Tax Inversions

Here are some reasons why you should know about Tax Inversions

Tax inversions have been in the news recently due to a number of high profile corporate tax inversions, which have led the US Treasury Department to impose tough new rules to limit the number of inversions. Examples of recent tax inversions are Burger King relocating its domicile to Canada after acquiring Canadian corporation Tim Hortons and Medtronic moving its domicile to Ireland after acquiring Covidien, an Irish corporation. US pharmaceutical giant Pfizer Inc was pursuing the acquisition of Allergan PLC, an Irish company, in order relocate its domicile to Ireland. That move has now been put on hold due to the Treasury Department’s new rules.


A corporate tax inversion is the relocation of a company’s domicile from one country to another in order to reduce the tax burden on income earned abroad. It is important to point out here that relocating its domicile does not equate to relocating its operations- the corporation can continue to carry out its operations in much the same manner as it did before the inversion; the only difference being that it is now subject to the laws of the new country of domicile rather than the old one. Reducing it’s tax burden this way can be hugely beneficial for a corporation- Elizabeth Chorvat, a Visiting Assistant Professor at the University of Illinois, has shown that between 1993 and 2002 inversions generated statistically and economically significant excess returns of 224.7% in the years following the inversion transaction.[1]


The chief reason inversions are such an attractive proposition for US multinational corporations (MNCs) is that the US, which operates a worldwide tax regime, is increasingly out of step with other industrialised countries, which use a territorial tax system.[2] Under the US worldwide tax regime income originating outside the US is taxed when those earnings are repatriated. Under the territorial tax system employed in other industrialised countries such as Canada, Germany, Japan and the UK, the residence country taxes only active business income earned within its borders. Foreign-owned MNCs are therefore able to significantly reduce their US tax liability on US operations compared with their US MNC competitors.[3] US MNCs therefore face a competitive disadvantage in comparison with their foreign-owned peers.


The failure of Congress to enact comprehensive tax reform to address this has led many US MNCs to undertake inversions. Bret Wells, Associate Professor of Law at the University of Houston Law Centre, has argued that faced with this situation it is no surprise that company directors, who have a fiduciary duty to maximize returns to their shareholders, choose to opt for inversions.[4] He quotes the decisions in Gregory v Helvering (1935)[5] and Commissioner v Newman (1947),[6] two prominent court decisions that say there is nothing wrong with arranging one’s affairs so as to keep taxes as low as possible and that nobody owes any public duty to pay more taxes than the law demands.


The problem with inversions, however, is that they erode the US tax base and put other US corporations at a competitive disadvantage.[7] After inversion most MNCs engage in earnings stripping, a practice in which foreign-based corporations avoid paying US taxes by artificially shifting their profits out of the US. They do this by having a US subsidiary pay interest on a loan from a subsidiary in another country, typically a low-tax country. The US subsidiary lowers its taxes in the US by deducting the cost of its interest payments and the foreign subsidiary owes little or no tax on those interest payments- it’s a win-win for the inverted MNCs.[8] This win, however, comes at the expense of other US corporations. Treasury Secretary Jack Lew argues that many MNCs that opt for inversion continue to enjoy the benefits of being based in the US including access to US markets, the rule of law, patent and intellectual property enforcement, support for research and development, infrastructure and a skilled workforce even though these inverted MNCs shift a greater tax burden to other businesses and American families.[9] The Congress Joint Committee on Taxation has said that inversions will cost the US Treasury over $40 billion in the 10 years between 2015 and 2025.[10]


The problems associated with inversions led the Treasury Department to bring in new rules, in April 2016, that make it more difficult and less lucrative for corporations to exploit the inversions loophole. Although these new rules will reduce the number of inversions, only legislation passed by Congress can get rid of inversions completely. The time is long overdue for Congress, not just to get rid of inversions, but also to comprehensively reform the US tax system in order to make it more efficient and effective.


[1] Elizabeth Chorvat, Expatriations and Expatriations, A Long-Run Event Study (September 20, 2015). U of Chicago, Public Law Working Paper No. 445. Available at SSRN: or [2] ibid [3] Bret Wells, What Corporate Inversions Teach About International Tax Reform, Tax Notes, June 21, 2010, p. 1345, Doc 2010-11447, 2010 TNT 119-5 [4] Bret Wells, Cant and the Inconvenient Truth About Corporate Inversions, Tax Notes, July 23, 2012, p.437 [5] Gregory v Helvering, 293 U.S. 465 (1935) [6] Commissioner v Newman, 159 F.2d 848, 850-851 (2d Cir. 1947) [7] Jeffrey Zients & Seth Hanlon, The Corporate Inversions Tax Loophole: What you Need to Know, The White House Blog, April 8, 2016, [8] ibid [9] US Department of Treasury, “Treasury Announces Additional Action to Curb Inversion, Address Earnings Stripping”, April 4, 2016, [10] Congress Joint Committee on Taxation, Memorandum on Revenue Estimate Request for H.R 415,

financial crisis

Restoring Confidence in the US Banking System

Considering the 2008 financial crisis, how can the US restore confidence in the US banking system?


