[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
CORPORATE INVERSIONS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON SELECT REVENUE MEASURES
of the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
__________
JUNE 25, 2002
__________
Serial No. 107-75
__________
Printed for the use of the Committee on Ways and Means
U. S. GOVERNMENT PRINTING OFFICE
81-550 WASHINGTON : 2002
___________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512-1800
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001
COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
E. CLAY SHAW, Jr., Florida FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut ROBERT T. MATSUI, California
AMO HOUGHTON, New York WILLIAM J. COYNE, Pennsylvania
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM McCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM McDERMOTT, Washington
JIM RAMSTAD, Minnesota GERALD D. KLECZKA, Wisconsin
JIM NUSSLE, Iowa JOHN LEWIS, Georgia
SAM JOHNSON, Texas RICHARD E. NEAL, Massachusetts
JENNIFER DUNN, Washington MICHAEL R. McNULTY, New York
MAC COLLINS, Georgia WILLIAM J. JEFFERSON, Louisiana
ROB PORTMAN, Ohio JOHN S. TANNER, Tennessee
PHIL ENGLISH, Pennsylvania XAVIER BECERRA, California
WES WATKINS, Oklahoma KAREN L. THURMAN, Florida
J.D. HAYWORTH, Arizona LLOYD DOGGETT, Texas
JERRY WELLER, Illinois EARL POMEROY, North Dakota
KENNY C. HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
Allison Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
______
Subcommittee on Select Revenue Measures
JIM McCRERY, New York, Chairman
J.D. HAYWORTH, Arizona MICHAEL R. McNULTY, New York
JERRY WELLER, Illinois RICHARD E. NEAL, Massachusetts
RON LEWIS, Kentucky WILLIAM J. JEFFERSON, Louisiana
MARK FOLEY, Florida JOHN S. TANNER, Tennessee
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisory of June 18, 2002, announcing the hearing................ 2
WITNESSES
Connecticut Attorney General's Office, Hon. Richard Blumenthal... 46
Johnson, Hon. Nancy L., a Representative in Congress from the
State of Connecticut........................................... 15
McInnis, Hon. Scott, a Representative in Congress from the State
of Colorado.................................................... 24
Maloney, Hon. James H., a Representative in Congress from the
State of Connecticut........................................... 27
Neal, Hon. Richard E., a Representative in Congress from the
State of Massachusetts......................................... 17
Salch, Steven C., Fulbright & Jaworski L.L.P..................... 41
SUBMISSIONS FOR THE RECORD
American Institute of Certified Public Accountants, Pamela J.
Pecarich, letter............................................... 67
Doggett, Hon. Lloyd, a Representative in Congress from the State
of Texas, statement and attachment............................. 5
Ingersoll-Rand, Hamilton, Bermuda, statement..................... 70
Moorehead, Donald V., and Aubrey A. Rothrock III, Patton Boggs
LLP, statement................................................. 72
Thompson, Samuel C., Jr., University of Miami School of Law,
Coral Gables, FL, statement.................................... 7
Western Shower Door, Inc., Fremont, CA, Craig McCarty, letter.... 73
CORPORATE INVERSIONS
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TUESDAY, JUNE 25, 2002
House of Representatives,
Committee on Ways and Means,
Subcommittee on Select Revenue Measures,
Washington, DC.
The Subcommittee met, pursuant to notice, at 3:23 p.m., in
room 1100 Longworth House Office Building, Hon. Jim McCrery
(Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON SELECT REVENUE MEASURES
CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE
June 18, 2002
No. SRM-8
McCrery Announces Hearing on
Corporate Inversions
Congressman Jim McCrery (R-LA), Chairman, Subcommittee on Select
Revenue Measures of the Committee on Ways and Means, today announced
that the Subcommittee will hold a hearing on Corporate Inversions. The
hearing will take place on Tuesday, June 25, 2002, in the main
Committee hearing room, 1100 Longworth House Office Building, beginning
at 3:00 p.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only. However,
any individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Committee and for
inclusion in the printed record of the hearing.
BACKGROUND:
As noted in announcing the full Committee hearing of June 6, 2002,
in recent months several corporations have either changed their
principal place of incorporation to a foreign country or announced
their intention to do so. On May 17, 2002, the U.S. Department of the
Treasury released its Preliminary Report on Inversion Transactions that
sets out the mechanics of and reasons for U.S. companies to undertake
these transactions. The report also highlights the disadvantages that
the U.S. Tax Code imposes on U.S. companies as compared to their
foreign competitors.
In announcing the hearing, Chairman McCrery stated, ``Some say
inversions are a problem which must be stopped. Others say they are a
symptom of a greater problem with our international tax rules. The
Subcommittee hearing will give Members an opportunity to learn more
about this complex problem and the consequences of proposed remedies.''
FOCUS OF THE HEARING:
The focus of this hearing is to build upon the full Committee
hearing and further examine the mechanics of inversion transactions and
examine policy options that will deter inversions and enhance U.S.
international competition.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Please Note: Due to the change in House mail policy, any person or
organization wishing to submit a written statement for the printed
record of the hearing should send it electronically to
[email protected], along with a fax copy to
(202) 225-2610, by the close of business, Tuesday, July 9, 2002. Those
filing written statements that wish to have their statements
distributed to the press and interested public at the hearing should
deliver their 200 copies to the Subcommittee on Select Revenue Measures
in room 1135 Longworth House Office Building, in an open and searchable
package 48 hours before the hearing. The U.S. Capitol Police will
refuse sealed-packaged deliveries to all House Office Buildings.
