The Acquisition of Foreign Companies to Avoid US Taxation
According to the Organization for Economic Co-operation and Development (OECD), the United States has the third highest tax rate when you take into consideration the top thirty-five industrialized nations. With tax rates reaching as high as 39%, American companies are trying to find alternative ways to avoid taxation. It’s pretty simple; the American company buys out a small foreign company, and the foreign company becomes the new headquarters of the cooperation, at least in the documentation. Then from there, the corporation is taxed under the new countries rules. The company itself isn’t changed all that much, just the address on the official documents is altered. The company therefore still gets to enjoy all the benefits of being and American company such as the laws, research and development, access to the US markets, enforcements of patents and intellectual property and the American workforce.
Is it Really That Easy?
Now, if it were that easy, everyone would be doing it. There is always a catch. This method only changes the tax rates for the profits earned in the foreign country. So, if they are still paying the same US taxes for the profits earned in the US, which, unless they actually changed their business plan, is essentially all of their profits, why was the acquisition of a foreign company beneficial? Of course, there is always a way around everything in accounting.
Accountants or Magicians?
I have a professor who always says “tell an account what numbers you want and they will get you there.” The same concept of number manipulation is used in corporate inversion. No, they are not magic, but any successful accountant will certainly know how to work the system. There are a few different methods companies use in order to move the profits from the US based company to the foreign company. One way to achieve this is when the newly acquired foreign company makes a loan to its parent company back in the US at a high interest rate. This is called earnings stripping. When the US Company pays out the interest expense to the foreign company, its profits drop (Profits = revenues – expenses), and the foreign companies’ profits rise. However, since they are all owned by the same company, the company as a whole is not losing or gaining any money off of its net profits. When it comes time for taxes nonetheless, the US based company now has less profit to be taxed on, and the money has been legally moved into the foreign company with a lower tax rate. Kind of sneaky, kind of tricky, but as of right now, it is one hundred percent legal.
Should America Do Something?
With the projection of twenty to forty billion dollars lost in US taxes in the next 10 years according to Congress’s Joint Committee on Taxation, it is pretty clear that America should do something to get at least some of that money back. The money lost is affecting the middle class families. The money could have been used towards buildings or roads, creating jobs or opportunities for Americans, making college more affordable, bettering the education system, or creating jobs but because of the loophole of corporate tax inversion these opportunities are lost. The only problem is, the Republicans and the Democrats cannot come even close to agreeing on what should be done or how the problem should be addressed.
The Republican Party believes that America should only tax their corporations on economic activity that occurs within the borders like the rest of the G8 countries (Canada, France, Germany, Italy, Japan, Russia and the United Kingdom). However, this raises concerns for the Democratic Party that companies will continue to use the power of legal accounting manipulation, to stay in the lowest tax jurisdictions as well and distributing profits back to shareholders, such as paying dividends, so they can avoid taxation as well. Both sides do agree that corporate tax rates need to be lowered.
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