John M. Samuels is the chairman of the International Tax Policy Forum (ITPF) (http://www.itpf.org), a group of more than 45 multinational companies representing a broad cross-section of industries.
This is an expanded version of the opening remarks delivered by Samuels at a conference titled "Corporate Inversions and Tax Policy," sponsored by the ITPF and the Urban-Brookings Tax Policy Center on January 23. The ITPF's mission is to promote independent economic research on the taxation of cross-border investment. The ITPF is not an advocacy group and does not take positions on legislation or regulations. The views expressed in this article are solely those of the author and should not be attributed to the ITPF or its members.
Copyright 2015 John M. Samuels.
All rights reserved.
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Good morning and thank you all for being here today. I am John Samuels, the chairman of the International Tax Policy Forum, and we have been sponsoring conferences on important issues of international tax policy, like the one we have today, for more than two decades. These conferences have spawned more than 30 academic papers and hopefully have advanced the state of our knowledge and contributed to a more informed and rational policy debate about these important economic issues -- the principal reason we formed the ITPF more than 22 years ago.
Today we will be discussing an issue of international tax policy that is certainly topical and ripe for consideration -- so-called corporate "inversions."
A corporate inversion is really nothing more than a merger between two companies that were headquartered and had their tax homes in different countries before the merger. And like in any cross-border merger, by necessity, the tax home of the acquiring company becomes the tax home of the newly combined group after the transaction.
While there is nothing new about cross-border mergers, recently some acquisitions of large and prominent U.S. companies by smaller -- but still sizable -- foreign companies has attracted a lot of attention in the media, Congress, and the administration.
And just as there is nothing new about cross-border mergers, there is nothing new about U.S. companies being acquired by foreign companies and changing their tax homes as a result of the transactions. For example, over the last two decades, U.S. companies were the targets in 57 percent of cross-border mergers based on dollar volume, and were the acquirers in only 43 percent of these deals.
But while there is nothing new about foreign acquisitions of U.S. companies, there has clearly been a dramatic increase in the number and size of these transactions in the last several years.
So what explains this recent wave of high-profile foreign acquisitions of U.S. companies, or so-called corporate inversions? What is going on?
It has been suggested there are at least three related reasons underlying the recent increase in foreign acquisitions of U.S. companies.
First, virtually every other major developed country has dramatically reformed its tax system to make it more "business friendly," including by adopting territorial tax systems that reduce or eliminate home country tax on international business income.
For example, the United Kingdom recently adopted a territorial tax system in addition to reducing its corporate tax rate to 20 percent and adopting a "patent box" regime that taxes patent-related income at a rate of only 10 percent.
The U.K. government was unabashedly explicit in explaining why it was making these changes to its corporate tax system. In announcing these changes, the U.K. government said, and here I quote, "The government wants to send out the signal loud and clear that Britain is open for business." And the government went on to say that it wanted the U.K. tax system to be an "asset" that would both attract foreign headquarters and investment to the U.K. and prevent existing companies from leaving the U.K. for countries with more favorable tax systems.
The U.K. is only one of the latest in a long list of countries that have adopted territorial tax systems to reduce or eliminate home country tax on the active business income earned abroad by their resident companies.
In 1995 only 27 percent of non-U.S. Fortune Global 500 companies in the OECD were headquartered in countries with territorial tax systems, while today 93 percent of these Fortune 500 companies are headquartered in countries with territorial tax systems -- and all of these countries have a lower corporate tax rate than the United States.
So today, in any cross-border merger involving a U.S. company, it is almost certain that the U.S. company's foreign merger partner will be based in a country whose tax system does not impose home country tax on business income earned abroad, making it far more attractive for the transaction to be structured so that the foreign company acquires the U.S. company.
And unlike in the past, these new business friendly tax regimes are in developed countries, like the U.K., that have stable governments, the rule of law, an educated workforce, major research centers and universities, and world class infrastructure -- countries that have a lot more to offer than the sandy beaches, warm climates, and waving palm trees of islands in the Caribbean.
A second development driving increased foreign takeovers of U.S. companies is the dramatic increase in the proportion of income earned by U.S. companies outside the United States.
In 1982 U.S. multinational corporations earned only 23.4 percent of their income outside the United States, while in 2012 more than 54 percent of their income was from their overseas operations -- an increase of over 100 percent in just a few decades. And this is a trend that is likely to continue given that 95 percent of the world's population and over 75 percent of the world's purchasing power lies outside the United States.
Simply put, as the business operations of U.S. companies have become more global, the tax stakes of having a U.S. tax home have been raised.
Today with more than 50 percent of their income and most of their future growth coming from outside the United States, U.S. companies have a lot more to gain by relocating their headquarters to a foreign country with a more hospitable tax regime. And conversely, they have a lot more to lose by remaining in the United States and having their growing global income swept into the worldwide U.S. tax net and taxed at the 35 percent U.S. corporate rate.
And since neither the growing importance to U.S. companies of their foreign earnings nor the proliferation of favorable tax regimes is likely to change any time soon, we can expect foreign acquisitions of U.S. companies to continue -- at least until the United States reforms its international tax system to bring it in line with the rest of the world.
Which brings us to tax reform, which for several reasons, perversely, may be a third factor driving the recent wave of so-called inversions.
First, and simply put, some companies may have lost hope that tax reform will happen any time soon, and they are tired of losing market share and being outbid for foreign acquisitions by their foreign competitors who are subject to much more favorable tax regimes.
