US Taxation of Multinational Enterprise: Part IX

In a few days, I will write more about the “extra” value in a multinational. Today, as promised, I want to talk about expatriot corporations.

A bunch of US corporations moved to Bermuda on paper to reduce US taxes. In such a transaction, technically, the old shareholders of the US operating corporation become shareholders of a new Bermuda holding company, which ends up owning the old US operating corporation. Because the old US corporation becomes a subsidiary of the new public Bermuda company, expatriation transactions are referred to as “inversions.” The tax benefits of inversions have been there for some time. But, inversions became popular only recently as corporate managers and the stock markets began accepting Bermuda corporations more.

The inversion alone saves no taxes, as the old US company continues to be taxed as before. (A good Treasury report is here: Treasury Inversion Report.) But, the inversion sets the stage for parking money offshore with US tax advantages. Most obviously, the new Bermuda parent and its foreign subsidiaries (not owned through the old US company) can earn foreign income free of US tax (until paid to US public shareholders as dividends). This benefit from inversions really is not that important, however, since real foreign income pays little US tax today (being parked in low-tax foreign corporations).

What is important is that foreign subsidiaries of the group now can get some US income — that's US income — at a reduced or zero US tax. As noted in an earlier post, to prevent artificially parking movable income, like interest and royalties, in tax havens, current US anti-abuse rules tax this movable income of foreign subsidiaries of US corporations as earned by the foreign subsidiaries. After an inversion, the group can have foreign corporations that are not owned by a US company. So, after an inversion, the US operating corporation can pay interest or royalties to a foreign member of the group and get a deduction that reduces the US corporation's (and, thus, the group's) US tax, while the payee corporation is subject to low or no US tax. (One popular technigue for securing a low US tax on the payee uses our income tax treaty with Barbados, as discussed in an earlier post.) Moving US income offshore in a deductible fashion is referred to as “stripping” US income.

Patriotic, huh? Note that business defends inversions by saying that inversions are a reasonable response to the US taxing foreign income of US persons. In fact, as just noted, the real juice in inversions is from stripping US income.The really interesting (pun?) issue here is why the US hasn't attacked stripping more forcefully. Tomorrow.

This entry was posted in Law: Tax. Bookmark the permalink.

4 Responses to US Taxation of Multinational Enterprise: Part IX

  1. Consultant says:

    So I am a small businessman with a little consulting engineering firm (incorporated) that grosses about $200,000 to $300,000 a year (net half of that). And I want to get some of the tax advantages of the big firms that don’t pay taxes the way little people do.
    First, I’m doing a corporate inversion with a local (cheap) lawyer in a tax haven where I vacation on the beach once in a while. I’m putting my corporation under control of a corporation my family owns in the tax haven. Then I’m forming a third corporation in a tax haven in which to park corporate assets like cash and investments.
    I will put the right to my corporation name and marketing materials in the third offshore corporation (the “name holder”). Since the majority of my gross income is the result of trust and recognition of the corporate name and history (because marketing is the most important thing in consulting work), I will charge the U.S. corporation for the use of the trade name and corporate identity and marketing materials. The U.S. corporation will pay a “franchise fee” of most of its income to the “name holder” corporation.
    The “name holder” corporation will exist to collect the rent on the reputation of corporations around the world that it certifies to use my corporate name and marketing materials (of which there will be only one, of course) and the royalty income in the form of large franchise fees will be U.S. tax free. Even under the Kerry plan, the franchise fees will never be controlled by a U.S. corporation because of the inversion.

  2. pgl says:

    Not to beat a deadhorse but much of the benefit in these transactions is having BermudaCo own the valuable intangibles, which were created by the U.S. entity. But then does not section 367(d) and section 1.482-4 require BermudaCo to pay the U.S. entity fair market value of the intangibles? Why, yes so enter the economists. Economist for the taxpayer tries to argue that the market value of a large stream of expected future income is very low, which of course is absurd. So what does the IRS do? Bring in a real economist to argue the obvious. They should but I’m not so sure they do such a good job at this. Why they don’t is the $64 million question.

  3. pgl says:

    Consultant: let me play IRS agent for a moment (I’m not one and even if I were, I doubt I could access the name of your organizations anyway). Your premise is that the franchise fee should be positive (say 5% of U.S. sales). I might challenge this premise saying the name is worth less (say 1% of sales). So we could fight over arm’s length royalty rates under section 1.482-4. But then I might choose to accept your asserted royalty rate and just turn to section 367(d), which says the offshore company should pay fair market value for the name, which was created by the U.S. entity. So, I take your forecast of U.S. sales and multiply by 5% and then discount at some appropriate cost of capital. Whatever that estimate of value is becomes your tax base for an immediate payment to the IRS. I hope your cheap attorney is telling you all of this and has some credible story that satisfies the local IRS agent. Then again – my earlier post suggests that your local IRS agent needs a smart economist to back him up.

  4. pgl says:

    Consultant: let me play IRS agent for a moment (I’m not one and even if I were, I doubt I could access the name of your organizations anyway). Your premise is that the franchise fee should be positive (say 5% of U.S. sales). I might challenge this premise saying the name is worth less (say 1% of sales). So we could fight over arm’s length royalty rates under section 1.482-4. But then I might choose to accept your asserted royalty rate and just turn to section 367(d), which says the offshore company should pay fair market value for the name, which was created by the U.S. entity. So, I take your forecast of U.S. sales and multiply by 5% and then discount at some appropriate cost of capital. Whatever that estimate of value is becomes your tax base for an immediate payment to the IRS. I hope your cheap attorney is telling you all of this and has some credible story that satisfies the local IRS agent. Then again – my earlier post suggests that your local IRS agent needs a smart economist to back him up.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Notify me of followup comments via e-mail. You can also subscribe without commenting.