Tax Chauvinism: Who Cares Where a Firm is Incorporated?

By :: May 20th, 2014

Following the recent offer by U.S drugmaker Pfizer to acquire British pharmaceutical firm AstraZeneca, congressional Democrats are proposing new limits on the ability of U.S.-based firms to establish foreign residence as a way to cut their U.S. corporate tax bill. Even before this latest flap, the Obama Administration proposed curbs on this practice, known as an inversion.

But why does it matter where a multinational corporation is headquartered? Certainly, it would affect U.S. tax receipts. By some estimates, Pfizer alone would pay $1.4 billion less in annual taxes by moving its corporate residence to London—though its offer has so far been spurned.

But beyond the revenue question, should we really care? After all, changing the corporate address of a firm has no real economic impact. There is no reason to believe the company would move production offshore if it shifts the address of its headquarters. After all, firms will produce goods and services wherever it is most cost-effective, after figuring regulatory, labor, and transportation costs.

Even the top executives and their staffs don’t need to go anywhere after an inversion since the U.S., unlike other countries, bases residence on where a firm is incorporated, not where its senior management or R&D is located. So the effect on labor markets is likely to be small or none at all.

Shifting legal residence isn’t likely to have any impact on a firm’s intellectual property either. U.S. based scientists or engineers will create cutting-edge software or a new drug irrespective of their firm’s mailing address. Many multinationals have long-since moved their patents and copyrights to low-tax jurisdictions—something they can easily do without relocating their legal address. Besides, does it matter to the U.S. economy if Apple’s patents are owned by an Irish subsidiary? Would it matter if it moved its corporate residence to Dublin?

The location of a firm’s legal headquarters has no economic effect on consumers either. Prices don’t vary based on where a firm is incorporated. Firms doing business in the U.S. are subject to U.S. regulation and pay the same corporate tax on U.S. source income, no matter where they are from. When Japanese-headquartered Toyota ran into high-profile problems with its brakes a few years ago, it was subject to the same laws as its Detroit competitors.

Is there evidence that firms are more likely to support U.S. foreign policy just because they are incorporated in, say, Delaware instead of Donegal? On the margins, perhaps. But who expects Exxon to withdraw its extensive energy operations from Russia in response to Moscow’s actions in Ukraine, just because the firm is incorporated in the U.S.?

So we are left with a sort of financial chauvinism. It is important to some politicians to be able to say that a company is a red-blooded American company. But when it comes to multinational firms in a global economy, why does that matter?

And what does it even mean? Is it an American firm if most of its shareholders are American? As my former Tax Policy Center colleague Chris Sanchirico pointed out recently, we don’t know the home countries of investors.

Is a firm somehow more American if its top management is American? Well, where does that leave Chrysler? Its recent turn-around was managed by now-CEO Sergio Marchionne, who is from Italy. The head of the firm’s truck division is a Canadian, and the head of its parts division is Italian. Does this make Chrysler less American?

All that said, the tax consequences of this sort of artificial corporate mobility are important, and yet more evidence that the U.S. tax system is out of synch with the rest of the world and needs fixing.

But beyond the tax issue, lawmakers may have better things to do than worrying about what makes a company American and what does not.

4Comments

  1. Michael Bindner  ::  12:55 am on May 21st, 2014:

    If the entire reason for moving a headquarters is tax evasion then countering that is enough. If a firm lies about its taxes, can’t we expect it to lie about safey issues until caught? Fixing this sounds like a good idea, impossible though that me be right now. Incorporation where the CEO sits sounds like common sense to me and that should be the rule. Putting in consumption taxes to match the world also makes sense – especially for our competitiveness.

    I am fine with multinational corporations – as long as they are employee-owned and as long as employee-owners extend the same management system to off-shore units – and if possible to the supply chain (which ideally should be purchased as well and converted). Of course, for employee-ownership to happen change is required in both Taft-Hartley and Social Security (equal employer contributions purchasing an insurance fund and employer voting stock (67%)). Of course, allowing more employee-ownership is about as possible as fixing the Inversion issue – at least until there is pressure to pass it. Sadly, Occupy had no demands. Perhaps it should.

  2. Vivian Darkbloom  ::  3:39 am on May 21st, 2014:

    Seldom have I encountered more conflicting statements in one comment.

    “If the entire reason for moving a headquarters is tax evasion then countering that is enough.”

    US corporate inversions don’t involve “moving a headquarters”. They involve moving the place of parent incorporation. Most jurisdictions in the world don’t follow the incorporation criterion of corporate residence, but for the US it is the sole criterion. Those other jurisdictions follow the “management” criterion, i.e., the place where management and control of corporate decision-making is centered.

    And, corporate inversions discussed here don’t involve “tax evasion”—they involve legal “tax avoidance”. If “tax evasion” were truly involved, then “simply enforcing current law would be enough”.

    “Incorporation where the CEO sits sounds like common sense to me and that should be the rule”.

    This sounds like you would like the US to adopt the rule of corporate residence that most other countries follow. A bright line incorporation rule has the advantage of simplicity—no need to wrestle with those messy facts. Changing the rule to the one you propose would make corporate inversions much easier—just have the CEO move to London! It’s not a bad place to live. (But, what about the rest of the management crew?).

    The US does generally follow corporate activity to determine where profits are earned and can be taxed. A UK incorporated company is taxed in the US on the profits earned here–that’s the concept of a “branch” or “permanent establishment”. To be sure, there is the messy business involving transfer pricing and income and expense allocation as to where those profits are earned. There is no easy way around these issues. But, Howard gets it mostly right—who *should* care if profits should be taxed where business and management activities occur and not based artificially on where a company chose to incorporate itself? Yet, that is largely what the US tax system currently does with its Subpart F rules and taxation of dividends and profits received from non-US subsidiaries and branches. If the latter rules were reformed and the US corporate tax rate would match those of the rest of the world, most of the reasons for corporate inversions out of the US would disappear. And profits still earned based on US activities and the returns to US individual shareholders would still be taxable.

    I’m also fine with employee ownership of corporate stock, but why the need to *require* corporations to be owned by its workers? Capital should have no role? If you are not happy with the lack of worker ownership of multinational corporations, there is one easy and non-coercive fix—have those workers save more of their discretionary income to purchase stock on the stock exchanges. Nothing prohibits them from currently doing so and it allows them greater diversification of ownership which is much more prudent. Workers of the world, invest!

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