Here’s Why Obama’s Tax Flight Plan is Doomed

Tax inversions – relocating a U.S. company’s headquarters to a lower-tax nation – are an attractive prospect for American shareholders. But President Barack Obama’s move to block them is doomed because the government has a bad track record in legal tax disputes. Plus, his plan likely would backfire, spurring more foreign takeovers of U.S. companies.

The administration’s plan is to make inversions difficult or impossible in the future. For instance, it intends to ban a U.S. company from using its untaxed foreign earnings to lend to its American operations. Treasury Secretary Jacob Lew is acting without seeking legislative support from Congress. The new rules would affect only deals not completed as of Sept. 22, such as the proposed merger of the U.S.-based Burger King (BKW) with Canada’s coffee and doughnut chain Tim Hortons.

However, unlike government-regulated banks, which under pressure have forked over billions of dollars in penalties for real and imagined offenses, most private corporations have legal teams that are well used to challenging Internal Revenue Service rulings. We have an active and independent Tax Court in this country.

The IRS is a frequent litigant and a not-infrequent loser, especially when it faces adversaries with technical knowledge and financial resources, such as major corporations. If the administration wants to challenge inversions using novel interpretations of the tax law, it should not expect most of corporate America to roll over the way that the banks have.

The initial reaction from most experts is that the just-announced Treasury policies might stand up to court challenge because they do not push the Internal Revenue Code’s boundaries too far, but that they probably will not stop inversions from continuing, for the same reason.

Even if the government succeeds in making inversions impractical for U.S.-based companies, the result probably won’t please it. Blocking inversions here will only turn American companies into takeover targets for foreign businesses. Acquirers will simply buy U.S. companies and relocate the headquarters, or their assets, once the deal is complete. In the process, even more American jobs will be lost.

When Canada lowered its corporate tax rate, critics warned that the move would be disastrous for Canadian federal government revenues. If the Burger King inversion is any indication, an attractive tax structure can more than make up for a lower rate by drawing new and existing businesses to establish headquarters in Canada.

Tim Hortons has long been a regular stop whenever I visit Canada. For one thing, I couldn’t avoid its outlets if I wanted to; they’re everywhere. I do genuinely like their doughnuts. The chain is the biggest coffee and doughnut seller in Canada and marked its 50th anniversary this spring. Given Tim Hortons’ ubiquity and popularity, it is no surprise that American dollars are chasing Canadian doughnuts.

When the news broke recently that Burger King Worldwide is engaged in talks to buy Tim Hortons, some U.S. politicians were outraged. Should the deal succeed, the combined businesses would together have about $22 billion in sales, making the new fast-food company the world’s third-largest.

Burger King aims to secure both a Canadian institution with habit-forming baked goods and a more favorable tax situation, courtesy of a move north of the border. In the proposed version of the merger, Burger King would create a new, Canadian-based parent company, housing both independently operating chains. This structure would give Burger King domicile in Canada and preserve Tim Hortons’ headquarters there.

While unnamed sources briefed in the deal told the New York Times that taxes were not the primary motivation behind the talks, Burger King is obviously aware of the tax implications. Canada cut its national corporate tax rate to its current level of 15 percent several years ago. (Companies there must also pay provincial taxes, meaning Ontario-based corporations such as Tim Hortons currently pay 26.5 percent total.)

The deal’s structure may give Burger King a credible argument that it is indeed not an inversion, further illustrating the difficulties the White House faces thwarting corporate tax flights. Charles Munger, vice-chairman of Berkshire-Hathaway, agrees. Berkshire is investing in the merger. Munger reasons that Hortons’ superior size (in revenues, but not market value) means it is fails to qualify as an inversion.

Meanwhile, the U.S. insists not only on a 35 percent federal corporate tax rate, plus state taxes in most places, but also on taxing corporations on earnings worldwide. Burger King doesn’t currently hold much cash outside the country, the Times reported, but it may certainly have an eye on expansion in the future, both in Canada and elsewhere.

Although Burger King is an American company, Brazilian investment firm 3G Capital owns about 70 percent of the hamburger chain’s shares. Why would Brazilians want to continue to pay U.S. tax on profits from burgers they sell in Buenos Aires or Hong Kong? There is no reason they would. Under the tax systems in place almost everywhere outside the United States, there is no reason they should, either.

Burger King’s American shareholders, like all corporate shareholders here, are taxed twice: once on corporate profits and again when the corporation pays out dividends. It’s worth noting, too, that those who criticize inversion most vehemently are almost always people whose income is only taxed once – and often, that income is a salary paid by taxpayers.

President Obama has made no secret of his displeasure with the practice. Before, and especially since, I last wrote about American companies fleeing to less hostile tax climates, Obama and the Democrats have bleated about unpatriotic U.S. corporations. It’s as if there were an inherent duty to have income earned abroad taxed back in the U.S. at least once.

In the wake of at least five large U.S. companies that have announced plans for inversions between mid-June and late July, Obama criticized a “herd mentality” at play in the decisions, calling the companies “corporate deserters who renounce their citizenship to shield profits.”

This characterization imagines that nobody owns these corporations, or perhaps Martians do.

The sensible thing is to recognize once again that neither Martians nor corporations pay taxes. Shareholders and customers – in other words, people – do. If those people have no connection to the U.S. other than a corporation’s legal domicile, they will find ways to sever their ties rather than fund a foreign government at exorbitant rates.

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Written by Larry M. Elkin, CPA, CFP. Larry Elkin is president of Palisades Hudson Financial Group LLC and Palisades Hudson Asset Management, L.P., in Scarsdale, N.Y.

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