The Tax Dodge That Has Plagued the U.S. for More Than a Decade

And why it keeps resurfacing
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Oh, inverted world (flatworldsedge/Flickr)

A little more than a decade ago, a company called Stanley Works was considering moving to Bermuda in order to save some money. Stanley, a tool-manufacturing company, had done some calculations, and figured out that it could save about $30 million per year in U.S. taxes by ditching its Connecticut headquarters. The decision seemed fairly clear-cut, as they’d be lowering their costs. But Stanley was also eyeing Bermuda because two of their biggest rivals—Cooper and Ingersoll-Rand—had just gone foreign, and it was getting harder to compete with them.

Certain members of the government were outraged at the idea. “They escape from millions of dollars of federal taxes. That’s wrong,” said Senator Chuck Grassley, as he proposed legislation that would prevent Stanley from leaving Connecticut. “Our bill requires the IRS to look at where a company has its heart and soul, not where it has a filing cabinet and a mailbox.”

Facing pressure from Grassley and others, Stanley peered into its heart and soul, or at least into the eyes of its public-relations team, and decided to step back. In what appeared to be a win for Congress and U.S. taxpayers, Stanley would keep doing business in Connecticut. The company said that it decided to stick around because Congress had shown that it was ready to start a tax-reform process that would make a move to Bermuda unnecessary. As a coda, in 2004, legislation was passed that made it more difficult to reincorporate abroad. (Stanley, for its part, survived, and is still headquartered in Connecticut.)

But now, 12 years later, it appears that only the nouns have changed. Walgreen (the company that owns Walgreens stores) was, a month or so ago, considering moving to Switzerland for the same reason that had inspired Stanley to explore Bermuda. It could save around $800 million per year by ditching Illinois for Western Europe. If Walgreen relocated, it could leave CVS, its Rhode Island-based competitor, in the dust.

Stepping in to fill in the Mad Libs blank for “irritated congressperson” this time around was Representative Sander Levin, who called corporations’ behavior “neither unusual nor surprising” as he proposed a bill that would prevent companies like Walgreen from fleeing. Walgreen’s plan seemed especially egregious in light of the fact that a quarter of its $72 billion in revenue in 2013 came from the U.S. government, in the form of Medicare and Medicaid. So, after several assaults on its patriotism, Walgreen caved. It said it wouldn’t be going through with a relocation.

Walgreen’s decision should please people who pay taxes in this country, since it relieves them of having to make up for the billions of dollars the company was going to stop paying to the IRS. But in the majority of the 19 cases announced since early 2013 in which companies have pondered this variety of international relocation, Americans haven’t been so lucky.

The strategy that Walgreen and Stanley were considering—and that scores of other companies have actually gone through with—is called “inversion.” The (entirely legal) maneuver gets its name from the corporate backflip that’s involved: A large U.S. company finds a smaller company based in a country with taxes lower than the U.S.'s, buys that company, and then claims that this smaller company owns it.

Because the new “parent” company is based abroad, the “subsidiary”—the original American company—is exempted from paying hundreds of millions of dollars to the U.S. government, even if the majority of its business is still done in the U.S. Ultimately, the company gets all the perks of doing business in the U.S.—intellectual property protections and federal research funding are just two—with few of the costs.

Opinions on whether this strategy is ethical divide along predictable lines. “Everyone seems apologetic about inversions. I’m not,” said one CEO involved an inversion deal. “I don’t think there’s anything to apologize for.” Commentators not running corporations, on the other hand, have said it’s madness: “It’s the equivalent of…getting a tax deduction for moving money from your right pocket to your left,” wrote David Cay Johnston, who reported on taxes for The New York Times in the Stanley era.

The logistics of inversion before 2004 differ from those of the deals done today. Back then, establishing offshore headquarters didn’t require a parent company abroad, so U.S. companies could simply relocate themselves. “You move some paper…You get a post-office box in a tax haven, and it works,” says Mihir Desai, a professor at Harvard Business School. That strategy was relatively easy to restrict, Desai says, and inversions died down after 2004’s legislation.

But if the mechanics of inversions have changed, the spirit hasn’t. The legislation placed requirements on how much of a company’s ownership needed to be foreign in order for it to qualify for a relocation. This edict, explains Craig Boise, dean of the Cleveland-Marshall College of Law, was hard to comply with at the time it was hammered out. But since then, other countries’ economies have developed, making international mergers more appealing. “Now, with the increased business case to be made for some of these cross-border mergers, it kind of reopens the chance to go back and say, ‘So, what were those requirements again?’" he says.

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Joe Pinsker is an assistant editor at The Atlantic. He has written for Rolling StoneForbes, and Salon.

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