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.
1. Due to the change in House mail policy, all statements and any
accompanying exhibits for printing must be submitted electronically to
[email protected], along with a fax copy to
(202) 225-2610, in Word Perfect or MS Word format and MUST NOT exceed a
total of 10 pages including attachments. Witnesses are advised that the
Committee will rely on electronic submissions for printing the official
hearing record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. Any statements must include a list of all clients, persons, or
organizations on whose behalf the witness appears. A supplemental sheet
must accompany each statement listing the name, company, address,
telephone and fax numbers of each witness.
Note: All Committee advisories and news releases are available on
the World Wide Web at http://waysandmeans.house.gov.
The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
business days notice is requested). Questions with regard to special
accommodation needs in general (including availability of Committee
materials in alternative formats) may be directed to the Committee as
noted above.
Chairman McCRERY. The hearing will come to order. Our
guests will take their seats.
Good afternoon, everyone. Today the Select Revenue Measures
Subcommittee continues its examination of the impact of the Tax
Code on the competitiveness of American businesses. The first
three hearings looked at possible responses to the World Trade
Organization's decision in the Foreign Sales Corporation/
Extraterritorial Income Exclusion Act (FSC/ETI) dispute. This
hearing will examine the practice known as inversions, whereby
some companies move their legal residence from the United
States to another country, usually a low-tax or no-tax
jurisdiction.
Let me begin by making clear what I said to Mr. Neal and
others during House debate last week. I agree inversions are a
problem. I agree there is something wrong with a Tax Code which
allows American companies to reduce their taxes by moving their
nominal residence to another country, and I agree that
legislation to address this problem is something this Congress
should, and I believe will, take up.
Let me also make clear that my support for legislation to
tackle the issue of inversions is not an endorsement of any of
the bills which have been introduced to this point. This
hearing will give us a chance to evaluate the strengths and
weaknesses of current proposals and examine whether other more
comprehensive approaches are necessary.
Inversions are not a new phenomenon. In fact, the first
inversion to attract significant attention involved a Louisiana
company back in 1983. Preventive legislation was enacted in
response to that.
A decade later, Helen of Troy inverted in a differently
structured transaction. The Internal Revenue Service responded
swiftly with new regulations.
Now, two decades after inversions first gained public
attention, they are back in the spotlight. The outcry from the
press and the public has prompted legislators to introduce a
slew of proposals to put a finger in the inversion dike.
Inversions are motivated by two types of tax savings.
First, the inverted company generally structures its affairs so
as to avoid U.S. tax on its global income, thereby getting
around our worldwide tax system. This has sometimes been
referred to as ``self-help territoriality.''
Second, and perhaps even more concerning, inverted
companies have engaged in a practice known as interest
stripping to reduce U.S. taxes on U.S. income. This occurs when
the parent loans money to the U.S. subsidiary. The interest
payments made to the parent or other foreign affiliate are
deducted from a subsidiary's income, thereby reducing taxable
U.S. income. The payments received by the parent are either not
considered taxable income or are subject to a very low rate of
taxation.
Combined, these incentives provide significant tax savings
to inverting companies but erode our U.S. tax base. They also
point out the danger of narrow legislative solutions. Just as
water will find another way through or over the dike,
legislation which leaves in place these incentives but only
places them further out of reach encourages clever tax
professionals to respond by redesigning and repackaging these
inversion transactions.
So long as we are focused on the headline-grabbing
inversions and not the underlying factors which prompt these
moves, I am concerned we will continue to play catchup with
enterprising companies and their tax planners who find ways
around the statutes.
The fundamental problem, as identified by the U.S.
Department of the Treasury, is the ``juice'' which makes
inversions such an attractive option for many companies.
Existing barriers such as toll charges on the shareholders of
inverting companies under section 367 are inadequate in some
cases. With stock prices depressed and many institutional
shareholders indifferent to this tax, this check on inversions
is not as formidable as it was once thought.
These challenges suggest the need to think broadly and
address not only the narrow issue of inversions but also the
broader flaws in our Tax Code which make it attractive for
long-established U.S. companies to invert.
I look forward to examining these issues with the witnesses
today and to working with my colleagues in the days and weeks
to come to craft legislation which responsibly removes the
incentive for American companies to send their headquarters
overseas.
It is now my pleasure to yield to my good friend from New
York, the Ranking Member of the Subcommittee, Mr. McNulty.
[The opening statement of Chairman McCrery follows:]
Opening Statement of the Hon. Jim McCrery, a Representative in Congress
from the State of Louisiana
The hearing will come to order. I ask our guests to please take
their seats.
Good afternoon.
Today, the Select Revenue Subcommittee continues its examination of
the impact of the Tax Code on the competitiveness of American
businesses. The first three hearings looked at possible responses to
the World Trade Organization's decision in the FSC/ETI dispute.
This hearing will examine the practice known as inversions whereby
some companies move their legal residence from the United States to
another country, usually a low-tax or no-tax jurisdiction.
Let me begin by making clear what I said to Mr. Neal and others
during House debate last week. I agree inversions are a problem. I
agree there is something wrong with a Tax Code which allows American
companies to reduce their taxes by moving their nominal residence to
another country. And I agree that legislation to address this problem
is something this Congress should and will take up.
