ACT Report: US Corporate Redomiciliations and the need for Tax ...

ACT Report: US Corporate Redomiciliations and the need for Tax Reform May 2014

Introduction • There has been a recent wave of cross-border mergers where the US company is larger, but the merged entity has chosen to establish its tax headquarters in a foreign jurisdiction. • These mergers are not subject to the provision in section 7874 (the antiinversion rules adopted in 2004) that, if it applied, would treat the new foreign entity as a US corporation for tax purposes. - Section 7874 was enacted to prevent transactions known as “inversions” in which the US parent is acquired by its own foreign subsidiary. Section 7874 targeted transactions that were essentially paper transactions, without a change in shareholders or combination of business assets. • The Administration expanded the section 7874 regulations in 2012. The effect has been to limit corporate redomiciliations to cross-border mergers involving a foreign company valued at more than 25% of the US company. • The frequent choice of a foreign tax home in cross-border mergers is a clear indication that the US corporate income tax system is no longer competitive. ACT Report Corporate redomiciliations

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Top Statutory (Federal and State) Corporate Tax Rates, OECD 1988-2013

50

45

40

44.3

39.1

38.6 U.S.

35

OECD Average Excluding U.S. 30

25.1

Since 1988, the average non-US OECD statutory corporate tax rate has fallen by over 19 percentage points, while the US rate has increased by 0.5 percentage points.

25

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

20

Source: OECD Tax Database ACT Report Corporate redomiciliations

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HQ Location of non-US OECD Companies in Global Fortune 500 (2012) Global competitors with HQs in worldwide countries, 7%

Global competitors with HQs in territorial countries, 93%

ACT Report Corporate redomiciliations

Cross-Border M&A Deal Value, 1990-2012

US is acquiror , 43%

US is target, 57%

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Implications For Tax Reform • While many point to the wave of corporate redomiciliations as indicating the need for tax reform, there are widely divergent views: - Some call for increasing tax penalties on corporate expatriations - Others call for a more competitive corporate tax system - Some (e.g., Sen. Wyden) call for both: put a stop to corporate expatriations pending adoption of a competitive corporate tax system. • Addressing only corporate expatriations would have unintended economic consequences and would not address the root cause of the problem – an outdated corporate tax system that is no longer competitive. • Comprehensive tax reform proposals must meet the competitiveness test to succeed in making the US an attractive tax home for global companies. • Ultimately, market forces are moving the ownership of assets into the hands of corporations that are not subject to worldwide taxation. In addition to cross-border M&A where a foreign tax home is chosen, this is occurring less visibly through sale of US assets, foreign incorporation of startups, US portfolio investment in foreign shares, etc. ACT Report Corporate redomiciliations

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How the UK Dealt with Redomiciliations •

In 2008, several UK companies, including UBM., WPP PLC, and Shire PLC, moved to Ireland.

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Rather than penalize expatriations, the UK decided to reform the corporate tax system.

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The 2010 Corporate Tax Road Map sets out the bold vision for tax reform: •

“The Government wants to send out the signal loud and clear that Britain is open for business ... In recent years too many businesses have left the UK amid concerns over tax competitiveness. It’s time to reverse this trend. Our tax system was once viewed as an asset. And it needs to be an asset again. That is why the Government is prioritising corporate tax reform. Responding to the concerns of business, the UK is headed for a more competitive, simpler, and more stable tax system in the future, creating the right conditions for business investment.”

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Chancellor Osborne’s 2011 budget accelerated the reforms with the goal to "create the most competitive tax system in the G20."

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Since 2008, the UK has enhanced the competitiveness of its corporate tax by:

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Lowering the corporate income tax rate from 28 to 21%, with a further reduction to 20% in 2015.

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Adopting a participation exemption (so-called “territorial”) tax system in 2009.

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Extending the territorial system in 2011 to cover foreign branches of UK companies.

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Enacting a “patent box” system effective in 2013 that provides a 10% rate on patent-related income.

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Adopting a new 10-percent, non-incremental, refundable R&D credit.

The UK strategy has been remarkably successful. UBM and WPP PLC have returned to the UK, the IMF projects faster UK growth than in other G7 countries, and KPMG and PwC both report working with about 100 multinational companies that wish to expand their footprint in the UK.


