- The US tax code became increasingly less competitive from the late 1980s, leading to a series of expatriations or business reversals, in which businesses reorganized abroad to escape the tax system. American.
- This phenomenon largely ceased following the enactment of the Tax Cuts and Jobs Act (TCJA) in 2017; since the adoption of the TCJA, no major reversals have been reported.
- The Biden administration proposes to revert the United States to its old uncompetitive tax system, with higher corporate tax rates and an outdated international tax regime, which has seen reversals occur with some regularity .
The United States has been slow to recognize the importance that corporate tax policies can have on the international competitiveness of their businesses. While the United States has hosted the most innovative companies in the world, this innovation has often come despite a tax code that has become singularly disadvantageous for companies in the country. Over time, this disadvantage grew to the point that US companies were encouraged to take equity stakes and locate in host countries with more competitive tax environments. Known as inversions, these blatant victims of outdated tax policies tormented policymakers, who attempted through a regulatory decree to stem the flow of reversals. Despite these efforts, the trend persisted until the United States substantially reformed its tax code through the Tax Cuts and Jobs Act (TCJA) in 2017. Since the passage of the TCJA, no major reversals have occurred. appears to have been achieved, while at least one major reversal has been reversed. The Biden administration is proposing tax policies that would bring the United States closer to the tax system, characterized by high corporate tax rates and an outdated international tax regime, which it had when reversals occurred with some regularity.
Corporate tax policy and inversions
In 1986, the United States enacted the Tax Reform Act, a comprehensive reform of the bipartite, revenue-neutral tax code. Prior to 1986, the United States imposed a corporate tax rate of 46%, which at the time was higher than the average for the United States’ major trading partners. The law raised the US corporate rate to a possible 34%, which put the United States below the current average. The United States’ major trading partners followed suit and, over the next decade and beyond, cut rates so that the United States was once again an international exception for corporate taxation. During this period, as other countries cut rates, the United States was the only Organization for Economic Co-operation and Development (OECD) country to ito augment its corporate tax rate. The result was that the United States was once again in a comparatively uncompetitive fiscal position.
The 1990s and early 2000s saw a series of corporate “expatriations”, in which US companies relocated overseas to reduce their tax burden. This phenomenon, also known as corporate “reversal”, has been the subject of Congressional hearings and the attention of Bush’s Treasury Department. The American Job Creation Act of 2004 (AJCA) included significant anti-reversal measures that remain in effect today. The AJCA has sought to limit the tax benefits resulting from reversal transactions unless the transaction meets certain criteria – the aim being to limit the benefits of purely fiscal expatriations without unduly encroaching on business activity. This policy somewhat curbed “naked” reversals, whereby companies simply reorganized into a low-tax jurisdiction but otherwise did not change owners or operations. It should be noted that this reform did not fundamentally reduce the relative disadvantage placed on companies headquartered in the United States. The result has been that cross-border mergers and acquisitions have taken the place of naked reversal as a means of achieving corporate expatriations.
The evolution of business reversals
As the United States continued to impose increasingly heavy corporate taxes, American competitors pursued innovations in the taxation of foreign income. In addition to significantly improving the competitiveness of the corporate tax rate, the main foreign competitors have increasingly adopted forms of territorial taxation. In a territorial system, in general, active income from a foreign source is not taxed, except for the tax imposed by the jurisdiction of origin. Thus, for a given foreign investment, no Additional tax is imposed and, therefore, the foreign investment is taxed at the same rate as an investment made under the domestic tax laws of the foreign nation. In short, a territorial tax system guarantees a level playing field for foreign investments.
In 2017, 29 out of 35 OECD countries had some form of this tax system. The United States clung to an outdated system whereby corporate income tax was applied to the worldwide profits of companies headquartered in the United States. U.S. businesses owed U.S. income taxes on income earned both at home and abroad, although the U.S. allows a foreign tax credit in the amount of U.S. tax at pay for taxes paid to foreign governments. Active income earned in foreign countries was generally not subject to U.S. income tax until repatriated, prompting companies to reinvest their profits elsewhere than in the United States. This system has distorted the international behavior of American companies and essentially trapped foreign income that might otherwise be repatriated to the United States.
