We have heard for years that our tax system has to be reformed to get rid of loopholes that major corporations use to avoid taxes and thereby create a fairer system for all taxpayers. Nothing has happened so far and, based on the current "do-nothing Congress," tax reform seems to be a dead issue at the moment.
Tax reform really became a public issue when major corporations started locating their headquarters in tax havens "offshore" (outside the U.S.), and in some cases the "headquarters" was nothing more than a post office box. But it worked and millions of dollars that should have been paid in U.S. taxes were avoided. The new way to accomplish the same thing is called a "corporate inversion."
In corporate inversions (also called "expatriation transactions"), a U.S. corporation becomes a wholly-owned subsidiary of a foreign corporation if it merges into the foreign corporation's subsidiary or transfers its assets to the foreign corporation. If the transaction is respected, U.S. tax can be avoided on foreign operations and distributions to the foreign parent, including payments of fees, interest and royalties.
Anti-inversion rules were added to the Tax Code in 2004 (under Code Sec. 7874) to address an inversion-related loophole, but they didn't stop the move toward inversions earlier this year, including Pfizer's attempted takeover of AstraZeneca or Medtronic's merger with Irish competitor Convidien.
Bills were introduced in the House and Senate this year that would bar companies from shifting tax residence offshore if their management and control and significant business operations remain in the U.S., but these bills have not advanced. In July, Treasury Secretary Jacob Lew sent a letter to members of Congress in which he described corporate inversions as "hollow(ing) out the U.S. corporate income tax base."
While acknowledging the desirability of comprehensive business tax reform to "improve the investment climate," Lew said there are concrete steps that can be taken in the meantime and that "we should prevent companies from effectively renouncing their citizenship to get out of paying taxes." He called on the Congress to "enact legislation immediately — and make it retroactive to May 2014 — to shut down this abuse of our tax system."
Meanwhile, Senators Jack Reed, Dick Durbin and Elizabeth Warren sent a letter to President Obama noting their efforts to pass legislation to eliminate tax breaks for inverted corporations, but they said their efforts "should not preclude executive action to prevent corporate inversions." They urged the President to use his authority "to stand up for American companies which are proud to be part of our nation and reduce U.S. incentives for other corporations which would abandon their responsibilities to their country for a nod of approval from Wall Street."