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.
As companies have asked themselves that question, inversions have resurged. The strategy factored into one percent of overseas deals in 2011, but that rose to 66 percent this year. This uptick has led the strategy to be called “the hottest trend in mergers,” a label that’s remarkable given that the tactic was called “perhaps the hottest topic in U.S. tax circles” more than a decade ago. The vocal resistance to inversions right now "is similar to that back in 2002," says Jim Seida, a professor at the University of Notre Dame. Even though it’s a perennially hot topic, little has been done to banish it.
The inverted companies haven’t been the only group benefiting from the deals. In fact, many companies invert at the recommendation of investment banks like JPMorgan Chase and Goldman Sachs. Once one company listens to a bank, inversions can become contagious—their competitors often have no choice but to follow suit. Investment banks have made nearly a billion dollars in the last three years by advising companies to invert. (It’s worth noting here that these investment banks, whose actions are reducing the tax base, are the very same ones that were loaned hundreds of billions of dollars from American taxpayers not long ago.)
Inversions, and the revenue losses they bring, have gotten many talking about what can be done, in the short-run and the long-run, to limit them. One fix available to Congress would be further upping the required percentage of foreign ownership. Other possible remedies—including a regulation that would limit the amount of debt a company could hold and then use to get tax deductions—were brought to President Obama’s attention only when a Harvard Law School professor wrote about them in a publication called Tax Notes.
These fixes might temporarily ward off inversions, but their effects are likely to wear off in time. “Even if we get a fix for it, there’ll be a new strategy, new tactics for avoiding taxes,” says Boise. He frames tax law as an ongoing standoff between legislators and the people companies hire to plan around legislation. “This is very cyclical,” he says in reference to 2014’s similarities with 2004. “It’s like playing Whack-a-Mole.”
“I think we should avoid that temptation [to do something now just] because it feels good to do something,” Desai says. According to him, the inversions we’re seeing now are simply the unanticipated effects of the legislation passed in 2004. Increasing the requirements on foreign ownership, then, might be a salve that not only would be temporary, but would also open up problematic possibilities down the line. “You will have made things worse because [then you’ll] have larger foreign acquirers who are going to be more interested in relocating activity away from the U.S.”
“What’s more profitable,” Desai goes on, “is to take a whack at significant reform.” The underlying reason why companies are so eager to relocate is that our tax rates are higher than those of other countries—yes, countries like Bermuda, but also the UK and Japan. If corporate tax rates were lowered here, that would remove what has been the impetus for decades' worth of inversions. Of course, lowering corporate taxes would only be reasonable if that lost revenue could be made up in full elsewhere. Taxing entities like master limited partnerships and real-estate investment trusts, for example, could take care of a lot of this, even though implementing that would be politically difficult.
Since the early 2000s, Stanley has been largely out of the spotlight. The company most recently made news when, back in 2010, it merged with Black & Decker. But there have been stirrings suggesting that the company hasn’t entirely forgotten why it found a relocation so appealing; an industry publication reported last year that Stanley was mulling a merger with Tyco, which is based in Switzerland (an outcome of Tyco's own inversion back in 1997). Maybe there’ll be a short-term fix that would bar Stanley, and others, from such a merger, but until something lasting is done to keep the attention of corporations on the U.S., their eyes will continue drifting overseas.
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