According to recent news, there may be fundamental flaws in the U.S. tax code that extend beyond the Obama administration and the competency of Internal Revenue Service (IRS) officials.
In a recent editorial report by the L.A. Times tax inversion is practiced by multinationals because these companies are incentivized by errors in the U.S. tax code.
“When is a U.S.-based company not considered a U.S. company by the IRS? When it buys a smaller firm in a foreign country and – presto chango! – deems that company to be its parent, escaping the obligation to pay taxes to the U.S. Treasury on its foreign earnings. This process, called “inversion,” is becoming increasingly popular among U.S. multinationals, drawing howls from lawmakers and the Obama administration. But a quick legislative fix won’t last long. That’s because the larger problem is a uniquely flawed U.S. tax code that encourages multinationals to engage in all sorts of accounting gimmickry,” wrote the L.A. Times editorial board.
The argument is that most developed countries tax their companies based on the profits they make on a local level, but the U.S. is different because they tax U.S.-based multinational companies on every dollar they garner internationally as well. Furthermore, the companies have to pay these taxes when they carry foreign earnings into the U.S. With the top tax rate at 35 percent, companies have to pay a hefty tax bill, regardless of the foreign taxes they have already paid.
“To avoid this hit, many U.S. multinationals have parked billions of dollars overseas, unused. Meanwhile, a small but growing cadre is seeking to acquire companies in foreign countries with much lower tax rates, then invert their ownership. Examples include medical device maker Medtronic, pharmaceutical company AbbVie and even the drugstore chain Walgreens,” writes the editorial board. “There was a wave of inversions in the 1990s as well, prompting a crackdown from Congress in 2004. But lawmakers exempted deals in which shareholders of the foreign company acquired more than 20% of the combined company’s stock, opening the door to the current surge. The administration wants to raise the threshold to more than 50% of the combined company’s stock, effectively barring companies from shedding their U.S. status unless they are taken over by a foreign firm.”
There are red flags with such methodology, one of those is when U.S. companies move out of the United States, this may encourage foreign takeover. The unfortunate truth is that as long as the U.S. tax code is steeper than many other developed countries, most multinational organizations will find a way to break the rules.
“A Band-Aid like the administration’s proposal might put a temporary crimp in one particular tax dodge, but solving the larger problem over the long term requires eliminating loopholes, broadening the tax base and lowering rates to more competitive levels,” writes the L.A.Times.
It might take drastic changes to the tax code to make any difference at all. If the IRS is serious about reversing tax debts and diminishing tax fraud, they may have to get creative about how to fix such inevitable problems.