The Global Financial Crisis of 2007-2009 had a profound effect on US and global financial markets and destroyed confidence in the banking systems in the US and other major economies. It caused a global economic recession and resulted in massive bailouts of US and other financial systems, and the global economy is only just recovering from the effects of this crisis.


The crisis highlighted weaknesses, in the US banking system, which will require a combination of different measures in order to be addressed. Among the myriad issues highlighted by the crisis the biggest issue is, arguably, the need to address the systemic risks inherent in the banking system.


The systemic risks inherent in the banking system have been widely discussed in the aftermath of the crisis. Systemic risk arises in the banking system because of the potential for the failure of one bank or financial institution to affect other banks or financial institutions to such an extent that those other banks also face financial problems or even failure as well. Banks are connected to each other through the payments system and the financial system, and if a bank faces difficulty meeting its obligations to other banks this could, in turn force those other banks to face difficulty fulfilling their own obligations thus triggering a chain of bank failures. The risk posed by this ‘interconnectedness’ of banks to each other is currently the biggest headache for bank regulators around the world.


Restoring confidence in the US banking system requires properly addressing this systemic risk. There are two aspects to this. The first is ensuring that banks are well capitalized and well run so that they are resilient and do not run into financial problems. The second is ensuring that when banks run into financial problems there are efficient, well laid out plans for dealing with those banks so that the problems do not spill over to other banks or the wider banking system.


Ensuring that banks are well capitalized and well run requires the type of comprehensive, far-reaching regulation that can be found in the Obama administration’s Dodd Frank Act 2010. The legislation improves the overall structure of bank supervision in the US, closes loopholes in banking regulation, protects consumers and provides the US authorities with the tools they need to manage future financial crises. Despite this progress that has been made there remains more to be done to restore confidence in the US banking system. The banks themselves are already failing to live up to the new standards set by the regulation- in 2015 some of the biggest US banks struggled to pass the Federal Reserve’s ‘stress tests’. Goldman Sachs Group Inc, Morgan Stanley and J.P Morgan Chase & Co had to make adjustments to their capital buffers, while Bank of America Corp had to submit a revised plan, addressing its shortcomings, to the Federal Reserve.

Stress tests are used by regulators to determine whether a bank has enough capital to withstand the impact of unfavorable or adverse scenarios such as a deterioration in global economic conditions. The fact that some of the largest US banks are struggling to pass stress tests is worrying and should serve as a wake-up call to the banking industry to put its house in order.


Ensuring that there are efficient plans for dealing with banks that do run into financial problems has become another top priority for regulators in the aftermath of the crisis. It is unrealistic to expect that banks will never face financial problems and bank failures can always be prevented. The more responsible view is that there will be some banks that run into financial problems and there has to be a way to deal with such banks so as to avoid the problem spreading to other banks and thereby adversely affecting the banking system. This is the reason regulators have embraced the idea of Recovery and Resolution plans (also referred to as ‘living wills’) for banks.


Dealing with failing banks in an efficient manner can also help to avoid bank bailouts whereby taxpayers’ money is used to rescue struggling banks. Bank bailouts encourage what economists refer to as ‘moral hazard’, a situation where one person or institution takes more risks because it knows someone else will bear the costs of those risks. There are, however, signs that the banking industry is not taking the issue of recovery and resolution as seriously as the regulators- the Recovery and Resolution plans of five of the largest US banks were rejected by the Federal Reserve and the FDIC because the regulators were not convinced they would ensure an orderly and efficient resolution of those banks if they faced financial difficulties. J.P Morgan Chase & Co, Wells Fargo & Co, Bank of America Corp, State Street Corp and Bank of New York Mellon Corp have been given until October 1 this year to re-submit revised plans that convince the regulators that their Recovery & Resolution would not require tax-payer funded bailouts.


Tackling systemic risk is the key to restoring confidence in the US banking system, and this involves all stakeholders playing their part. The regulators have increased the level of supervision of the banking industry after the crisis and the onus is now on the banking industry to show that it recognizes, and is prepared to deal with, the systemic risks in the banking system. If the banking industry fails to get its act together then there is a greater likelihood that there will be another major financial crisis. It is, therefore, important for the banks to ensure that, at a minimum, they are complying with both the spirit and the letter of the new regulatory rules.