The general policy trend to free trade has increased competition for corporations to adopt more efficient production as previously closed economies reduce tariffs and other trade barriers. That competition has also led multinationals to acquire productive assets around the world in an ever greater search for reduced costs. Countries have responded by also reducing corporate tax rates, leaving some countries, such as the United States, with significantly higher rates.

A natural consequence of that trend is that merger candidates in low-tax jurisdictions have become more attractive. The result is tax base erosion as mergers shift corporate headquarters away from high-tax jurisdictions through the use of corporate inversions. These transactions have led to scrutiny by tax authorities around the world. This article examines economic issues that arise when tax authorities examine corporate inversions.

Around 50 former U.S. corporations have inverted, in large part between 1996 and 2014. (See Appendix, tables 1 and 2 for a summary of inversions by country and a full list of inversions.) Inversions generally involve reincorporation in a country such as Ireland or Bermuda that subjects the corporate parent to a lower statutory corporate tax rate or different tax regulations. Figure 1 shows that for the six countries where most inverted companies reincorporate, inversions tend to occur when a country's tax rate has fallen (or has always been) significantly below the U.S. statutory tax rate.

IRS Requirements for Corporate Inversion

For the inverted corporation to avoid taxation as a U.S. corporation, the resulting structure must fail specific anti-inversion criteria, defined in IRC sections 7874 and 367.

Section 7874 specifies two criteria that if met, result in adverse tax consequences:

  • less than 25 percent of the new multinational entity's business activity is in the home country of the new foreign parent; and
  • the shareholders of the old U.S. parent end up owning at least 60 percent of the shares of the new foreign parent.

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Previously published by Tax Notes International

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