Tax Analysts Blog

Closed Mind on Open Borders

Posted on Aug 1, 2014

Could that venerable legal scholar, Judge Learned Hand, have been wrong lo these many years? In 1934, not long after the ratification of the 16th Amendment had definitively put to rest constitutional doubts on the federal government’s plenary power to tax income, Hand disabused those wielding that power of fanciful notions of appealing to patriotic commitment to amplify its impact. "Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes." Eight decades later, another legal scholar, the current occupant of the Oval Office, evidently disagrees.

Claiming that U.S. corporations seeking to invert offshore are "cherry-picking" their tax liabilities, President Obama exhorted them last week to refrain from inversions and instead embrace "economic patriotism." Presumably, shielding non-U.S. earnings from U.S. taxation is unpatriotic. After all, the tax liabilities that an inverted corporation “cherry picks” and undertakes to pay are no less than all those related to its entire earnings from U.S. operations.

To be sure, those earnings are vulnerable to stripping via questionable interest charges, royalty payments, and the like. But each one of those devices is equally available to any foreign-based multinational, not just inverted ones. In fact, many remain available even to a U.S.-based multinational -- that is, an uninverted one. Remedying earnings stripping calls for systemic reforms to the ability of any U.S. corporation, whether foreign owned or not, to deduct payments to related offshore entities. Focusing only on inversions in this context misses the forest for the trees.

There is, however, one unquestionable benefit that is properly attributable to an inversion—liberation of cash trapped offshore in controlled foreign corporations. Post-inversion, that money can be moved from a CFC to the new foreign parent, which can then put it to virtually any use, including buying back stock or making other investments in the U.S., without U.S. tax consequences. But for the inversion, any such onshore expenditures would have constituted taxable repatriations.

Is this "hopscotch" across U.S. taxing authority an abuse that rises (or, more aptly, sinks) to the level of an unpatriotic act? Before we judge, a few points merit mention.

First, note that the cash trapped in a CFC constitutes non-U.S. earnings. To the extent an inverted multinational attempts to bring that cash out from under the reach of U.S. taxation, the result can be viewed as simply renouncing worldwide taxation—albeit with retroactive effect.

Second, any alleged abuse remains limited to those instances in which that cash is brought back home. If the CFC were to spend the cash offshore, there would be no U.S. tax consequences, and more importantly, no allegations of abuse. It seems somewhat perverse to label as unpatriotic an outcome in which expenditures are made on- rather than offshore.

Finally, it is true that Congress has signaled its displeasure with inversions. It did so by enacting section 7874. But the legislation that contained section 7874, the American Jobs Creation Act of 2004, also added to the code section 965, which allowed U.S. corporations a one-time dividends received deduction for repatriating offshore profits. Rumors of another similar tax holiday persist. Clearly then, repatriating offshore profits at reduced, or even no, taxation is well within the realm of congressionally contemplated taxpayer actions—not exactly unpatriotic.

The Spanish Catalan cellist Pablo Casals once said, “The love of one’s country is a splendid thing. But why should love stop at the border?” Paraphrasing for our purposes here, why should a quest to stop U.S. taxing authority at the border amount to a betrayal of the national cause?

The republic has endured, without apparent ill effects, the tax-motivated expatriations of several scholars, athletes, entertainers, and entrepreneurs. Surely it can shrug off the tax-motivated inversions of a few pharmaceutical corporations.

Read Comments (3)

edmund dantesAug 2, 2014

Mr. Jones, that depends critically upon your definition of "full share." My
definition is "all that is legally required." Yours seems to be "everything you
have."

Characterizing one's following the requirements of the tax code as "desertion"
is silly.

Lee JonesAug 3, 2014

this is silly. of course, it is unpatriotic not to pay your full share.
deserters are usually shot.

Lee JonesAug 3, 2014

silly is what silly does. it's one thing to avoid (evade) u.s. taxes and park
money abroad. it's quite another to bring it back as if it's foreign money.
that's the end result of these inversions.

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