Let me also make clear that my support for legislation to tackle
the issue of inversions is not an endorsement of any of the bills which
have been introduced to this point. This hearing will give us a chance
to evaluate the strengths and weaknesses of current proposals and
examine whether other, more comprehensive approaches, are necessary.
Inversions are not a new phenomenon. In fact, the first inversion
to attract significant attention involved a Louisiana company in 1983.
Preventive legislation was enacted in response.
A decade later, Helen of Troy inverted in a differently structured
transaction. The IRS responded swiftly with new regulations.
Now, two decades after inversions first gained public attention,
they are back in the spotlight. The outcry from the press and the
public has prompted legislators to introduce a slew of proposals to put
a finger in the inversion dike.
Inversions are motivated by two types of tax savings. First, the
inverted company generally structures its affairs so as to avoid U.S.
tax on its global income, thereby getting around our worldwide tax
system. This has sometimes been referred to as ``self-help
territoriality.''
Second, and perhaps even more concerning, inverted companies have
engaged in a practice known as interest stripping to reduce U.S. taxes
on U.S. income. This occurs when the parent loans money to the U.S.
subsidiary. The interest payments made to the parent or other foreign
affiliate are deducted from the subsidiary's income, reducing taxable
U.S. income. The payments received by the parent are either not
considered taxable income or are subject to a very low tax rate.
Combined, these incentives provide significant tax savings to
inverting companies but erode the U.S. tax base. They also point out
the danger of narrow legislative solutions.
Just as water will find another way through or over the dike,
legislation which leaves in place these incentives but only places them
further out of reach encourages clever tax professionals to respond by
redesigning and repackaging these inversion transactions.
So long as we are focused on the headline-grabbing inversions and
not the underlying factors which prompt those moves, I am concerned we
will continue to play catch-up with enterprising companies and their
tax planners who find ways around the statute.
The fundamental problem, as identified by the Treasury, is the
``juice'' which makes inversions such an attractive option for many
companies. Existing barriers, such as toll charges on the shareholders
of inverting companies under section 367, are inadequate in some cases.
With stock prices depressed, and many institutional shareholders
indifferent to this tax, this check on inversions is not as formidable
as once thought.
These challenges suggest the need to think broadly and address not
only the narrow issue of inversions but also the broader flaws in our
Tax Code which make it attractive for long-established U.S. companies
to invert.
I look forward to examining these issues with the witnesses today
and to working with my colleagues in the days and weeks to come to
craft legislation which responsibly removes the incentive for American
companies to send their headquarters overseas.
It is now my pleasure to yield to my friend from New York, Mr.
McNulty.
Mr. McNULTY. Thank you, Mr. Chairman, and before I make my
opening statement, I ask unanimous consent to submit the
statement of Congressman Doggett concerning his bill, H.R.
4993.
Chairman McCRERY. Without objection.
[The statement of Mr. Doggett follows:]
Statement of the Hon. Lloyd Doggett, a Representative in Congress from
the State of Texas
The parade of corporations changing their charter and buying a
foreign mailbox as their home address is only the most blatant example
of abusive corporate tax shelters that increasingly plague our country.
Effectively resolving this particular form of abuse is urgent, but the
broader issue must also receive prompt attention. Regretfully, just as
the Committee has shown no recent interest in exploring tax rip-offs by
Enron, it has given no attention to the Abusive Tax Shelter Shutdown
Act (H.R. 2520), or related recommendations by the Joint Tax Committee
\1\ or the Department of the Treasury \2\ since a hearing on November
10, 1999.
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\1\ ``Study of Present-Law Penalty and Interest Provisions as
Required by Section 3801 of the Internal Revenue Service Restructuring
and Reform Act 1998 (Including Provisions Relating to Corporate Tax
Shelters),'' Joint Committee on Taxation, July 22, 1999.
\2\ ``The Problem of Corporate Tax Shelters: Discussion, Analysis
and Legislative Proposals,'' Department of the Treasury, July 1999.
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When corporations renounce their U.S. citizenship, they take much
of their U.S. income with them. Of the $30 million that Stanley Works
expects to avoid each year in U.S. taxes under its reincorporation
plan, well over two-thirds is apparently a result of moving abroad
income earned on operations here in the U.S. Once a company has
inverted, several accounting tricks allow it to artificially shift
American income to no- or low-tax jurisdictions without first paying
its fair share of taxes due in the U.S.
One common means of shifting income is by having a U.S. affiliate
borrow heavily from a related foreign company; taxable income generated
here can be converted into interest deductions and sent abroad. Even
the Treasury Department has recognized that the ``U.S. subsidiary can
be loaded up with a disproportionate amount of debt for earnings
stripping purposes through the mere issuance of an intercompany note.
Thus, the desired earnings stripping, and the U.S. tax reduction, can
be accomplished without any real movement of assets or change in
operations.'' \3\
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\3\ ``Corporate Inversion Transactions: Tax Policy Implications,''
Office of Tax Policy, Department of the Treasury, May 2002, at page 21.
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The Treasury has failed, however, to grasp the seriousness and
scope of the problem. Rather than the zero tolerance attitude that is
required, the Administration provides the Congress with many
suggestions on how to maintain this loophole: through safe harbors
based on the company's ability to leverage itself on a world-wide
basis; by removing accelerated depreciation values from the formula;
and by giving a free-ride 100% deduction on all interest stripping up
to a ``to-be-determined'' threshold.
