Love It and Leave It?

The hue-and-cry over inversions may change the way overseas income is taxed.

Employees of Ingersoll-Rand Co.’s Bobcat division were deeply moved by a photograph of firefighters gathered around a Bobcat skid-steer loader to pay tribute to a victim of the World Trade Center collapse. Just six days after the terrorist attacks, the firm began manufacturing a special-edition “Spirit of America” loader, painted in patriotic red, white, and blue.

At the same time, CEO Herbert Henkel was putting the finishing touches on a plan to reincorporate the New Jersey manufacturer in Bermuda–a proposal that was put to shareholders six weeks later. “We urge you to join [the board] in supporting this important opportunity,” wrote Henkel. “The reorganization should help enhance our business growth and cash flow and reduce our worldwide effective tax rate.”

Ever since, congressional Republicans and Democrats alike have blasted Ingersoll-Rand and other companies that pursue such so-called inversions as being un-American. Says Iowa’s Chuck Grassley, the ranking Republican on the Senate Finance Committee and co-author of a bill aimed at stemming the practice, “It’s outrageous that some companies are willing to leave their country during a war and a recession just to save some taxes.”

Yet the outcry–and the inversions themselves–are merely a skirmish in a larger international tax battle involving Congress, the World Trade Organization (WTO), and companies worldwide. At stake is whether the United States will continue to tax income earned overseas–an issue of enormous consequence. “There is hardly a U.S.-based company of any significant size that is not faced with applying the international tax rules to some aspect of its business,” notes a May U.S. Treasury report, called “Corporate Inversion Transactions: Tax Policy Implications,” that urges a broader policy response to the inversion issue.

Without a broader response, finance executives will remain in the precarious position of having to defend any international tax policies aimed at maximizing shareholder value against their patriotic duty. Current tax rules create “a major disparity between what is right for the country and what is right for your company,” says Thomas M. Jones, in the Chicago office of McDermott, Will & Emery. “We should strive to achieve a tax system that aligns patriotism with good business sense. That is the [real] challenge that Congress needs to take on.”

Island Hopping

Ingersoll-Rand’s expatriation is not unique. At this year’s round of annual meetings, shareholders of Cooper Industries, Leucadia National, Noble Drilling, and The Stanley Works all voted to move overseas–on paper, at least.

Inversion is largely a paper transaction, in which a U.S. corporation creates an offshore subsidiary–typically little more than a mailbox in a foreign tax haven–and then “inverts” the ownership, transforming the subsidiary into the legal parent of the U.S. corporation that created it. That instantly eliminates U.S. taxes on income earned abroad. Once established, the offshore parent can also issue intercompany debt and charge licensing fees on intangible assets, which provides deductions and reduces the remaining taxable profits of the U.S. firm.

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