Acquisition transaction reporting is incomplete, inaccurate
Corporate tax deserters, tax traitor, economic patriotism: We have heard these terms many times in recent weeks. The criticism has been rather direct and intense. The past month or two has seen several more inversion announcements by U.S. corporations in addition to statements by administration officials and members of Congress to limit the use of the strategy.
There are always two sides to any story; often, only one side gets all of the attention. There appears to be a lot of noise limiting the appreciation of the facts of the current corporate tax environment regarding such tax planning. The key is to have all the facts so a proper analysis can be provided. In many cases, the recent reporting of the acquisition transactions hasn’t reported the resulting tax consequences completely or accurately.
Some of the reporting and comments in Washington seem to imply that businesses would undertake a significant financial and business transaction solely for tax benefits. Based on my 30-plus years of business experience, I seriously doubt any corporation would acquire another corporation and/or engage in an inversion transaction solely to lower their tax rate.
If the acquisition has strategic and long-term value for the acquirer, then tax planning can be considered as to best structure of the acquisition or merger transaction for the affected shareholders and the corporation.
I have used the comparison in my own conversations to a situation of utilizing the like-kind exchange rules in the tax code to defer gain recognition and taxes on real estate transactions. One doesn’t use the like-kind provisions unless there is a viable business transaction to acquire the new property. The economics and commercial rationale must justify the transaction, not the tax consequences. Likewise, corporate boards are obligated to consider the strategic business reasons and impact for shareholder value for engaging in an acquisition or merger transaction.
There tends to be confusion of the actual tax impact of inversion transactions. First, the U.S. operations of the converted companies continue to be subject to U.S. federal and state taxes after the transaction. The inverted companies still have U.S. operations, and those operations remain in the U.S. tax regime. U.S. corporate taxes may be reduced going forward as a result of post-transaction tax planning.
However, what many are missing is that most of the recently announced transactions are taxable transactions to U.S. shareholders of the corporation that is seeking to invert. There is an upfront tax cost to shareholders to allow the corporation to reduce its corporate taxes over time. Federal and state governments benefit from this additional tax revenue.
The Joint Committee on Taxation provided Congress in May with estimates of the impact of changing the inversion tax rules. The JCT estimated the Federal government would generate $19.5 billion over 10 years in additional corporate tax revenues. Another way of stating it is that the current law will cost $19 billion over the next 10 years if it isn’t changed or modified significantly.
This amount is rather small when compared to the April 2014 Congressional Budget Office estimate of corporate tax revenue over the next 10 years of $4.5 trillion. So $19 billion out of $4.5 trillion doesn’t seem to mean the end of the world as some comments have indicated. Even if the $19 billion amount is understated, there is a large corporate tax revenue base that remains in the U.S., even with inversions.
It appears the JCT estimates on inversion tax revenues didn’t consider the additional capital gains taxes of individuals who are shareholders of these corporations. I recently looked at the quoted market value of four of the companies that announced deals in June or July of this year. I then analyzed what a hypothetical tax result might be for capital gains tax revenue. The combined market value of these companies is approximately $170 billion. The stocks have had a run up in value in the past year or two. For purposes of discussion, let’s assume 20 percent appreciation is represented in the market value and is the resulting gain by the shareholders. That is nearly $35 billion of hypothetical taxable gain, and using a 20 percent tax rate on the gain (a blended rate of the short- and long-term capital gains tax rates as well as the 3.8 percent Medicare net investment tax) results in approximately $7 billion of hypothetical tax revenue.
There have also been recent acquisition transactions by already inverted companies of U.S. targets. I looked at the cash components of two of those deals (these deals are a combination or cash and stock, and the cash component is generally taxable to selling shareholders). Using the cash proceeds as a proxy for any gain, this results in an additional $10 billion of gain taxed at 20 percent, or $2 billion of hypothetical tax revenues. These two amounts of additional shareholder tax result in $9 billion of additional hypothetical revenues to the U.S. Treasury.
So, this revenue is an actual current benefit to the U.S. Treasury of nearly half of the projected revenue loss for the next 10 years. There has been some reporting of the shareholder taxes that will flow into the government coffers, but it certainly hasn’t received the same headlines as the deal announcements and Congressional and administration comments.
We have discussed in past columns the concern by many that the U.S. tax regime is uncompetitive compared to our trading partners. The last major corporate tax rate overhaul was the Tax Reform Act of 1986. At that time, the U.S. was the leader in reducing corporate tax rates. Now the U.S. is the laggard. Congress passed the current rules on tax inversions in 2004, and the tax results in 2014 are precisely determined by what was placed into the 2004 law.
Congress can change the law it passed 10 years ago. Congress now has a great opportunity to take on corporate tax reform and modify the inversion issue along with other uncompetitive features tin the tax code. There have been several comprehensive proposals in recent years, but nothing has advanced to being seriously considered. A lame duck session later this year could allow for constructive tax reform, though not many are counting on it.
Bill Roth is a tax partner with the local office of accounting firm BDO USA LLP. The views expressed are those of the author and are not necessarily those of BDO. The comments are general in nature and not to be considered specific tax or accounting advice and cannot be relied upon for the purposes of avoiding penalties. Readers are advised to consult with their professional advisers before acting on any items discussed herein.