Dodging Taxes Through Corporate “Inversions”

(Photo: AP/Kristoffer Tripplaar)

 

In January, Johnson Controls announced that it would transfer its official corporate headquarters from Milwaukee, Wisconsin (above), to Cork, Ireland.

In 2014, Wisconsin-based manufacturing giant Johnson Controls rose to 66th place on the Fortune 500. The company’s soaring profits came thanks in no small part to a string of bailouts, tax breaks, and subsidies from the federal government.

But in January, Johnson announced that it would merge with overseas manufacturer Tyco International and transfer its official corporate headquarters to Cork, Ireland, where Tyco is already based. Johnson called the merger a chance for both companies to leverage the emerging home products market. But the move conveniently saves the new company $150 million a year in U.S. taxes. That’s because Ireland has a corporate tax rate of 12.5 percent, while Johnson Controls paid a rate of about 19 percent in the U.S. last year.

It’s a maneuver that economists have dubbed an “inversion”—a process whereby an American company acquires a foreign firm and slashes its tax bill by relocating its headquarters to that firm’s overseas base. And it’s becoming increasingly popular among American companies, from drug-maker giant Pfizer to Coca-Cola’s largest bottling operation.

The companies themselves, along with their Republican defenders on Capitol Hill, say the inversions are a logical response to high corporate tax rates in the U.S. But the inversions allow companies to reap all the benefits of operating in the U.S. while shouldering none of the responsibilities. And they are costing Americans thousands of jobs. The debate over corporate inversions has spilled onto the presidential campaign trail, where inversions have drawn fire from the leading Democratic candidates. Until Congress or federal regulators intervene, the nation’s corporate tax base will continue to collapse.

According to Fortune, some 60 U.S. firms have pulled off inversions in recent years, shifting their official headquarters to low-tax nations offshore, and at least a dozen more may follow suit. The inversions deliver huge tax savings to the companies but drain billions from the U.S. Treasury.

As of 2012, U.S. corporations had shifted as much as $111 billion overseas through inversions and other tax-saving strategies, according to economist Kimberly Clausing of Reed College in Portland, Oregon. “I estimate that multinational firms shifting profits away from the U.S. tax base likely costs the U.S. government in excess of $100 billion each year,” Clausing told Fortune this year.

Johnson Controls’ inversion has proved especially controversial, given the company’s history of pleading for and receiving special taxpayer help. The company benefited from the 2008 bailout of auto-parts makers, receiving at least $149 million in tax breaks in Michigan alone. Johnson Controls has received over $529 million directly from taxpayers in state and local assistance, according to Good Jobs First. Yet the company has slashed domestic employment while maintaining more than 20 production plants in Mexico and more than 60 in China.

All that prompted The New York Times editorial board to brand Johnson Controls “quite possibly the most brazen tax-dodger” of all the many U.S. firms staging inversions. The shift of the company’s official “domicile” to Cork, Ireland, has the look of a move made purely for tax purposes, as its real operational headquarters will remain unchanged and stay in Milwaukee.

A spokesman for the company now known as Johnson Controls plc denied that the merger was motivated by tax savings.

“The planned merger with Tyco International is the next step in our journey to grow in the United States and globally, drive innovation, and invest in customer solutions,” said spokesman Fraser Engerman in an email.

Yet the merger follows the classic pattern of a “minnow swallowing a whale” that characterizes many inversions. Dropping its official U.S. “domicile” will save Johnson Controls $149 million a year thanks to Ireland’s lower tax rate. The company’s new “domicile” is officially Ireland, but will retain its real operating headquarters in its present site just outside Milwaukee. The only actual change in operations will be the designation of three office rooms in Cork, a source familiar with Johnson Controls told The American Prospect.

The company has come in for special criticism from this year’s crop of Democratic presidential candidates, who have consistently campaigned on the need to protect U.S. workers and their jobs.

“If you want the advantages of being an American company then you can’t run away from America to avoid paying taxes,” thundered Senator Bernie Sanders on the campaign trail.

Hillary Clinton has assailed Johnson Controls for being “willing to walk away ... instead of doing what they should to support our country.”

 

REPUBLICANS ON CAPITOL HILL say inversions like the recent Johnsons-Tyco merger prove that U.S. corporate tax rates are too high.

House Republican James Sensenbrenner of Wisconsin has fiercely defended Johnson Controls’ shifting its national headquarters to Ireland, arguing that the country, after 131 years of operating in the U.S., is simply trying to remain “competitive.”

“Despite the negative effects the departures of these companies are having on the American economy, it is difficult to blame corporate leaders when you crunch the numbers,” wrote Sensenbrenner in an op-ed in the Milwaukee Journal Sentinel. “The current rate paid by American companies is 35 percent—the highest corporate tax rate among developed countries. Plainly stated, this is unacceptable and is causing serious problems for this nation.”