The US tax system was fundamentally uncompetitive and drove US businesses overseas. Despite the enactment of the AJCA in 2004, cross-border mergers continued. A 2012 the Wall Street newspaper article describes an accelerated rate of reversals after a period of relative inactivity. Between 2009 and 2012, at least 10 companies moved abroad. A wave of announced or proposed cross-border mergers involving established brands such as Sara Lee, Pfizer, Chiquita and Medtronic, among others, have caught the attention of lawmakers and regulators. The Treasury Department issued guidelines and regulations for the period 2014-2016 that thwarted at least one major reversal, but in the absence of tax reform, the incentive to reverse persisted. At least five large companies continued to structure reversals to avoid restrictions imposed by Treasury regulations.
Inversions and the TCJA
In December 2017, Congress passed the most radical set of changes to the federal tax code since 1986. The TCJA significantly reformed three major elements of the federal tax code: personal income tax, personal income tax corporate income and the tax treatment of income. These last two elements have enabled the United States to significantly improve its international tax competitiveness by reducing its corporate tax rate to 21% and to reach most of its trading partners by adopting a territorial tax system. These key reforms have considerably weakened the incentives for companies to reverse. Additional reforms also reduced the tax benefits of the reversal. Overall, the Joint Committee on Taxation estimated that the TCJA would lead to increased investment in the United States. This finding is consistent with other research that the uncompetitive United States tax code has resulted in the loss of assets to foreign buyers. According to one estimate, if the United States had adopted a corporate tax code similar to that created by the TCJA, it would have retained 4,700 companies over the period 2004-2016. Data from 2018 and 2019 suggests that U.S. acquisitions of foreign firms increased by 50%, while acquisitions of U.S. firms declined by 25%, compared to the previous two-year period.
Since the enactment of the TCJA, no major reversals have been reported. Indeed, the most striking example of the post-TCJA reversal landscape is Assurant, Inc. Prior to the enactment of the TCJA, the company announced its intention to emigrate. After the passage of the TCJA, however, the company restructured the transaction to keep its headquarters in the United States.
The Biden administration has proposed a number of tax policies that would raise the corporate tax rate, move the United States closer to an outdated global tax system, and impose new restrictions on cross-border transactions. These restrictions were previously estimated to risk more than 40,000 high-quality jobs on their own. Data collected over the decades suggests that as long as the United States maintains a tax regime that is significantly out of step with the rest of the world, the incentive to reverse will persist.
Inversions have largely been banned from business pages. Where large companies once announced their intention to set up abroad, they now stay put. Other companies headquartered in the United States would be looking to return, now that the United States has a tax policy that is not clearly disadvantageous for companies based in the United States. This is a political success after decades of half measures. Some policymakers cannot accept this success and seek to overturn the current tax system and return the United States to a comparatively uncompetitive tax system. If these efforts are successful, observers should not be surprised to see a return of reversals. https://www.americanactionforum.org/research/economic-and-budgetary-consequences-of-pro-growth-tax-modernization/  http://waysandmeans.house.gov/legacy/fullcomm/107cong/6-6-02/107-73final.htm; http://faculty.law.wayne.edu/tad/Documents/Country/Treasury%20inversion%20report%205%2017%2002.pdf  https://taxfoundation.org/territorial-tax-system-oecd-review/  https://www.wsj.com/articles/SB10000872396390444230504577615232602107536#:~:text=Despite%20’04%20Law%2C%20Companies%20Reincorporate,Saving%20Big%20Sums%20only%20Taxes&text%20Sums%20only%20Taxes&text%20At%20 20it, by% 20about% 20% 24100% 20million% 20year.  Chiquita and Pfizer  https://fas.org/sgp/crs/misc/R43568.pdf  https://www.jct.gov/publications/2017/jcx-69-17/  https://www.businessroundtable.org/buying-selling-cross-border-mergers-and-acquisitions-and-the-us-corporate- Income-tax; note that these businesses can be relatively small transactions.  3 Andrew Lyon, “Insights on Trends in US Cross-Border Mergers and Acquisitions After the Tax Cuts and Jobs Act”, Tax Notes, October 2, 2020, pp.497-507  https://www.businesswire.com/news/home/20180109005906/en/Assurant-and-The-Warranty-Group-Amend-Deal-Structure  https://www.americanactionforum.org/research/economic-risks-proposed-anti-inversion-policy-update/