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What are Tax Inversions?

“Tax inversion” is the term used when a business incorporates or re-incorporates itself in a country with a lower tax rate. “The company reorganizes its structure so that the ‘parent’ element of the group is a foreign corporation rather than a corporation chartered in the United States,” a CRS report explains. Corporate entities use tax inversions to drastically lower their tax liabilities.

High Corporate Tax Rate

Tax InversionsCompanies often site the high corporate tax rate in the United States as the reason for tax inversions. The U.S. has the highest corporate statutory tax rate among developed nations. According to Trading Economics, the current corporate tax rate in the U.S. is 39%.

“Corporate Tax Rate in the United States averaged 39.23 percent from 2000 until 2015, reaching an all time high of 39.30 percent in 2001 and a record low of 39 percent in 2015. Corporate Tax Rate in the United States is reported by the Internal Revenue Service,” Trading Economics explains.

Difference between Corporate Tax Rate & Effective Tax Rate

Though the U.S. corporate tax rate is high, it is the effective tax rate (ETR) that companies actually pay to the government. The effective tax rate is the rate you reach after using all qualifying deductions and credits. According to Government Accountability Office (GAO), effective tax rates can differ significantly from the statutory rate.

GAO’s 2008 report on corporate tax liabilities found that nearly 55 percent of all large U.S.-controlled corporations reported no federal tax liability in at least one year between 1998 and 2005. “As a group, the 288 corporations examined paid an effective federal income tax rate of just 19.4 percent over the five-year period — far less than the statutory 35 percent tax rate. Twenty-six of the corporations, including Boeing, General Electric, Priceline.com and Verizon, paid no federal income tax at all over the five-year period. A third of the corporations (93) paid an effective tax rate of less than ten percent over that period,” a report by Citizens for Tax Justice reveals.

Why Companies Choose “Inversions”

Even though the effective tax rate is much lower than the corporate tax rate, corporate groups still choose “inversions” because the tax rate in some countries is very low. In Ireland, the corporation tax rate is 12.5% for trading income, and 25% for non-trading income. When you add deductions and credits, and the effective tax rate becomes even less.

Many high-profile companies, including Burger King, Pfizer, Applied Power, and Tyco International underwent the process of inversions to bypass taxes in the U.S. To curb inversions by corporate organizations, the government suggested closing loopholes in the tax code that allow inversions or completely overhauling the tax code.