Tax Break

John Fisher, international tax consultant

Archive for the tag “internal revenue code”

Taking the mojo out of inversions

By now, everybody has heard of the aborted takeover of  British pharmaceutical firm AstraZeneca by US giant, Pfizer. The latest in a series of US corporate inversions, the new corporate structure was  to be headed by the smaller UK company, thus largely spiriting the merged group beyond the lascivious tentacles of the US Internal Revenue Service.

Fascinated by the subject, I trawled  the quality press and professional literature for relevant articles. As I will explain later, despite the extensive coverage of the topic, I was utterly frustrated by the universally poor standard of reporting. The experience brought back vivid memories of  my first fresh-off-the-production-line car.

Twenty-five years ago, I took delivery of a sparkling white  Austin Montego. To be precise, by that stage in Austin’s long and painful decline as part of the government-owned British Leyland, it was simply a Montego: an orphaned car, no make or mark  willing to admit parenthood.

The ultimate driving machine

The ultimate driving machine

I think I realized there was something wrong when I first clapped eyes on it. Arriving at the delivery point, and after completing the relevant paperwork, I was confronted with a neat row of identical vehicles. I noticed that one of the newborn had a white spot of paint disgracing the otherwise pure black bumper. I prayed but to no avail. That was my car. A black blob hurriedly splashed onto the offending area, the car was soon heading for home with yours truly at the wheel. By the time I reached our car park, the driver’s mirror had fallen off the windscreen. By the end of the 12 month guarantee period the car was on its fourth alternator. Driving the Montego made me imagine piloting a Spitfire in the Battle of Britain. Before the car was finally towed away for the last time from under our house some twelve years later, anything that was not bolted to the exterior had fallen off and the lining of the ceiling had sagged down as far as the dashboard, giving the impression that the car was a mobile bordello.

Some years later I saw a documentary about the, by then defunct,  factory where my car was built. A group of former production-line workers sat in the pub explaining how it all worked. It turned out that, if someone was sick, late for work or needed a pee, the production line did not stop. When it got to fitting their part, either one of the other workers  did a rush job or, if the part was not considered critical by the professors manning the production line, it would simply be omitted. This was related without humour or bitterness – just that confident matter-of-factness that is the mark of the unmitigated moron.

Which brings me to my point.

Financial journalist phoning in his copy

Financial journalist phoning in his copy

Every single article that I read about US corporate inversions (and there were many) had critical parts missing or not properly connected to each other, resulting in the whole being incomprehensible (even after trying to put the jig-saw puzzle of articles together with all the pieces laid out on my dining table).  Had the articles been my Montego, by the time I got home on that first day I would have been driving an engineless go-kart .

The thinking behind inversions is that, since US corporate tax is punitive and there are loads of  planning schemes on how not to pay tax on unremitted income from abroad – there is a clear advantage in a US group having its parent company in a convenient jurisdiction beyond the shores of the United States. Enter the corporate inversion which, once upon a time, enabled the shareholders to quite simply insert a foreign holding company between themselves and the US company.  Convenient locations were the usual suspects that had the common virtue of never having heard of income tax.  In 2004 the US authorities woke up and imposed anti-avoidance legislation that effectively ignored the inversion to the foreign jurisdiction if at least 20% of the ownership in the new parent did not pass to third parties. The exception to this rule was if there were substantial business activities in the foreign jurisdiction which led companies to start looking at slightly less sunny jurisdictions such as Switzerland and Ireland where tax could be magically reduced to manageable proportions.

With the recent wave of mergers of the Pfizer – AstraZeneca type (the UK is still a lot more favorable tax location than the US) which meet both the 20% rule and substantial business activity test, Congress is now considering upping the 20% to 50% and tightening up the substantial business activity rules. Loss of control is expected to be just a little too much for the average US multinational.

The problem with the available literature on the subject is that, while inversion transactions are presented (on an amalgamated basis) as dark acts of genius to escape the draconian levels of US tax while avoiding US CFC legislation  and enabling tax-free repatriation of cash, it is far from clear how any of this is to be achieved.