The use of intercompany debt to siphon American income abroad is
only one piece of the puzzle. If you have wondered why some
corporations have chosen to celebrate their new foreign address by
discarding not only their citizenship but also by swapping a valuable
and well-known trade name for something new, one answer is in the
royalties. Probably a large consulting firm could only be convinced to
name itself after a day of the week if there were significant moneys to
be made in the process. By generating new intellectual property abroad,
and then renting it at unreasonable prices to the U.S. subsidiary, more
artificial shifting of American income can occur. A decade ago, the
Ways & Means Committee recognized that foreign companies could use
royalty payments to evade U.S. taxes in the same way that debt and
interest payments are used,\4\ but the Tax Code offers even fewer
protections against such royalty abuse. This is not new, but it has
been ignored during the current debate.
---------------------------------------------------------------------------
\4\ See, for example, Hearing Before the Subcommittee on Oversight
of the Committee of the Ways and Means on the Department of the
Treasury's Report on Issues Related to the Compliance with U.S. Tax
Laws by Foreign Firms Operating in the United States. (Pages 2-4.)
April 9, 1992.
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While both pleased that the Senate Finance Committee has provided a
bipartisan response through S. 2119 and fully supportive of the
approach adopted by Representatives Neal and Maloney in H.R. 3884 of
which I am a cosponsor, the broad extent of tax evasion requires a
multi-faceted response. It should also be noted that those corporations
that were first out of the gate with abusive moves would not be
immediately affected by these proposals. Among those corporations which
appear to have reincorporated before September 11, 2001 are: Helen of
Troy; Triton Energy Corporation; ADT Ltd.; Global Crossing; Tyco
International; Fruit of the Loom, Inc.; Xoma Corporation; Transocean
Offshore, Inc.; PXRE Corporation; Everest Reinsurance Group; Foster
Wheeler Corporation; and Accenture, Ltd. In addition to these,
Ingersoll-Rand and Global SantaFe appear to have reincorporated prior
to March 20, 2002, the effective date of S. 2119. There is a need to
reach those companies that have already expressed an interest in
circumventing H.R. 3884 and S. 2119.
I believe the root of the problem lies in extending the valuable
benefits of our tax treaties to tax evading corporations, which lack a
legitimate claim to use them. Tax treaties quite properly are meant to
avoid double taxation but should not be a means for avoiding any
taxation.
Most of our more modern income tax treaties recognize that there
can be opportunities for abuse in cross-border payments between related
parties, through ``treaty shopping.'' Some of our treaty partners may
even promote such activity by establishing very low ``residency''
requirements for purposes of accessing tax treaty benefits. Many
treaties contain ``limitation on benefits'' provisions to limit access
to significant (often total) reductions on the withholding taxes levied
on interest and royalty payments. Such provisions contains a series of
tests meant to ensure that treaty benefits go only to true residents of
the tax treaty partner. The Treasury Department has stated, in its
technical explanation to the 1996 model income tax convention, that
``[t]he assumption underlying each of these tests is that a taxpayer
that satisfies the requirements . . . probably has a real business
purpose . . . or has a sufficiently strong nexus to the other
Contracting State (e.g., a resident individual) to warrant benefits
even in the absence of a business connection. . . .'' Unfortunately one
of these tests reflects an outdated assumption about residency that
renders the limitation on benefits provision of little value where it
is most needed.
The limitation on benefits provision, as included in over thirty of
our tax treaties, provides that any corporation that satisfies the
domestic residency rules of a tax treaty partner and trades its shares
primarily on a recognized stock exchange (generally including ``any
stock exchange registered with the U.S. Securities and Exchange
Commission as a national securities exchange under the U.S. Securities
Exchange Act 1934'') will be granted full access to the benefits of the
tax treaty. In this age of globalized securities markets, a listing on
the NASDAQ has no more relevancy in determining whether a company is a
resident of a foreign partner to a tax treaty than does an annual
beach-side board meeting, but it can nevertheless translate into tens
of millions of dollars in taxes evaded for a corporation that chooses
to reincorporate abroad and become a ``resident'' of the right tax
haven.
H.R. 4993, the No Tax Breaks for Corporations Renouncing America
Act of 2002, would close this loophole. This legislation would require
that corporate beneficiaries have true ties to the treaty partner,
either through ownership or through a public stock market listing and
substantial activities. It is similar in approach to prior
congressional action to close tax treaty loopholes that were providing
unanticipated and unbargained-for benefits to third parties.\5\
---------------------------------------------------------------------------
\5\ See, for example, section 884(e) of the Internal Revenue Code,
responding to treaty shopping by foreign corporations to avoid branch
profits taxation.
---------------------------------------------------------------------------
What American businesses need immediately is a return to a level
playing field. When Stanley Works can unilaterally cut its taxes by $30
million overnight, its competitors are disadvantaged and American
families are unfairly required to pay an increased share of the costs
for meeting our security and other needs.
[An attachment is being retained in the Committee files.]
Mr. McNULTY. I also ask unanimous consent to present for
the record the statement of Professor Samuel Thompson of the
University of Miami concerning his views in general on
corporate inversions.
Chairman McCRERY. Without objection.
