So what is a corporate inversion, and why are so many companies moving their parent company to Ireland? It all revolves around Ireland’s favorable tax policies and the U.S.’ antiquated corporate income tax system. While most countries require their citizens (i.e., real people) to pay tax on their worldwide income, few countries require the same of corporations outside of the U.S. After all, corporations can move. And that’s just what Medtronic and others are doing to avoid the onerous corporate tax regime of the U.S. government.
The use of a corporate inversion is the same strategy that put Google and Apple in the news in 2013 and had President Obama accusing these and other companies doing corporate inversions of being “unpatriotic.”
In September 2014, Medtronic announced that it would borrow $16 billion to acquire Covidien PLC in Ireland instead of using it’s own cash. On the same day, Salix Pharmaceuticals announced that it was abandoning its efforts to acquire Cosmo Pharmaceuticals and move to Ireland. What do these two announcements have in common and why is Ireland such a great place to be?
Both Medtronic and Salix changed their plans as a result of the U.S. Treasury issuing new regulations limiting the use of corporate inversions to avoid U.S. corporate income tax.
When a company is incorporated in the U.S., the U.S. asserts tax on its 100% of its income throughout the world. Simply by converting its parent company to an Irish company, a company can avoid paying U.S. tax on what they earn outside the U.S. For a giant medical device company like Medtronic, this could save billions of dollars in corporate income taxes. Effectively, the acquired company becomes the primary entity and the acquiring company ends up being a U.S. subsidiary of the foreign company. Hence the term “inversion.” The acquiring company inverts and becomes the subsidiary of the new foreign parent company.
When Medtronic first announced its decision to acquire Covidien, the tax rules suggested that they could use cash from their foreign units to purchase the Irish company. Since then, everyone has heard the uproar over companies “defecting” to other countries, especially Ireland. Somehow, the President and other politicians have it in their minds that a company that is currently headquartered in the U.S. owes a patriotic duty to pay tax on 100% of its income, no matter where it is earned.
If it were to remain a U.S. company, Medtronic conceivably could earn 90% or more of its money overseas and still have to pay tax on 100% of those earnings in the U.S. And then add to that tax imbalance, the U.S. has one of the highest corporate tax rates in the world (plus a double tax on dividends). And surprise, surprise, you have companies deciding to leave?
Of course, no U.S. company wants to leave the U.S. in its entirety. They simply want to avoid tax on earnings that have little or nothing to do with the U.S. The easiest way to do this is through the corporate inversion. A company simply purchases another company in a low-tax country like Ireland, and then makes the acquired company the parent. By doing so, the company becomes an Irish company, not a U.S. company, and it doesn’t have to pay U.S. tax on any income earned outside the U.S.
Just like Google and Apple before it, Medtronic thinks it’s a good idea for its shareholders to pay less tax. It especially doesn’t want to pay the high U.S. tax rates on income earned outside the U.S.
The reality is that all of these companies pay a lot of corporate income tax. The smart ones, with the best tax advisors, simply have found a way to only pay U.S. tax on U.S. income. How unpatriotic is that?
Tom Wheelwright, CPA and CEO of ProVision, is a leading tax and wealth expert, published author (Tax-Free Wealth) on partnerships and corporation tax strategies, and a Rich Dad Advisor/Speaker for Robert Kiyosaki, who wrote Rich Dad Poor Dad. Tom is best known for making taxes “fun, easy and understandable,” and specializes in helping entrepreneurs and investors build wealth through practical and strategic ways that permanently reduce taxes. He has been on the Real Estate Guys Radio Show, Money Radio 1510 Business for Breakfast and frequently speaks at Rich Dad conferences worldwide.