Firstly, the transfer of the US company under the new foreign parent appears to be a s367a transaction which only escapes tax if a Gain Recognition Agreement is achieved with the IRS (under the circumstances I don’t know if that is a slam dunk).  Next, if the US company wants to avoid CFC legislation  it needs to sell/dividend/transfer its foreign subsidiaries to the foreign parent – which would generally involve a lot of tax. As regards ‘repatriation’ of cash trapped abroad, unless the US company’s foreign subsidiaries are transferred to the foreign parent,  the profits still have to pass through the US company – incurring the same US tax as before the merger plus likely withholding tax to the foreign parent.

While some articles clearly state that the CFC problem would remain, others hint at the US company disappearing into the new foreign parent. One states that the main advantage is that the foreign parent could loan extensive amounts to the US company enabling US profits to be cut by half due to interest expenses. When it comes to repatriation, I found one truly beautiful and incomprehensible graphic that has the merger involving cash payments to the US company and subsequent loans from Barbados through the foreign parent to the US company. I discussed all this with two US international tax experts who sympathised and went off to lunch.

My take on all this is that inversions must be very complicated and financial journalists cannot afford to burn copy when they realize they are out of their depth.

Vorsprung durch technik. Almost

Vorsprung durch technik. Almost

I do wonder, however, whether with Congress hot on the tails of multinationals (Senators also presumably do not understand what is going on), the planning may be a little too clever for comfort. In that same documentary about British Leyland, there was a piece about the Triumph Stag. The Stag was a cabriolet designed in Italy, the contours of which were generally considered to be thirty years ahead of their time. It was a truly magnificent driving machine. While Triumph’s sister mark, Rover, fitted  Buick 3.6 litre engines in its top-of-the-range model, the executives at Triumph decided they could go one better. Triumph had a boring family saloon called the Dolomite that just happened to have a 1.8 litre engine. You guessed it. They took two Dolomite engines and fused them together. This explains why, throughout my youth, when traveling on motorways I would regularly see Stag owners lounging luxuriously in their Italian leather seats, waiting to be towed. There has to be a lesson there somewhere.

 

 

 

Beating about the Bush tax cuts

Keep it simple

Keep it simple

I believe it was  John the Baptist  who coined the  phrase, “In the beginning  was the Word”. Whatever your creed, words have definitely had a pretty serious effect on the world from time immemorial. For me, the mere mention of the word “War”, in all its mono-syllabic, animal-like simplicity, is enough to strike fear into my cowardly heart. Some years ago, speaking at a conference about Investment in France –  in the presence of the French Ambassador and other dignitaries – I put paid to any ambitions I may have fostered to advise French nationals by telling an apocryphal Churchill story. Asked why he considered his 1940 speech, “We will fight them on the beaches….”   his most effective of the war, Churchill  is reputed to have explained that it was because, with one exception, his main vocabulary had been ancient Anglo-Saxon –  short and bold. That one exception – from Norman French – was “Surrender” . Nobody (and I mean,  n-o-b-o-d-y)  spoke to me at lunch.

It is interesting that two words uttered in an obscure speech nearly a year ago by an individual not normally known for his oratorical prowess,  managed to grip the entire American nation  in fear. While Joe  Public calmly went about his daily business ignoring the real nuclear threats coming out of Iran and North Korea, any mention of Ben Bernanke’s “Fiscal Cliff” would bring beads of sweat to his brow as he  imagined watching helplessly while his wife, children, home and SUV tipped over the edge of a mountain into the abyss.

As became apparent to all doubters last week, there never really was a Fiscal Cliff. The witching hour came and went on December 31 and it was only a full day later that the House of Representatives “pulled the country back from the brink” (spare me). It was a full day after THAT that President Obama, back at his “I’m as cool as a cucumber” vacation pad in Hawaii,  had it signed  into law by “autopen” with retroactive effect from the beginning of the year.  But we Old World people should remember that this is the land of Hanna Barbera where cartoon animals (an elephant and a donkey?) can go careering, horns locked, off a precipice and belatedly realizing their predicament, raise dust in the air as they do panic bicycle-riding motions with their feet regaining dry land. Ever the miserable rationalist, I prefer to think of  the blinded Duke of Gloucester in King Lear being deceived by his son into attempting suicide by jumping over a harmless bump, rather than the White Cliffs of Dover as he intended.