[The statement of Mr. Thompson follows:]
Statement of Samuel C. Thompson, Jr., Professor and Director, Center
for the Study of Mergers and Acquisitions, University of Miami School
of Law
I. BACKGROUND
My name is Samuel C. Thompson, Jr., and I am a Professor of Law and
the Director of the Center for the Study of Mergers and Acquisitions at
the University of Miami School of Law. I am submitting these comments
because I have an academic and scholarly interest in the topic of
inversions, which involve various transactions in which a publicly held
U.S. corporation becomes a subsidiary of a publicly held foreign
holding company. I do not represent any client that has an interest in
inversions, and all of the views expressed on this subject are my own
and have not been approved by any other person or organization.
As a young lawyer, I worked in the Treasury's Office of
International Tax Policy, and as a practicing lawyer for many years, I
counseled clients on various issues relating to the Federal income
taxation of international transactions. As a law professor, I have
taught International Taxation for many years, and I have published a
casebook on the topic: U.S. Taxation of International Transactions
(West Publishing 1994). I first became interested in inversions and
similar transactions in 1998 in connection with a lecture I gave at the
University of Cincinnati Law School on section 367 of the Code. The
lecture was published in the University of Cincinnati Law Review: The
Impact of Code Section 367 and the European Union's 1990 Council
Directive on Tax-Free Cross-Border Mergers and Acquisitions, 66 U. Cin.
L. Rev. 1193 (1998). I continued my interest in this subject by
publishing in the March 18, 2002 issue of Tax Notes an article
entitled: Section 367: a `Wimp' For Inversions and a `Bully' For Real
Cross-Border Acquisitions, 94 Tax Notes 1505 (March 18, 2002) [Section
367: A Wimp and a Bully]. This article was the basis of the Polisher
Tax Lecture I gave at the Dickinson Law School on April 24, 2002. I
also recently published in Tax Notes International the following three
articles on this subject: Analysis of the Non-Wimpy Grassley/Baucus
Inversion Bill, 26 Tax Notes International 741 (May 13, 2002) [Analysis
of Grassley/Baucus Bill], Treasury's Inversion Study Misses The Mark:
Congress Should Shut Down Inversions Immediately, 26 Tax Notes
International 969 (May 27, 2002) [Treasury Misses the Mark], and U.S.
Treasury Official Gives Unconvincing Reason For Not ``Blockading''
Inversions, 26 Tax Notes Int'l 1321 (June 17, 2002) [Treasury's
Unconvincing Reason]. I also made a written submission to the House
Ways and Means Committee in connection with its hearing on corporate
inversion transactions, which was held on June 6, 2002, and this
submission builds on that submission.
II. FOCUS OF THESE REMARKS
Several bills have been introduced to stop these inversion
transactions, including bills by Representatives Doggett, Johnson,
Neal, McInnis, and Maloney and by Senators Grassley, Baucus, Wellstone
and Dayton. I have previously analyzed the bill introduced by Senators
Grassley and Baucus. See Analysis of Grassley/Baucus Bill. Also, on
Friday, May 17, 2002, the U.S. Treasury issued a tentative report on
corporate inversion transactions. See Office of Tax Policy, Department
of the Treasury, Corporate Inversion Transactions: Tax Policy
Implications (May 2002) [Treasury Report], and on June 6, 2002, the
Treasury testified on this topic before House Ways and Means Committee.
See Treasury's Unconvincing Reason. My comments today focus on the
Treasury Report, the Treasury's June 6, 2002 testimony, and the policy
question of whether the case has been made to bring these transactions
to an end. I do not comment here on the technical aspects of the bills
that have been introduced, but I think the Grassley/Baucus REPO bill
would provide a good starting point for closing down these
transactions. This submission does not repeat the sections of the June
6 submission that discuss the background of inversions and summarize
the Treasury's Report.
III. SUMMARY OF MAJOR POINTS
LBy avoiding the CFC provisions, inversion
transactions extend de facto territorial taxation to both
active foreign income and passive foreign income; not even the
most avid proponent of territorial taxation supports such a
system for passive income.
LThe Treasury Report and the National Foreign Trade
Council's (NFTC) Study do not establish that U.S. companies
face a competitive problem in conducting business in foreign
markets; there may be such a problem, but it has not been
established.
LThe NFTC's June 11, 2002 position against adopting a
territorial system is an acknowledgement that the entire issue
needs further study.
LInversions create a real competitive problem for U.S.
firms that cannot, or choose not to, engage in inversions,
while their competitors pursue such transactions.
LThere is no reason to refuse to act now on inversions
because of concern with similar transactions. It is possible to
address similar transactions, which is the case with the
Grassley/Baucus bill, and there is no evidence that cross
border mergers with real companies in OECD countries have been
used to accomplish the purposes of inversion transactions.
LThe Treasury and Congress should be careful not to
overstate the potential simplification advantages of a
territorial system. As Ron Pearlman, a former Assistant
Secretary of Treasury for Tax Policy in the Reagan
Administration said many years ago: ``Corporate transactions by
their nature are complex and * * * the rules governing those
transactions will be complex.''
LWithout respect to one's views on the desirability of
a territorial system, it is difficult to comprehend on tax
policy grounds why the Congress would not act immediately to
close down inversions.
LAfter shutting down inversions, Congress and Treasury
should then turn their attention to the real issue: a thorough,
effective, careful, and honest study of the merits of both (1)
a move to a territorial system, and (2), in the words of the
NFTC's June 11 Report, the ``reform of our current deferral and
foreign tax credit system.''