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Section 7874 • Enacted in 2004 in response to “inversions,” sec. 7874 imposes adverse tax consequences if all 3 conditions occur: 1. “Substantially All” – A foreign corporation acquires substantially all the properties of a domestic corporation;

2. “Ownership Test” – Shareholders of the US corporation receive at least 60% (or 80%) of the stock of the foreign acquiring corporation; and 3. “Substantial Business Activities” – The group of which the foreign acquiring corporation is a member does not conduct substantial business activities in the foreign acquiring corporation’s jurisdiction of incorporation. • Adverse tax consequences vary depending on US ownership continuity: ◦ At >80%, the foreign acquiring corp. is treated for US tax as a US corp. ◦ At >60%, inversion gain may not be reduced by use of the US company’s tax attributes (NOLs and FTCs). ACT Report Corporate redomiciliations

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Section 7874 Inversion In a pure inversion, a US company is acquired by its own foreign subsidiary, which becomes the new parent company. There is no business combination nor change in management and control. Corporate level tax

• New Foreign Co. will be respected as a foreign corporation for US tax purposes if the New Foreign Co. group has “substantial business activities” in New Foreign Co.’s country of incorporation. Shareholder level tax

• Shareholder gain.--Under section 367, US shareholders recognize gain (but not loss) in the transaction. • Officer/director excise tax –Under sec. 4985, officers and directors of must pay a 15% excise tax on the value of any stock-based compensation held by such persons 6 months before and 6 months after the transaction.


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Section 7874 2012 Temporary Regulations

• 2012 Temporary Regulations replaced the prior “facts and circumstances” test by defining “substantial business activities” to mean 25% of each of: 1. tangible assets,

2. gross income (based on the destination of sales/services), and 3. employees (measured by both headcount and compensation). • The 2012 regulations preclude pure inversion transactions for geographically-diversified multinational companies that do not have 25% of their sales, assets, and employees in a single country. - Since these regulations were promulgated, corporate redomiciliations have occurred in the context of cross-border business combinations where the ownership test can be met (i.e., the foreign entity’s value exceeds 25% of the US entity’s value). ACT Report Corporate redomiciliations

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Potential Tax Benefits of Foreign Tax Home • Most cross-border M&A is driven primarily by non-tax factors. But, in deciding where the tax home of the merged entity should be located, the US rarely is the best choice. Residence in a “territorial” tax jurisdiction allows: - Future foreign growth to occur under a foreign parent (so earnings can be accessed with little or no repatriation tax). - Potential reduction in income subject to the high US corporate tax rate via intercompany loans (planning that is available to all foreign-based companies with US subsidiaries, within the limits of sec. 163(j)). • In the unlikely case the US were selected as the merged entity’s tax home: - The foreign target’s income could not be distributed to shareholders or used in the US for investment, R&D, etc. without triggering US tax. - The foreign target would become subject to US subpart F (anti-deferral) rules. - It would be more difficult for the merged entity to compete with foreign-based multinationals. ACT Report Corporate redomiciliations

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Policy Responses FY 2015 Budget Proposal to Limit Ability of Domestic Entities to Expatriate

The Administration’s Budget proposal would amend Sec. 7874 by: • Reducing the 80% shareholder continuity test to a greater than 50% test. • Eliminating the 60% test. • Treating a transaction as an inversion regardless of the level of shareholder continuity, if: - The affiliated group that includes the foreign corporation has substantial US business activities, and - The foreign corporation is primarily managed and controlled in the US. • Includes transactions where there is an acquisition of substantially all of the assets of a domestic partnership.


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Policy Responses Concerns with Administration Proposal • The Administration’s proposal would have unintended consequences. Some companies would plan around the rule by: - Sale of US companies’ business units (bite size expatriation) - Shifting management and control abroad, costing US jobs

- Other merged entities that cannot redomicile will face a competitive disadvantage compared to foreign-based rivals unless the US corporate income tax system is reformed. • The Administration’s proposal does not address US base erosion concerns that arise equally in non-inversion foreign acquisitions. - Another FY 2015 Budget proposal would limit US interest deductions of US companies that are part of global groups. The Joint Committee on Taxation estimates the proposal would raise $41 billion over 10 years. - The Camp and Baucus tax reform discussion drafts both include interest deduction limitation provisions within the context of comprehensive tax reform. ACT Report Corporate redomiciliations

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Policy Responses Concerns with Administration Proposal The Administration’s sec. 7874 proposal treats the symptom of a dysfunctional, noncompetitive US corporate tax system rather than the root cause, so the less visible economic costs would continue: • US leverage. Due to the high tax cost of accessing foreign cash, US multinationals increasingly rely on domestic borrowing to meet US cash needs, boosting the share of debt in their capital structures. • Loss of market share. US multinationals cannot access their foreign cash for US investment, R&D, dividends, etc., which is a “lock-out” cost that their competitors do not bear. This hinders the ability of US MNCs to grow. • Startups. When US entrepreneurs consider where to incorporate their businesses, increasingly they are advised to incorporate abroad. • Portfolio investment. When US shareholders decide whether to invest in a US- or a foreign-based MNC, other things equal, the foreign MNC is more attractive because it can distribute foreign income to US shareholders with little if any corporate-level repatriation tax. ACT Report Corporate redomiciliations

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