John Varella, Lourie & Cutler

Corporate inversions are a topic of much debate during this presidential election year. In a corporate inversion, a United States-based corporation relocates its headquarters to a foreign country through a merger or acquisition with a foreign corporation. By relocating the corporation’s headquarters to a foreign country, the corporation (i) removes itself from the United States corporate taxation system, which taxes the worldwide income of a corporation that is United States-based, (ii) avails itself of a lower corporate tax rate in its new country, (iii) is no longer subject to tax on its worldwide income, and (iv) may be able to access on a no-tax or reduced tax basis previously earned profits that would have been taxed by the United States if repatriated to the United States.

To thwart corporate inversions Congress and the Internal Revenue Service have enacted various statutes and rules. In general, these rules are triggered whenever: (i) there is a transaction in which a foreign acquiring corporation acquires substantially all of the property of a United States corporation; (ii) the shareholders of the United States corporation ultimately own at least 60% of the foreign corporation; and (iii) after the acquisition, the foreign corporation does not have substantial business activities in the foreign country when compared to all its activities (including the activities of its subsidiaries). “Substantial business activities” is defined as having at least 25% of the assets, employment and income of the corporate group derived from, or located in, the foreign country.

When the shareholders of the U.S. corporation end up owning 60% or more of the foreign corporation, then (i) for the 10 years following the inversion, the United States’ company’s taxable income must be at least equal to the gain from the transaction and the company cannot take advantage of any net operating losses that it had accrued, and (ii) there is a 15% excise tax on insider’s equity compensation. These penalties have not deterred inversions. However, if the shareholders of the U.S. corporation end up owning 80% or more of the foreign corporation, then the foreign corporation is treated as if it were a United States corporation subject to worldwide tax. Recent regulations has given these rules even broader applicability by reducing the likelihood that a foreign corporation will be deemed to have substantial business activities in the foreign country after the inversion.

The Presidential candidates have both expressed their views on corporate inversions. Hillary Clinton would like to strengthen the inversion rules to deter further inversions. Donald Trump would like to reduce to reduce the corporate tax rate to encourage United States corporations to remain in the United States. It will be interesting to see if corporate tax policy changes next year.

John Varella is an attorney with Lourie & Cutler, Boston, Mass.