IV. CRITIQUE OF THE TREASURY REPORT
A. Relationship of Inversions to Possible Move to a Territorial System
The Treasury Report correctly points out that it is appropriate for
Congress to consider the possibility of moving to a territorial regime
for active income. Senators Grassley and Baucus \1\ made the same point
in introducing their anti-inversion bill. So there is no real debate on
whether Congress should consider moving to a territorial system, and
the treatment of inversions should have nothing at all to do with that
coming debate.
---------------------------------------------------------------------------
\1\ Analysis of Grassley/Baucus Bill, supra.
---------------------------------------------------------------------------
A move in the direction of a territorial system has been one of the
principal goals of the National Foreign Trade Council, Inc. (NFTC), an
industry sponsored organization, which has argued for such a change in
its book: International Tax Policy for the 21st Century.\2\
The NFTC has been careful only to make the case for a territorial
system for active foreign income, and there are principled arguments
that can be made for adopting such a regime.\3\ However, with respect
to the treatment of foreign passive income, the NFTC has said: ``[W]e *
* * have * * * recommended no change relating to the basic operation of
the foreign personal holding company income rules of subpart F.'' \4\
Thus, the NFTC does not argue against the current CFC treatment of
passive income, which generally imputes such income to controlling U.S.
shareholders.
---------------------------------------------------------------------------
\2\ National Foreign Trade Council, Inc., International Tax Policy
for the 21st Century (December 15, 2001) [NFTC Report].
\3\ I do not believe the case for a territorial system has been
adequately made in the NFTC Report or otherwise, but I believe the move
to a territorial system for real active foreign income is something
Congress should consider.
\4\ NFTC Report, supra note 17 at 26-27.
---------------------------------------------------------------------------
By avoiding the CFC provisions, the inversion transactions extend
de facto territorial taxation to both active foreign income and passive
foreign income. The Treasury Report only addresses the avoidance of tax
on foreign source passive income in a footnote, and in that footnote
the Treasury says: ``Further study must be given to this issue.'' \5\
Thus, the Treasury must think that there could be some argument in
favor of extending a territorial regime to foreign passive income. I
submit that no principled argument can be made for such a position. For
example, all of our significant trading partners with territorial
systems only extend territorial treatment to active foreign income.
Even though the Treasury seems to support a territorial system, it
should have recommended immediate action to end inversions on the
grounds that these transactions extend the territorial principles
beyond the breaking point.
---------------------------------------------------------------------------
\5\ Treasury Report, supra at 29, footnote 50.
---------------------------------------------------------------------------
Further, the NFTC has recently backed away from its support for a
move toward a territorial system; in a June 11, 2002 Report, it states
that its (apparently recently formed) Territorial Study Group
``concludes that, on balance, legislative efforts to improve current
international tax rules are better spent on reform of our current
deferral and foreign tax credit system and on finding a WTO compliant
replacement for FSC/ETI than on adopting a territorial system.'' Id.
Executive Summary at 3. Thus, since the principal proponent of a move
in the direction of a territorial system has abandoned that position
and recommended more study, it would be irresponsible for Congress to
decide not to immediately shut down inversions. This recent action of
the NFTC emphasizes the need for Congress and the Treasury to carefully
study this issue.
B. The Competitiveness Argument
Although the Treasury Report asserts that U.S. corporations face a
competitive disadvantage, the Report does not adequately document such
a disadvantage. Thus, I believe that there is absolutely no foundation
for the following statement in the Treasury Report: ``The impact of
this competitive disadvantage is seen most starkly with the recent
inversion activity * * *.'' \6\ There is nothing in the Treasury Report
to support the assertion that inversions are undertaken to address a
competitiveness problem these companies face overseas. Certainly
inversions reduce the overall tax liability, but there is no evidence
that the tax liability these companies are facing is greater than the
tax liabilities their competitors face. Although the Treasury says that
it reviewed the proxy statements of many companies engaging in
inversion transactions, the Treasury Report does not cite to any
statements in those proxy statements to the effect that the
transactions are being undertaken to allow the companies to address
competitiveness problems they face.
---------------------------------------------------------------------------
\6\ Treasury Report, supra at 28.
---------------------------------------------------------------------------
In fact, it would appear that our current deferral system for
active income, in large measure, addresses the basic competitiveness
issue. For example, assume that a U.S. corporation (USC) operates an
active business through a foreign subsidiary located in foreign country
(X). Also, a foreign competitor (FC) that is organized in a country
with a territorial system operates a competing active business through
a foreign subsidiary in X. In this case, the foreign subsidiaries of
USC and FC face the same foreign tax in X, which is, say, at a 30%
rate. The CFC provisions do not require the imputation to USC of the
income of its sub, because the income is active income earned in X.
Therefore, at the time the business operations are conducted or
earnings are reinvested, there is a level playing field for USC and FC
in X from an income tax perspective.
At the time the earnings of the subs are repatriated, USC is
subject to tax on the repatriated amounts, but USC is, subject to
certain limitations, allowed a foreign tax credit for the 30% taxes the
sub has paid to X. Where the tax paid to X is less than the U.S. tax
liability, the full amount of the foreign tax is generally allowed as a
credit. Thus, in such case, the net additional tax due to the U.S.
would be the 5% difference between the 30% rate in X and the 35%
corporate rate in the U.S. On the other hand, under the territorial
system that applies to FC, it can repatriate the income from its sub
tax-free. Thus, in this case, the competitive disadvantage faced by USC
with respect to its current operations is the present value of the 5-
percentage point difference in tax rates between the U.S. and X, which
is to be incurred at some point in the future when the income is
repatriated. A careful analysis of this type of situation could lead to
the conclusion that this difference is insignificant from a
competitiveness standpoint.