So instead of waiting any longer for tax reform, some companies may have decided to take matters into their own hands and adopt a sort of "self-help" tax reform by merging with a foreign company based in a country like the United Kingdom that has already reformed and modernized its corporate tax system.
And another group of U.S. companies may have inverted to avoid the risk that while they were waiting for tax reform they would be taken over by a larger foreign company who would use the tax savings that would be unlocked by the deal to help finance and justify the acquisition, and who then might replace U.S. management with a foreign management team of their own.
So to avoid being a "sitting duck" for a foreign acquisition, some U.S. companies may have inverted by merging with a smaller foreign company as a kind of "poison pill," since after the merger the U.S. managers would remain in control of the combined enterprise, and therefore be in a position to both enjoy the tax savings from the deal themselves and keep their jobs.
Ironically, and perhaps most importantly, tax reform may have contributed to the recent wave of so-called inversions because some U.S. companies have gotten a glimpse of what U.S. tax reform might look like -- and in particular how it would affect their international operations -- and they did not like what they saw. Because under most of the tax reform proposals that have been put forward to date, the U.S. international tax system would still not be aligned with the rest of the world.
For example, under some tax reform proposals that have been put forward U.S. companies would be required to pay an immediate "minimum tax" on the active business income they earn outside the United States -- a tax that would clearly be out-of-line with international tax norms.
So some U.S. companies may have inverted because they concluded that, even after tax reform, it would still be more attractive to be headquartered in a foreign country. This is a very important point, because it shows that unless U.S. tax reform aligns our international tax system with the rest of the world we can expect inversions to continue even after tax reform.
Now some argue that instead of trying to align the U.S. international tax system with the tax systems of the rest of the world, the better way to stop inversions would be to enact tougher anti-inversion provisions as part of tax reform.
However, many believe that, as in the past, stop-gap measures aimed at preventing inversions will prove to be both ineffective and counterproductive.
For example, proposals that would treat a foreign company that acquires a U.S. company as a U.S. company for tax purposes unless the foreign acquirer was larger than the U.S. target could result in both (1) increased foreign takeovers of U.S. companies, and (2) U.S. companies splitting off their foreign operations into smaller, bite-sized pieces to facilitate their acquisition by a foreign company.
Similarly, proposals that would treat a foreign-incorporated company that is managed and controlled in the United States as a U.S. company for tax purposes could encourage these companies to move their management teams outside the United States.
The reason many believe stop-gap measures like these will be no more successful in the future in preventing takeovers of U.S. companies than they have been in the past is because of a simple, basic, and undeniable economic truth:
In today's global economy, one way or another, income producing assets will ultimately end up being owned by companies in whose hands they will produce the highest after tax rate of return.
Inversions are only one way -- albeit a highly visible one -- in which the foreign operations of U.S. companies end up being owned by foreign companies in whose hands they produce higher after-tax rates of return.
So even if all inversions could somehow be stopped, like water seeking its own level, the migration of the foreign operations of U.S. multinationals to foreign companies, in whose hands they would produce higher after-tax returns, would continue, but just morph into a different form.
For example, stop-gap measures would not prevent -- and might even encourage -- foreign takeovers of U.S. companies, transactions in which foreign management would be in control of the combined companies after the merger.
U.S. companies also could sell their foreign operations to foreign buyers in whose hands they would produce higher after tax returns -- like Merck's $14.2 billion sale of its global consumer products division to Bayer, a German company, that does not have to pay home country tax on profits earned abroad.
Foreign corporations could also acquire the foreign operations of U.S. companies in a more subtle, less visible way -- in "creeping acquisitions" by using their tax advantages to take market share from U.S. companies in global markets.
And stop-gap measures would not prevent new companies from starting up outside the United States to avoid having the income from their international operations swept into the worldwide U.S. tax net.
And more capital would flow out of the United States at the portfolio level when U.S. shareholders sold their stock in U.S. companies to buy stock in foreign companies whose international operations were earning higher after-tax returns in growing global markets -- resulting in lower stock prices and a higher cost of capital for U.S. companies.
So, perhaps for good reason, many believe that in today's open, global economy attempts to use our tax system to wall capital into the United States, when other countries are reducing the tax burden on international business income, are no more likely to be successful than King Canute's efforts to hold back the tide, or the Berlin Wall to restrain the spread of democracy.
So many believe it is time for the United States to stop trying to prevent companies from leaving the United States, and instead start thinking about what can be done to make it more attractive for companies to stay in this country -- and by doing so, also make the United States a more attractive location for the headquarters of existing foreign companies and new global start-ups.
All of this reminds me of an apt analogy I heard from my good friend and colleague Peter Merrill:
When your love interest leaves you for another, at first you are inclined to blame it on the deserter's character defects rather than on your competitor's attractiveness. But when it happens 20 times in a row, perhaps it is time to look in the mirror and address your own deficiencies.
Well we are fortunate to have a blue ribbon cast of leading academics, economists, practitioners, and government officials here with us today to help us look into the mirror and address what we should do about corporate inversions.
A question that demands and deserves full, rigorous, and open discussion and debate -- exactly the kind of public discourse the ITPF was formed to foster.
It will be surprising if all of the participants in today's conference find themselves in complete agreement. I am sure several of today's presentations will engender lively, and hopefully enlightening discussion. In this spirit, I encourage our large and well-informed audience to join in the discussion today.
Remember, where there is heat there is usually light!
Thank you all for coming and participating in today's conference.
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