Tax Analysts Blog

Yep, Son, We Have Met the Enemy

Posted on Aug 29, 2014

After Ronald Reagan reduced him to a lame duck, Jimmy Carter signed the Omnibus Reconciliation Act of 1980 into law. Subtitle C of Title XI of that legislation, which has come to be known as the Foreign Investment in Real Property Tax Act, was sponsored by no fewer than 49 senators from both sides of the aisle, and as many as 151 members of the House, also cutting across party lines.

What brought legislators together in this remarkable show of bipartisanship during the rancor of a general election campaign? A perceived loophole allowing foreign persons -- individuals and corporations -- to escape tax on gains from disposition of U.S. real estate. To be sure, foreign persons were exempt from tax on all capital assets. But the potential for abuse lay in a foreign person’s ability to use a real estate asset in a trade or business, claim excess deductions, wind up the trade or business, and then sell the asset with no tax on the resulting gain. Congress’s remedy for this was FIRPTA, which subjected to tax all U.S. real property interests, including those held in corporate form.

The breadth of that remedy reveals the legislators’ true motivation. It wasn’t the narrowly identified tax planning technique that animated most members of Congress; what truly worried them was the specter of vast chunks of domestic real estate falling under foreign ownership. Congressional action merely reflected a larger national sentiment that persisted well after FIRPTA first appeared on the books. Nearly a decade later, William F. Buckley mocked that sentiment in a December 1989 column in the National Review headlined “The Japs Capture Rockefeller Center.” Two months earlier it had been announced that Mitsubishi Estate Co. Ltd. would buy a majority stake in the Rockefeller Group, owner of Rockefeller Center and other landmark Manhattan properties. The intricacies of international commerce are messy. It is much easier to reduce them to a portent of national calamity: “The Japanese Are Coming, the Japanese Are Coming!”

Fast forward to 2014. We are now crying wolf not over an impending invasion but a brewing decampment: “Walgreens Is Leaving, Burger King Is Leaving!” Again, the details are a little more complex than the simple-minded narrative of corporate desertion dominating the news media. Burger King, for example, is majority owned by 3G Group, a Brazilian private equity firm. “The Brazilians Are Leaving, the Brazilians Are Leaving"?

As with FIRPTA, inversions confront us with a well-defined hazard for abuse -- in this case, earnings stripping. Also as with FIRPTA, we can be sure that any attempted solution will, instead of tackling that discrete issue, pander to the whipped-up hysteria. In fact, Congress already tipped its hand in 2004 when it enacted section 7874. That legislation squarely targets “Expatriated Entities and Their Foreign Parents,” but it makes no attempt at curbing the distinct and systemic problem of earnings stripping.

FIRPTA is universally acknowledged as bad legislation motivated by bad policy. It sought to raise barriers to keep foreign capital out. Three decades later, legislators are exploring ways to reform its provisions to invite offshore funds to invest in undercapitalized sectors, including the creaking U.S. infrastructure.

With inversions, the temptation is to raise barriers to keep domestic corporate charters in. Yielding to that temptation will mean more cash being trapped offshore. And fairly soon, legislators will be exploring ways, as indeed some already are, of inviting that money to invest in undercapitalized sectors, including, you guessed it, the creaking U.S. infrastructure.

It turns out that the enemy in the ‘80s was not the pools of offshore money ready to descend on onshore real estate. Nor will the enemy this time be the many offshore tax havens ready to shelter departing onshore companies. The enemy, as always, is closer to home.

A related article will appear in next week’s Tax Notes International

Read Comments (2)

Lee JonesAug 28, 2014

Unlike with real estate, nothing real changes when a company moves its HQ.
This is a race to the bottom. Of course, we have to stop it. So what if we
use hysteria to do it?!

Michael KarlinSep 1, 2014

The problem we have with inversions, and indeed with many other U.S. tax laws,
is that we insist on all or nothing solutions. We insist on a company founded
in the United States being treated as entirely American, and therefore subject
to the full rigors of our tax laws, even if it is majority owned and financed
by foreign persons and a majority of its business activities are conducted
abroad. We need a more subtle, more workable approach than our monstrous CFC
and foreign tax credit rules, especially if we want to attract foreign capital
into the United States and to encourage U.S. entrepreneurs to spread their
creative wings abroad. The hysteria about inversions simply ignores reality.

Lee Jones: You're right that nothing really changes - including the taxation
of U.S. earnings. Inversions are about U.S. multinationals' foreign income,
not about their U.S. income. While concerns about earnings stripping put a
legitimate dent in that argument, the answer is to attack earnings stripping,
not trap companies in the United States or tax their foreign income so heavily
that their ability to compete abroad is hamstrung.

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