Let me be clear, I am not asserting that there is no
competitiveness problem. I am merely stating that (1) the Treasury
Report has not presented evidence of a competitiveness problem, and (2)
the issue needs to be carefully studied. There are many elements to
this competitiveness issue. For example, consider the impact the
following facts have on competitiveness: (1) the U.S. has the lowest
tax to GDP ratio of any of its major trading partners except Japan,\7\
and (2) in Japan, the corporate tax is 13% of total tax revenues,
whereas in the U.S. the corporate tax is only 9% of total tax revenues,
which is the average for the OECD.\8\ The competitiveness issue is too
complex and too important for any one to ``jump the gun.''
---------------------------------------------------------------------------
\7\ OECD Economic Outlook, 171 (June 2001).
\8\ Id. at 174.
---------------------------------------------------------------------------
C. The Reverse Competitiveness Argument with a De facto Territorial
System
While the Treasury Report focuses on the competitiveness problem
between U.S. companies and their foreign competitors, the inversion
transaction creates a competitiveness problem between competing U.S.
firms. For example, assume that the major U.S. competitor of Coopers
Industries, which is considering an inversion, also competes with
Coopers in foreign markets. Also, assume that the competitor's
shareholders vote no on a proposed inversion transaction because the
tax cost to the shareholders under the section 367 regulations is too
high. However, Coopers Industries goes forward with its inversion
transaction, because the tax cost to its shareholders is not a barrier
to the transaction. In such case, it would appear that Coopers
Industries has attained a real competitive advantage over its U.S.
competitor. Also, the lower tax rate might give Coopers an advantage in
attracting capital. It would appear that this is a much more serious
competitiveness problem than the potential and unproven competitiveness
problem Coopers Industries may face with its foreign competitors.
D. Treatment of Similar Transactions
The Treasury Report argues for moving slowly on inversions because
there are other transactions that can have a similar effect, such as
initial incorporations in tax havens in going public transactions and
acquisitions by substantial foreign acquiring corporations of U.S.
targets. It appears that the Grassley/Baucus anti-inversion bill would
apply to many foreign, going public incorporations, and in any event,
the bill should be amended to clarify and broaden its application to
these transactions.\9\
---------------------------------------------------------------------------
\9\ Analysis of Grassley/Baucus Bill, supra.
---------------------------------------------------------------------------
With respect to real cross border transactions, there seems to be
no evidence that these transactions are motivated for the purpose of
avoiding the U.S.'s CFC provisions. Indeed, most such transactions
involve acquiring corporations that are located in countries that have
CFC provisions, such as the U.K., Germany, and France. But if the
purpose of any such transactions is the avoidance of the U.S.'s CFC
regime, the IRS should be given the tools to challenge those
transactions along the lines of the prior approval provisions of the
Grassley/Baucus bill.\10\ There is no need to wait on addressing
inversions, because these similar transactions can be also addressed.
---------------------------------------------------------------------------
\10\ Id.
---------------------------------------------------------------------------
E. Concern with Congressional ``Deal Chasing''
If creative lawyers and accountants come up with new inversion
schemes not covered by the legislation, which is certainly a
possibility, Congress should act to shut down such transactions.
Indeed, this has been the pattern with legislation dealing with tax
shelters. For example, during the Ford Administration in 1976, Congress
enacted the ``at risk'' rules under section 465 to address real estate
tax shelters. These rules proved ineffective, and as a response during
the Reagan Administration in 1986 Congress enacted the very effective
passive loss rules under section 469. Also, during the Reagan
Administration, in 1981 Congress enacted the disallowance of loss rules
under section 1092 and the mark to market rules under section 1256 to
eliminate tax sheltering in futures straddles transactions, and in 1983
Congress extended those rules to stock option straddles transactions,
which had become a new market for such sheltering. These are examples
of what some may refer to as ``deal chasing'' by Congress. I believe
that in view of the very creative tax bar we have in this country, it
is necessary for Congress to be prepared to ``chase deals.'' Otherwise,
tax planners will find ways to undermine the tax system.
LF. Assumption that a Territorial System would be Less Complex than the
Current System
Although the Treasury Report criticizes the complexity with our
current system of taxation of foreign income, it fails to acknowledge
that there will be similar complexities in structuring a territorial
system for active income. For example, there would have to be rules
distinguishing between the active income that qualifies for such
treatment and the passive income that does not. It would be a mistake
to think that in an interconnected global world of business, it is
possible to write simple rules that taxpayers will not be able to
abuse.
The Treasury would be wise to listen to the words of Ron Pearlman,
a very effective former Assistant Secretary of the Treasury for Tax
Policy in the Reagan Administration and a former Chief of Staff of the
Joint Committee on Taxation. In commenting at a 1988 conference on
efforts to simplify the corporate tax provisions of the Code, Assistant
Secretary Pearlman said:
L We think it a bit dangerous * * * to sell these [corporate
reform proposals] as simplification. Corporate transactions by their
nature are complex and they will continue to remain complex, we
suspect. We would guess that, ultimately, the rules governing those
transactions will be complex.\11\
---------------------------------------------------------------------------
\11\ Pearlman, The Political Environment of Corporate Tax Reform, A
Report of the Invitational Conference on Subchapter C 34 (1988).