With the Fiscal Cliff  receding from view, we are being told that  all that happened was that “the can was kicked down the road”. Holdonasecond! Where did the  road come from? For the last year America has been hurtling towards a precipice across virgin green fields and rock formations, with the nation ending up dangling over the edge. Now, all of a sudden, there is a road. On the edge of a cliff?  No – there has simply been one of those sudden scene changes that typify Hollywood action movies and Washington speechwriters.

An open tin can with a dangerously serrated edge is now bumping down the stairs of the Capitol heading for the Mall, where it will roll happily along until it veers right two months from now at the Washington Monument and comes to rest on the White House lawn.  Then, with Washington required to negotiate deeply wounding spending cuts, the President and Congress will have to come up with something new and scary. How about  “The Great Mowing”? Frankly, they are more likely to go for something less consistent but more direct. “Washington Chainsaw Massacre”  is the sort of thing that should really give Ol’ Joe Public the willies.

If the branches of government still can’t find their common trunk, “the can will be kicked back  into the long grass” eventually reaching the end of the Mall at the foot of the Lincoln Memorial, where President, Senators and Representatives will be reminded that “Government is for the people”. If the greatest political speech in American history doesn’t do the trick, nothing will.

Tea Party Caucus

Tea Party Caucus

Meanwhile, the US is floating irreversibly up towards the “Debt Ceiling” – a rather gentle phrase that conjures up Nash terrace houses with high ceilings, Chippendale furniture and heavy scarlet curtains (not to mention scenes from Mary Poppins and Harry Potter). In reality, if the Tea Party Republicans lose all radio contact with Mission Control and vote not to increase the ceiling, that  really could plunge the entire planet into crisis overnight as the US starts to default on its liabilities.

On January 2, the Fiscal Cliff behind him and free to pursue the Republicans on the Debt Ceiling, President Obama released the safety catch on his mouth and turned it to semi-automatic: “We can’t not pay bills that we’ve already incurred”. Apart from being a candidate for unforgiveably worst line of 2013, it was a brilliantly awkward double negative that indiscriminately strafed  House Republicans. Unlike his predecessor, Obama normally manages to  place one word in front of another, and I am tempted to believe the sentence  construction was intentional.

Metaphor, idiom and daft constructs aside, it is  clear that both sides have got it wrong in this debate. Republican reluctance to raise more tax revenue in an acute deficit situation is barmy while Democrat insistence on raising tax rates only on the higher echelons (even before they agreed to a raised $400k threshold from the original $250k) will hardly scrape the protective coating off the deficit.

NASCAR got a tax break - increased depreciation. Understandable really

NASCAR got a tax break – increased depreciation. Understandable really

Meanwhile, there can be no way out of the current dire situation until President Obama decides which items of spending are really important to him and then takes an industrial lawn mower (or chainsaw) to the rest. The Republicans could well be right that – if they have no choice but to agree to higher taxation – rather than raise tax rates, Congress should do away with the countless deductions that render the headline tax rate irrelevant. Even the Act passed this week quietly included tax breaks thanks to all sorts of weird and wonderful lobbies. Essentially, the Internal Revenue Code needs to be thrown over a cliff.

The only serious question remaining is that of timing. Americans, having watched aghast at the austerity-induced implosion of the Euro zone, know that they need to balance the situation carefully. Paul Krugman, guru of the Neo-Keynesians, misses no opportunity to reject any quick fixes. But that does not imply  that there should not be a medium to long-term plan. Obama needs to show leadership – and leadership is not just fancy lines on the teleprompter. The recent election was totally negative as was the spat over the Fiscal Cliff. Time to think positive Mr Obama. “Yes, we can’t keep kicking the can down the road”.

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