Congressional Republicans have blocked even modest proposals to curb inversions and rejected fundamental changes out of hand.

But virtually no major corporations pay the full “sticker price” of 35 percent, tax experts say. That’s because the current tax code permits corporations to exploit a variety of loopholes and subterfuges to diminish their tax bills to the U.S. 

Among the most common corporate ploys include what’s known as “accounting alchemy,” whereby a U.S. corporation sets up a subsidiary in a tax-haven country. About two-thirds of multinational U.S. corporations have engaged in this practice, according to the Institute on Tax and Economic Policy.

Here’s how it works, according to tax expert and Pulitzer Prize–winning author David Cay Johnston: A parent corporation sells its patents and copyrights—the fruits of its research and development in the U.S.—at low cost to a wholly-owned subsidiary in a low-tax jurisdiction. This enables firms to make their U.S. units appear only marginally profitable, while the overall firm can report high earnings to potential investors.

“Accounting alchemy actually works, turning the black tax ink of profit into red ink of debt,” Johnston told the Prospect. “You appear as a pauper to government but valuable to investors.

Another corporate tax dodge is known as “endless deferral.” Corporations are able to endlessly defer taxes on foreign earnings, turning the tax system into a “profit center” for huge firms, Johnston says.

“If you are a multinational corporation, the federal government turns your tax bill into an interest-free loan,” he explains. Thus, he adds, “Apple and General Electric owe at least $36 billion in taxes on profits being held tax-free offshore, Microsoft nearly $27 billion, and Pfizer $24 billion.”  

The upshot is that the effective tax rate for large U.S. firms is actually about 19 percent, a bit more than half the statutory rate, with some estimates placing it as low as 13 percent. U.S. corporate taxes actually rank third-lowest among 30 major nations, according to Citizens for Tax Justice.

“U.S. corporations generally pay well below the sticker price, at about half the 35 percent level. U.S. corporate taxes are among the lowest,” Matt Gardner, executive director of the Institute on Tax and Economic Policy, said in an interview.

Many huge firms manage to avoid taxes entirely, shelling out more in CEO pay or lobbying expenditures than they pay in taxes. GE, with its tax department of 975 people working to hold down its tax burdens, made $14.2 billion in profits in 2010, but had a negative income tax because of $3.2 billion in federal tax credits. GE, a leader in shipping U.S. jobs overseas, enjoyed a tax rate of just 1.8 percent on $81.2 billion of profits from 2002 to 2011, revealed a study by Citizens for Tax Justice.  

 

SLASHING CORPORATE TAXES, as many conservatives recommend, is a “fool’s errand,” argues Gardner, because some corporate CEOs won’t be happy until the corporate tax rate approaches zero.

Instead of capitulating to CEOs who will never be appeased, Gardner recommends both short- and long-term steps to stem the tide of corporate inversions. Over the long haul, argues Gardner, “America needs to take away the incentive to invert.” This means closing such loopholes as “accounting alchemy” and “endless deferrals.”

That will mean a thorough tax overhaul, argues Johnston, including corporate tax reform so that assessments are based on full global earnings—both foreign and domestic.

Of course, such policy changes would take action on Capitol Hill—something not likely while Congress remains under GOP control, and tough even if Democrats retake the Senate this fall. A new bill offered this week by Senator Sander Levin of Michigan and Representative Chris Van Hollen of Maryland, both Democrats, appears certain to meet a similar fate.

But even if Congress does nothing, the administration could narrow the opening for inversions through executive action. This could include denying government contracts to firms that invert, and tightening up Treasury Department rules to impose tougher conditions on inversion.

“Even without Congressional action, the Treasury Department can establish new rules to discourage inversions and close up any loopholes that remain,” says Gardner.

In the meantime, public anger over corporate inversions is mounting, as household incomes continue to fall for tens of millions of Americans. An August 2014 poll by Americans for Tax Fairness revealed that more than two-thirds of likely voters disapprove of corporate inversions—86 percent of Democrats, 80 percent of independents, and 69 percent of Republicans.

Such numbers demonstrate massive public opposition to the inversions that permit corporations to renounce their U.S. citizenship and brush aside their history of public subsidies and support. In a global economy, it seems, companies like Johnson Controls have no compunction about offshoring jobs on a large scale in their quest to maximize profits.

As David Cay Johnston puts it, “We’ve reached the point where the entire foundation of our prosperity and freedom is under attack with these corporate inversions.”

Even the generally corporate-friendly writer and columnist Allan Sloan warns that inversions like Johnson Controls’ gambit are not only draining the tax base, but stoking populist flames in this year’s presidential race.

“All of this threatens to undermine our tax base, with projected losses in the billions,” wrote Sloan in The Washington Post. “It also threatens to undermine the American public’s already shrinking respect for big corporations.”

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