Sealing Off the Bermuda Triangle?

Too many corporate tax dollars are disappearing because of headquarters relocations, and Congress looks ready to act

By Howard Gleckman

Normally, Corporate America's efforts to trim its tax bill are met with little more than a yawn in Washington. Indeed, many lawmakers and policymakers would just as soon repeal the corporate income tax, on the theory that administering the complex corporate tax code is more trouble than it's worth. But once in a while, a scheme sends the outrage-meter twitching.

Case in point: the furor surrounding companies that are limiting their U.S. tax liability by relocating headquarters to offshore havens such as Bermuda. And as the bipartisan criticisms heats up, chances are increasing that by fall Congress will curb such deals -- at least temporarily.


  On June 18, the Senate Finance Committee approved a measure that would limit, though not stop, the practice, known as corporate inversions. The bill was sponsored by the panel's chairman, Max Baucus (D-Mont.), and its senior Republican, Charles E. Grassley (R-Iowa). "These corporate expatriates aren't illegal, but they are sure immoral," fumes Grassley. He says companies ought to be helping to pay for the war on terrorism, not dreaming up ways to evade taxes. "These fictional headquarters are no more than a folder in a filing cabinet."

How does an inversion work? A U.S. company moves its nominal headquarters to Bermuda. This allows it to shift income from the U.S., which has a 35% tax rate on corporate profits, to Bermuda, which has no corporate tax. The company can then further trim its federal tax liability by loading tax-deductible expenses onto its U.S. subsidiaries. For instance, a U.S. subsidiary can borrow from its Bermuda parent, taking a big tax deduction for the interest payments. Or it can shift its patents to Bermuda so the U.S. subsidiary pays large tax-deductible royalties to its offshore parent.

In the long run, such deals promise to boost aftertax returns of the relocated companies. But there is one immediate downside for U.S. shareholders: Because an inversion is technically a sale of stock, investors must pony up capital-gains taxes on the deal.


  Inversions aren't new. In the 1990s, reinsurance companies such as ACE Ltd. moved to Bermuda. So did industrial giant Tyco. But since 2001, about a half-dozen U.S. companies have made the shift, among them manufacturer Ingersoll-Rand and consulting giant Accenture. And a number of other companies, such as New Britain (Conn.) toolmaker Stanley Works, are trying to move (see BW Online, 6/10/02, "Stanley's CEO: We're Being Hammered"). Hill aides figure the practice will cost Treasury $4 billion over the next decade.

The companies argue that in a highly competitive worldwide marketplace they have no choice but to take advantage of the lowest available tax rates. "We have a competitive disadvantage," Stanley CEO John M. Trani told BW Online on June 5. "If we locate offshore, we have leveled the playing field."

Moving offshore doesn't play well with the public

Trani has a point. U.S. tax treatment of international commerce is a mess, giving huge advantages to some companies, such as Boeing, while stiffing others. But an American company ducking $30 million in taxes by headquartering offshore isn't going to be very popular with the American public, no matter how you explain it.

Small wonder Democrats have been pounding on the issue for months. In March, Representative Richard E. Neal (D-Mass.) proposed banning the inversions. Under growing pressure for their reluctance to adopt substantive post-Enron reforms, both the White House and the House GOP leadership have been thrown on the defensive.

The Bush Treasury Dept. first resisted any curbs on the deals. But it supports limits on interest deductions for both U.S. companies that do inversions and all foreign-headquartered companies. That would hit foreign-owned multinationals such as Nestlé and Bayer, and they're lobbying furiously to get the restrictions dropped. As an alternative, top Treasury tax official Pamela Olson says a moratorium on future deals "might be appropriate." Hill backers say such a freeze might last through 2003.


  For months, House Republicans insisted they would address inversions only as part of broader international tax reform. Now they, too, hint they might back a temporary halt to the deals. One key reason: local politics. Veteran House Ways & Means Committee member Nancy L. Johnson (R-Conn.) is in a tough race for reelection. Stanley's planned inversion is a hot issue in the Nutmeg State, where most people oppose the move by the locally headquartered company, as does Johnson. And with control of the House likely to be decided by a few key races this fall, GOP leaders want to back Johnson's efforts to slow Stanley's departure.

The fate of anti-inversion legislation won't be settled until fall. But with the GOP taking flak for failing to clean up the excesses of Corporate America, shutting down the Bermuda Triangle -- even for a while -- might be a good way to relieve some of the pressure.

Gleckman is a senior correspondent in BusinessWeek's Washington bureau. Follow his views every Tuesday in Washington Watch, only on BusinessWeek Online

Edited by Douglas Harbrecht

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