, less strict corporate regulations, and fewer governance requirements than their nation of origin in which to incorporate. The company then transfers company ownership to the foreign entity. Now, much of the money-generating activity can be allocated to the foreign entity, rather than the US entity. Corporate inversion is usually employed by big firms that receive most of their revenue or a significant part of their income from operations in foreign countries.

How Does Corporate Inversion Work? 

Corporate inversion is one of the strategies which multinational firms employ to reduce their tax burdens, usually imposed on them by their home country. A firm can be able to reincorporate abroad by having a foreign firm purchase their present operations. When this happens, the foreign firm would then take ownership of the company, its asses, and the old firm will be dissolved, while its business activities, while unchanged, will be carried out effectively in the new country of origin or residence. In some cases, companies can buy businesses abroad or even merge with a foreign corporate entity and use that entity as a new headquarters to carry out operations.

How Corporate Inversion is Used

For instance, let us look at a company in the manufacturing sector that incorporated itself in the United States in the 1970s. Now, most of its revenue during its long years of operations came from its operations in the United States, however, during the last few years, its foreign sources seemed to generated more profits than the United States. According to U.S. corporate governance requirements, the income generated from outside the company would be subject to U.S. and it is well known that the United States tax credits doesnt provide coverage for taxes on revenue generated in other countries. As the percentage of revenue from foreign sources increased rapidly, much more than that generated in the United States, the company had to pay a higher tax in the United States, as it is the nation where it is domiciled (domiciled refers to the area where a multinational firm is headquartered). In addition, its U.S. income is taxed at a home rate in addition to the tax on international revenue generation. Now, an easy way for this business to avoid high tax burdens is by incorporating abroad, as this will allow it to not pay taxes on the revenue generated outside the country. The company will then employ corporate inversion to achieve this goal. While corporate inversion is mainly focused on getting the firm to pay lower taxes due to the nature of taxation of the home country where it is domiciled, it can also help reduce the domestic taxes of a nation, as the operations of branches in that region can be financed by loans, and would count as expenses when tax is filed. This way, the tax payable on domestic incomes in the United States will be hugely reduced if the company decides to incorporate abroad and finance its U.S. operations via loan from the parent company.

Different Opinions on Corporate Inversion

Corporate inversion is a legal strategy and for this reason, it is not considered tax evasion, even when it is clearly a way of reducing tax burdens from the current home country. Corporate inversion wont be tagged as tax evasion if it doesn't involve misrepresenting information on tax returns or engaging in illegal practices to cover up profits from the government agency in charge of revenue. Although this strategy is not termed tax evasion, there has been different opinions surrounding the ethics and morals of firms that opt to employ this technique. A number of high-profile inversions have made this strategy more famous, and several calls has been made to the legislative arm of government to thwart possible future inversions. An example of a corporate inversion was when Burger King Inc. left the United States for Canada when it acquired Tim Hortons LTD, a famous Canadian donut chain. Another example of an attempt was the announcement from Pfizer Inc. that it will be moving to Ireland as part of a merger with Ireland based Allergen PLC. These two moves, as well as a number of other moves prompted a strong reaction from the United States government, and in April 2016, the government announced new practices and innovative measures that increased the difficulty of successful corporate inversions. Pfizer and Allergen PLC had to call off their merger after these new measures were incorporated.