April 11,2002

Grassley Announces Bill to Rein in Corporate Expatriation

WASHINGTON – Sen. Chuck Grassley, ranking member of the Committee on Finance, todayannounced legislation to rein companies that set up nominal operations overseas to avoid payingmillions of dollars of federal taxes.

“It’s tax season. Citizens across America are filing their taxes this week. They’re paying theirtaxes, a lot of taxes,” Grassley said. “But some corporate citizens are relaxing this tax season.They’ve moved their mailing address out of the country. They’ve set up a filing cabinet and a mailbox overseas. This way, they escape from millions of dollars of federal taxes. That’s wrong.”

Grassley and Sen. Max Baucus, Finance Committee chairman, announced they soon willintroduce the Reversing the Expatriation of Profits Offshore (REPO) Act. The bill requires theInternal Revenue Service to look at where a company is controlled. If a company remains controlledin the United States, the bill requires the company to pay its fair share of taxes.

Grassley cited two examples of corporate expatriations, as this practice is called. He saidIngersoll-Rand, whose jackhammers reportedly carved Mount Rushmore, left the United States forBermuda after Sept. 11. According to media reports, the company pays less than $28,000 a year toBermuda and receives $40 million in U.S. tax savings. Stanley Works makes tools, such as handsaws, and has announced it is leaving the United States to go to Bermuda. Company officials haveexpressed pride in avoiding part of their tax obligation, Grassley said.

Grassley said the overseas deals draw attention to the shortcomings of international tax rules.Many companies that rejected these deals and stayed in the United States have to struggle with thecomplexity and burdens of international tax rules. The flaws often hurt these companies’ ability tocompete in the global marketplace. The U.S. international tax system should be in line with thenation’s open market trade policy, Grassley said.

“These expatriations aren’t illegal. But they’re sure immoral,” Grassley said. “During a waron terrorism, coming out of a recession, everyone ought to be pulling together. If companies don’thave their hearts in America, they ought to get out. Adding insult to injury, some of these companieshave fat contracts with the government. So they’ll take tax dollars, but they aren’t willing to pay theirshare.

“Our bill requires the IRS to look at where a company has its heart and soul, not where it hasa filing cabinet and a mail box. If a company remains controlled in the United States, our bill requiresthe company to pay its fair share of taxes, plain and simple.”


APRIL 11, 2002


Senate Finance Committee Ranking Member Chuck Grassley (R-IA) and Chairman MaxBaucus (D-MT) today announce their legislative response to the growing problem of corporateinversions. Generally, corporate inversions result in the removal of foreign assets of a U.S.corporation from the United States’ taxing jurisdiction, which may lead to a significant erosion of theU.S. tax base.

An inversion transaction typically involves the formation by a U.S. corporation of a subsidiaryin a foreign tax haven. Certain of these tax havens do not share tax, banking, or other financialinformation with the United States. After forming the foreign subsidiary, the U.S. corporation causesthe foreign subsidiary to become the parent corporation of the U.S. corporation itself, thereby"inverting" the corporate chain of ownership. This is generally accomplished by inducing theshareholders of the U.S. corporation to exchange their shares in the U.S. corporation for shares inthe foreign subsidiary. This share exchange will cause the foreign subsidiary to simultaneously "invertabove" the U.S. corporation and hold all (or nearly all) of the U.S. corporation’s outstanding shares.

Once this inversion structure is in place, the new foreign "parent" corporation may cause theU.S. corporation (which is now a subsidiary of the foreign parent) to transfer its foreign assets andsubsidiaries to the foreign parent corporation. When these assets and subsidiaries are moved underthe ownership of the new foreign parent corporation, they are no longer subject to U.S. tax becausethe United States’ taxing jurisdiction does not tax the foreign operations of a foreign corporation.Consequently, under this inversion structure, the United States’ taxing jurisdiction is limited to theU.S. operations of the U.S. corporation itself. To further exacerbate this erosion of the U.S. tax base,many inversion schemes "strip" earnings out of the U.S. corporation by creating a U.S. deduction forpayments to a foreign related party, with the related party receiving the payment in a tax freejurisdiction.

Some commentators have noted that inversion transactions are defensible as an electiveterritorial tax system. The territorial systems of most developed countries require that passive incomeremain taxable in the taxpayer’s home country. The inversion structures, however, would block U.S.taxation of passive offshore income, and in this respect, yield a more advantageous result than wouldbe allowed by most territorial tax systems.

An equally troubling aspect of inversion transactions is that the new foreign parentcorporation is usually an inactive "shell" corporation, having no substantial operations or activitiesin its country of formation. Often, these foreign parent corporations are nothing more than a sheetof paper in a filing cabinet. Thus, the U.S. company that initiates a corporate inversion may escapeU.S. taxation on foreign earnings through a purely paper transaction, with no substantive change inthe current business operations of the U.S. corporation or its foreign subsidiaries.

Current U.S. tax laws permit inversions, but attempt to stem erosion of the U.S. tax base bycapturing untaxed value that is migrating outside the U.S. taxing jurisdiction. For example, currentlaw imposes income tax on U.S. shareholders when they exchange their U.S. corporation shares forshares in the foreign subsidiary. Tax is generally imposed on the difference between the fair marketvalue of the shares and the shareholders’ cost bases. This provision, however, may be ineffectivewhen the shares’ market values are severely depressed by recession or external events (such as theterrorist attacks of September 11th), or when the shares are held by institutional investors that arenot subject to income tax.
Current tax laws may also impose tax on the U.S. corporation itself when it transfers itsforeign assets and foreign subsidiaries to the newly formed foreign parent corporation. This tax isimposed on untaxed earnings and appreciation in value that may be imbedded in those foreignproperties. This corporate level tax, however, may be offset by other corporate tax attributes, suchas net operating loss carryforwards (which may accrue during a recessionary period) or minimizedby suppressed asset values (which can be affected by recession and external events).

