The U.S. has attempted to curb the practice, with little success, and it’s become a sensitive political issue with a presidential election less than a year away.
WASHINGTON — Pfizer and Allergan are pursuing the biggest buyout in health-care history, a $160 billion deal that would essentially send one of the biggest U.S. corporations overseas, or at least its legal domicile and main executive offices.
Under a maneuver known as an “inversion,” Pfizer will be able to lower its corporate tax load by reorganizing as a company in Ireland, which has a lower tax rate.
The United States has tried to curb the practice, with little success, and it’s become a sensitive political issue with a presidential election less than a year away.
Some things to know about corporate inversions:
1. What is it?
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An inversion happens when a U.S. corporation and a foreign company merge, with the new parent company based in the foreign country. For tax purposes, the U.S. company becomes foreign-owned, even if all the executives and operations stay in the U.S.
2. Why invert?
There can be many business reasons for two companies to merge. The decision to incorporate the new parent company in a foreign country can generate significant tax savings over time.
The U.S. has the highest corporate income-tax rate in the industrialized world, at 35 percent. The U.S. is also the only developed country that taxes corporate profits earned abroad.
Foreign profits are subject to U.S. taxes once they are brought to the U.S., though corporations can deduct any foreign taxes paid.
Companies that become foreign-owned don’t have to worry about the Internal Revenue Service trying to tax the profits they make abroad.
Most U.S. corporations pay federal income taxes at rates much lower than 35 percent because the tax code is filled with breaks for businesses. Inversions open the door for even more.
3. What is earnings stripping?
Inverted corporations must still pay U.S. taxes on the profits they earn in the U.S. However, they can lower their U.S. tax bills through a maneuver called “earnings stripping.”
Here is how it works: The new foreign parent company “lends” money to the U.S. firm, which must pay it back. The U.S. firm then deducts the interest payments it makes to the parent company, reducing its taxable profits — “stripping” them from its balance sheet.
“You haven’t raised any new money,” said Robert Willen, a New York-based tax adviser. “All you’ve done is literally out of thin air, you’ve created a debt obligation on which the U.S. company is the debtor and the foreign parent is the creditor.”
4. What is hopscotching?
Many U.S.-based corporations are hoarding money overseas, either to invest abroad or to shield it from U.S. taxes. Experts say the total amount could exceed $2 trillion.
If a foreign subsidiary sends profits directly to a U.S. corporation, the U.S. firm must pay taxes on it. However, if those profits are funneled through a foreign parent company that was formed through an inversion, the money can be invested in the U.S. without paying U.S. taxes.
The technique is called “hopscotching” because the money — at least on paper — bounces from country to country while avoiding U.S. taxes.
5. How big is this issue?
About 50 U.S. companies have inverted in the past decade, and more are considering it, according to the nonpartisan Congressional Research Service.
Several Democrats in Congress have announced bills to make it harder for U.S. corporations to invert. President Obama has renewed his push to limit the strategies. .
Key Republicans say the only way to adequately address inversions is to overhaul the tax code, making it more attractive for businesses to locate in the U.S.