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U.S. Corporations Are Exploiting a Huge Tax Loophole, but the GOP Doesn't Want to Close It

Alex Wong/Getty Images

The brothers Levin—Senator Carl Levin and Representative Sander Levin—are fed up with domestic companies merging with foreign firms to lower their tax bill, especially when the new entity’s business and management remains located in the United States. So on Tuesday, they introduced bills in the Senate and House respectively that would crack down on this tax-avoidance strategy, known as tax inversion.

American companies have exploited this loophole by merging with foreign firms and transferring their official address to the foreign country. Under current U.S. tax law, if the American company transfers at least 20 percent of its shares to the foreign firm, it can avoid paying the 35 percent U.S. corporate rate. Instead, it would fall under jurisdiction of the foreign nation. “In that situation, I would say it’s not really a new company,” said Steve Wahmoff, the legislative director at Citizens for Tax Justice. “It’s still the same American company, it just gobbled up some smaller company. They haven’t changed. They’re still managed in the U.S. They’re still doing most of their business in the U.S.”

Companies have been using tax inversion to lower their tax bill more frequently in recent years, with 14 firms doing so since 2011, according to Bloomberg. Pharmaceutical firms have been particularly active in merging with smaller pharma companies in Ireland, where the corporate tax rate is just 12.5 percent. The most prominent of these was Pfizer’s attempted purchase of AstraZeneca for $119 billion—with Pfizer potentially saving $1 billion a year in U.S. taxes in the process. The deal fell apart because AstraZeneca believed that Pfizer was buying it for cost and tax-minimization purposes.

The Levin proposal, which mirrors one in President Barack Obama’s budget, would curtail this strategy by raising the threshold from 20 to 50 percent. In other words, foreign shareholders must own the majority of shares of the new entity for it to avoid U.S. taxes. In addition, if management and control of the company remain in the United States, it must pay the U.S. corporate tax.

To most people, that would seem fair. Under the worldwide tax system the U.S. has, if the majority of shareholders are based in the United States, then the company should fall under U.S. tax jurisdiction. But the Levin legislation, which has 13 Democratic co-sponsors in the Senate and nine in the House, is unlikely to find much support among Republicans. In a floor speech on May 8, Orrin Hatch, the ranking member of the Senate Finance Committee, said:

Broadly speaking, there are two different ways to address the problem of inversions. The first way is to make it more difficult for a U.S. corporation to invert. Just today, we’ve read accounts of Members of Congress who propose doing just that. The second way is to make the United States a more desirable location to headquarter one’s business. I believe the latter is the better way… Instead of imposing arbitrary inversion restrictions on companies retroactively and thereby further complicating the goal of comprehensive tax reform, we should first keep our focus on where we can agree.

Both parties agree that the U.S. corporate tax system is unnecessarily complicated and that the 35 percent rate for corporations is too high. But Hatch is acting as if Republicans and Democrats have similar goals for tax reform. That’s not true. Tax reform is not happening in this Congress. After Republicans ran as fast as they could from Dave Camp’s reasonable tax plan, it’s hard to see it happening in the 114th Congress either. In fact, the Levin plan would be temporary: the threshold change would only last two years, closing the loophole while giving Congress time to come to an agreement on tax reform.

With that in mind, look again at the two ways Hatch outlines: make it tougher for U.S. firms to invert (aka the Levin bill) or hope that Congress can somehow pull off tax reform in the near future. It's an easy choice.