Senator Grassley and Senator Baucus believe that the current tax law provisions areineffective in stemming the rising tide of corporate inversions. They are extremely displeased thatcorporations (and some partnerships) are capitalizing on a period of recession and terrorism tomaximize their opportunities to escape U.S. taxation on foreign earnings. At the same time, thesenators do not wish to impede cross-border transactions that are entered into for legitimate non-taxbusiness reasons. Accordingly, the senators offer their bill, "Reversing the Expatriation of ProfitsOffshore" (REPO) Act, to remove the tax incentives associated with these corporate "expatriation"inversion schemes.

The REPO Act

The REPO Act addresses two different classes of inversion transactions – the typical "pure"inversion and "limited" inversions.

A. Pure Inversions

The first class of inversion transactions are the "pure" inversions, in which:

1. A U.S. corporation becomes a subsidiary of a foreign corporation or otherwise transferssubstantially all of its properties to a foreign corporation,

2. The shareholders of the U.S. corporation end up with 80% or more of the vote or value ofthe stock of the foreign corporation immediately, and

3. The foreign corporation, including its subsidiaries, does not have substantial business activitiesin its country of incorporation.

Corporations with no significant operating assets, few or no permanent employees, or nosignificant real property in the foreign country do not meet the substantial business activity test.Under this legislation, companies are not considered to be conducting substantial business activityin the country of reincorporation by merely conducting board meetings in the foreign country or byrelocating a limited number of executives to the foreign jurisdiction. The purpose of this substantialbusiness activity requirement is to attack inversion structures that utilize a manila folder in a filingcabinet or a foreign post office box to establish their corporate presence.

For corporations that engage in a pure inversion transaction, the new foreign parentcorporation would be deemed a domestic corporation for U.S. tax purposes. By dragging the foreignshell corporation back onto U.S. shores, the anticipated benefit of escaping U.S. tax on foreignoperations would be completely denied. This pure inversion legislation will extend to U.S.partnerships that invert into a foreign corporation.

B. Limited Inversions

Limited inversions are similar to pure inversions, except that the shareholders of the U.S.corporation end up with more than 50% and less than 80% of the vote or value of the stock of theforeign corporation. Limited inversions capture inversion transactions that are structured to evadethe 80% test of the pure inversion provisions, while at the same time allow the U.S. shareholders toeffectively control the new foreign parent corporation. Limited inversions, which include invertedpartnerships, will be treated in the following manner:

1. Unlike pure inversions, the foreign parent corporation created by limited inversiontransactions will not be treated as a U.S. corporation.

2. The current law provisions that impose tax on the U.S. corporation when it transfers itsforeign assets and foreign subsidiaries to the newly formed foreign parent corporation would bestrengthened. Specifically, the REPO Act would not allow the tax imposed on the untaxed earningsand appreciation in value of foreign properties to be reduced by any corporate tax attribute, credit,or other means. This is intended to strengthen the current law provisions that impose thecorporate-level "toll charge" for moving assets out of the U.S. taxing jurisdiction.
3. Limited inversion structures will be monitored to ensure that income cannot be stripped outof the U.S. corporation through transactions with foreign related parties. The REPO Act will requirethat, before any related party deduction is allowed, the U.S. corporation must obtain IRS approvalof the terms of their related-party transactions annually for 10 years following the inversion. Thiswould cover all related party transactions, including intangibles transfers, cost sharing arrangements,and similar transactions. As a further measure to prevent income stripping, the REPO Act will modifycurrent law to substantially reduce the amount of interest expense that may be deducted by a U.S.corporation for interest payments remitted to a related foreign party after an inversion transaction.

Effective Dates

During the Finance Committee hearing on March 21, 2002, Senator Grassley and SenatorBaucus made clear that any corporations engaging in inversion transactions would do so at their ownperil. Accordingly, the REPO Act is generally effective for inversions occuring on or after March 21,2002.

Numerous U.S. companies have engaged in inversion transactions prior to March 21, 2002.The REPO Act would not reverse those transactions, even if they were pure inversions. However,concern remains that certain of those prior inversions were structured to inappropriately strip-outthe earnings of the U.S. company that is now a subsidiary of a foreign corporation. Accordingly,these companies will be subject to the 10-year IRS deduction approval process otherwise imposedon limited inversion transactions. In addition, any asset transfers by those companies on or afterMarch 21, 2002 will be subject to the limited inversion provisions prohibiting reduction of thecorporate-level tax "toll charge" for moving assets out of the U.S. taxing jurisdiction.

Closing Comment

Senators Grassley and Baucus are committed to halting corporate inversions. Nonetheless,the senators also recognize that the rising tide of corporate expatriations demonstrates that ourinternational tax rules are deeply flawed. In many cases, those flaws seriously undermine anAmerican company’s ability to compete in the global marketplace. This competitive disadvantage isoften cited by companies that engage in inversion transactions.

The senators believe that we need to bring our international tax system in line with our openmarket trade policies. They wish to affirm their view that reform of our international tax laws isnecessary for our U.S. businesses to remain competitive in the global marketplace. Moreover, thoseU.S. companies that rejected doing a corporate inversion are left to struggle with the complexity andcompetitive impediments of our international tax rules. This is an unjust result for companies thatchose to remain in the United States of America. The senators are committed to remedying thisinequity.