The latest headlines in tax news have been dominated by the buzz of transactions known as corporate inversion transactions, the most notable being a contemplated inversion by Walgreens Co. What in the world is an inversion may you ask? Read below to find out.
Tax Inversion Mechanics
While there are many variations, inversion transactions typically involve a U.S. multinational company acquiring a foreign company with a tax home in a foreign country with a corporate tax rate lower than that in the U.S. (35%) and subsequently moving their headquarters to the foreign country. The result forms a company where a large portion of its income is taxed in the foreign country at lower rates. This income can now be distributed to shareholders without bringing the money back to the U.S. and incurring corporate level tax in the U.S.
Benefits of Inversion
As seen in the example above, the ultimate benefit of an inversion transaction is the portion of a company’s earnings earned overseas multiplied by the differential in U.S. vs. foreign tax rates. For Walgreens, that number is estimated to be $4 billion over the next 5 years.
Pitfalls of Inversions
The downside to inversions? Typically, shareholders must pay tax on the unrealized gain in their stock upon inversion. Even worse, the inversion transaction is usually a stock for stock transaction in which the shareholders receive no cash to pay taxes on their gains in the stock. Therefore, inversions are clearly a long term play for shareholders of companies that can withstand the short term tax bite.
Applications to Privately Held Companies
While public companies tend to reap greater benefits from inversions due to their greater proportion of overseas earnings, private companies can take advantage of inversions too if they so choose. The only other significant caveat for private companies is the issue alluded to above regarding capital gains on appreciated shareholder stock. For private companies, this tax exposure could be quite large and more concentrated with individual shareholders, resulting in a bigger tax hit for those involved in an inversion.
Tax inversions are indeed a powerful tool for tax savings, but one must be aware of the potential pitfalls when engaging in these transactions to make sure all of the estimated benefits are captured as expected. For more information on planning for inversions, please contact Ryan Giolitto at 630-285-0215 x8214.