The congressional response to corporate expatriations: the tension between symbols and substance in the taxation of multinational corporations

Virginia Tax Review, Wntr, 2005 by Michael S. Kirsch

During the past few years, several high-profile U.S.-based multinational corporations have changed their tax residence from the United States to Bermuda or some other tax haven. They have accomplished these expatriations, and the resulting millions of dollars of annual tax savings, merely by changing the place of incorporation of their corporate parent, without the need to make any substantive changes to their business operations or their U.S.-based management structure. Congress and the media have focused significant attention on this phenomenon. Despite this attention, Congress initially enacted only a non-tax provision targeting corporate expatriations--a purported ban on expatriated companies entering into contracts with the Department of Homeland Security. This article addresses this alternative sanction, concluding that it is prototypical symbolic legislation, with no instrumental effect. The article also discusses the extent to which the initial Congressional debate over expatriations may have had indirect instrumental effects by furthering the informal enforcement of social norms. Ultimately, after almost three years of debate, Congress enacted a tax provision intended to deny the desired tax benefits to expatriating corporations. The article also addresses the substantive tax policy implications of this response, concluding that it illustrates the tenuous normative underpinnings of the place-of-incorporation rule for determining corporate residence and the need for Congress to reconsider what makes a corporation "American" in an increasingly globalized world.

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INTRODUCTION

In the past few years, (1) several well-known U.S.-based multinational corporations have engaged in restructurings known as "expatriations" or "inversions." (2) Pursuant to an inversion, a corporate group changes the parent corporation's place of incorporation from a U.S. state, such as Delaware, to a foreign country, such as Bermuda or the Cayman Islands.

It is important to distinguish these corporate expatriations from related phenomena such as "runaway plants" and "outsourcing." The runaway plant phenomenon involves corporations with U.S. manufacturing operations shutting down those operations and shifting production to a foreign location. Similarly, outsourcing involves a corporation eliminating service positions in the United States and instead hiring service workers in a foreign location. In contrast to these phenomena, a corporate expatriation does not involve any immediate change in the physical location of the corporate group's management headquarters, manufacturing operations, services, or other activities. (3) Instead, expatriation merely reflects a formal legal change in the country in which the parent corporation's articles of incorporation are filed. (4)

Recent corporate expatriations have been driven by a desire to reduce U.S. income tax liability. The Internal Revenue Code (Code) (5) imposes significant tax consequences based on a corporation's residence, (6) which is determined solely by its place of incorporation. (7) Accordingly, by changing the place of incorporation of the corporate parent, a multinational group might be able to save millions of dollars in U.S. taxes. (8) For example, Cooper Industries anticipated a $55 million annual tax savings from its expatriation, (9) while Ingersoll-Rand expected a $40 million savings in the first year and larger amounts thereafter. (10)

As might be expected, the prospect of large multinational corporations reincorporating abroad to escape U.S. tax liability has attracted significant media and political attention. In the past three years, more than three dozen bills were introduced in Congress to address corporate expatriations, (11) and numerous legislative hearings and debates occurred. (12)

The expatriation phenomenon has, in effect, become a Rorschach test of international tax policy. In interpreting the causes of and appropriate responses to corporate expatriations, legislators have projected their own tax policy belief systems onto the phenomenon. For example, some legislators view expatriations in a sympathetic light, as an understandable response to an overreaching tax code, and argue that the phenomenon reflects the need to curtail drastically the scope of U.S. international taxation. Others view the U.S. international tax system as fundamentally sound, or perhaps even too limited in its scope, and characterize expatriations as unpatriotic tax avoidance by greedy corporations. The legislative proposals and debates reflect these widely varying viewpoints.

Despite the significant legislative attention given to corporate expatriations over the past few years, Congress initially refrained from enacting legislation directly addressing the tax consequences of corporate expatriations. Instead, Congress initially targeted the phenomenon through non-tax legislation. (13) That non-tax legislation, part of the Homeland Security Act of 2002, (14) purports to prevent expatriated corporations from entering into government contracts with the Department of Homeland Security. (15) Thus, rather than directly addressing the tax provisions and underlying tax policies implicated by corporate expatriations, Congress initially relied on an "alternative sanction"--i.e., a mechanism outside of the traditional civil and criminal sanctions that is used to stop a perceived abuse of the tax law. (16)