An Analysis of Corporate Inversions
How much do companies benefit from corporate inversions? In this report, CBO analyzes the reasons for and effects of inversions. CBO also projects how inversions and certain other strategies will affect future U.S. corporate tax revenues.
U.S. multinational corporations—businesses incorporated and operating in the United States that also maintain operations in other countries—can use a variety of strategies to change how and where their income is taxed. One such strategy is a corporate inversion, which can result in a significant reduction in worldwide tax payments for a company. U.S. companies have engaged in corporate inversions since 1983, and public and government attention to them has varied over the years. Concern grew most recently in 2014 because the group of corporations that announced plans to invert that year included some that were very large: Their combined assets were $319 billion, more than the combined assets of all of the corporations that had inverted over the previous 30 years.
What Is a Corporate Inversion?
A corporate inversion occurs when a U.S. multinational corporation completes a merger that results in its being treated as a foreign corporation in the U.S. tax system, even though the shareholders of the original U.S. company retain more than 50 percent of the new combined company. An inversion changes the way that the income of the corporation is taxed by the United States because a multinational corporation’s residence for tax purposes is determined by its parent company’s country of incorporation. Multinational corporations with a U.S. parent company pay U.S. taxes on their U.S. and foreign income (although they are able to defer taxes on most foreign income until that income is brought back to the United States). In contrast, multinational corporations with a foreign parent company generally pay U.S. taxes only on income they earn in the United States. After an inversion, a multinational can effectively eliminate any U.S. taxes on its foreign income. Additionally, the existence of a new foreign parent can provide the multinational with new ways to move income to lower-tax countries and lower its worldwide tax liability. However, a corporate inversion also has a number of drawbacks for the company and its owners.
How Much Do Companies Benefit From Inversions?
Among companies that inverted from 1994 through 2014 and that reported positive income in the financial year both before and after the inversion, the amount of worldwide corporate tax expense reported on their financial reports fell, on average, by $45 million in the financial year after the inversion, the Congressional Budget Office estimates. Those companies reduced their ratio of worldwide tax expense to earnings from an average of 29 percent the year before inversion to an average of 18 percent the year after inversion. However, individual corporations’ experience varied widely, and some corporations were estimated to have a higher ratio of worldwide tax expense to earnings after inversion.
The reduction in companies’ worldwide tax expense includes changes in both U.S. and foreign tax expense. One reason that the reduction in U.S. tax expense would not equal the reduction in worldwide tax expense is because of the new opportunities following an inversion to shift income from the United States to lower-tax jurisdictions. Because that shifting would increase a company’s foreign tax expense, the resulting reduction in U.S. federal corporate tax expense would be larger than the reduction in worldwide tax expense. Consistent with that, among companies that inverted in the two decades before 2014 the average reduction in U.S. corporate tax expense was about $65 million, indicating that the companies’ other corporate tax expenses increased by about $20 million, on average (for a net decline in worldwide tax expense of $45 million).
How Will Inversions and Other Strategies Affect Future U.S. Corporate Tax Revenue?
CBO projects that the U.S. corporate income tax base will be reduced because of further inversion activity and the expansion of strategies to move profits to lower-tax jurisdictions, causing corporate tax revenues in fiscal year 2027 to be approximately 2.5 percent ($12 billion in nominal dollars) lower than they would have been if tax-minimization strategies were effectively unchanged from those used in 2016.