Since the time Mr. Pearlman wrote those words 14 years ago, as he
predicted, corporate transactions have become more complex, and this is
particularly true of international corporate transactions. The lesson
the Treasury should learn from Mr. Pearlman is that it would be a ``bit
dangerous'' to sell a territorial regime as simplification.
Also, if simplification is the principal goal in structuring an
international tax regime, it might be advisable to move in the opposite
direction of a territorial system and eliminate all deferral by simply
imputing all of the income of controlled foreign corporations to their
U.S. shareholders. This would eliminate the need to determine subpart F
income and could dramatically simplify the foreign tax credit rules.
Indeed, there would be complexity with such a move, but on balance, it
could be less complex than either the current system or a territorial
system.
G. Decoupling the Territorial Issue From the Inversion Issue
There is no sound basis for coupling the examination of the
potential move to a territorial system with the inversion problem. They
are different problems and should be treated as such. Without respect
to one's views on the desirability of a territorial system, it is
difficult to comprehend, on tax policy grounds, why Congress would not
act immediately to close down inversions, because these transactions
produce territorial taxation for passive income, which is not even
supported by the NFTC. Indeed, the ability of an inverted company to
park passive income offshore tax-free will act as a giant magnet
sucking capital out of the U.S.
H. Potential Additional Approach to Interest Stripping
Both the Treasury Study and the Grasssley/Baucus bill address
interest stripping with potential amendments to section 163(j). A
potential additional approach to interest stripping might be an
amendment to the Code, along the lines of Congressman Doggett's bill,
that overrides any treaty, such as the Barbados treaty, insofar as the
treaty is employed in an inversion or similar transaction for purposes
of interest stripping or other transactions having a similar effect.
This would merely be a statutory extension of the Treasury's anti-
treaty shopping provisions of the Model Treaty. The inadequacy of those
provisions makes interest stripping possible.
V. TREASURY JUNE 6, 2002 TESTIMONY
A. Summary of Treasury Testimony
On Thursday June 6, 2002, Pamela Olson, the Treasury's Acting
Assistant Secretary for Tax Policy, testified at a hearing before the
House Ways and Means Committee on Corporate Tax Inversions. Her
testimony basically followed the arguments made in the Treasury's May
17, 2002 Interim Report on Inversions. She also recommended ``removing
the juice'' from inversions by curtailing earnings stripping. She said,
however, that Treasury does not favor action directly attacking
inversions, because a ``blockade'' against inversions may make other
transactions that can have a similar effect ``more beneficial.''
Specifically, she referred to start-up incorporations in tax haven
jurisdictions and to foreign acquisitions of U.S. companies. In
response to Chairman Thomas's question concerning the wisdom of a
``narrow approach'' to inversions, she said something to the effect
that ``foreign companies will have an advantage if we only address
inversions.'' At a later point she said that putting up a ``Berlin
Wall'' against inversions or ``blockading'' them would be harmful to
the U.S.
B. Critique of Treasury's Testimony
This explanation for not immediately ``blockading'' inversions is
unconvincing. First, foreign corporations can acquire U.S. corporations
whether or not U.S. corporations can engage in inversions. Second, the
Treasury has cited no evidence that acquisitions by substantial foreign
companies located in non-tax haven jurisdictions, such as Germany and
France, have been acquiring U.S. companies for tax motivated reasons.
Third, any acquisition of a U.S. company by a foreign company located
in a tax haven jurisdiction, such as the prior acquisition by a Bermuda
based company of Tyco in a reverse acquisition, likely would be treated
as a pure inversion under the Grassley/Baucus REPO bill, and as a
consequence, the foreign acquiror would be treated as a U.S.
corporation. In any event, there seems to be no evidence that foreign
acquirors with active business operations in tax havens are acquiring
U.S. corporations. Fourth, the Grassley/Baucus REPO would address in
part many start-up foreign incorporations, and the bill should be
amended to pick-up these transactions more completely.
The Treasury's approach would in essence retain the status quo with
inversions, except for modification of the earnings stripping
provisions, tightening the transfer pricing rules, renegotiating
treaties, and enhancing reporting requirements for gain under the
section 367 regulations. With the exception of the reporting issue,
all of these changes are focused on the base erosion aspects, such as
interest stripping, of these transactions, and the Grassley/Baucus bill
would address these issues more directly and with less complexity by
treating the foreign holding companies in pure inversion transactions
as domestic corporations.
To summarize, the Treasury's no ``blockade'' approach would give
companies engaging in inversion transactions de facto territorial
taxation for all types of foreign income, including: (1) active foreign
income that would be foreign base company sales income and, therefore,
subject to imputation under the Controlled Foreign Company (CFC)
provisions in the absence of an inversion, and (2) passive foreign
income that also would be subject to imputation under the CFC
provisions in absence of an inversion. Thus, as indicated above, the
Treasury's acceptance of a de facto territorial approach would even go
further than the approach initially proposed by the NFTC.
VI. CONCLUSION
The Treasury has missed the mark by a wide margin in both its
Interim Report and in its Testimony. Under the Treasury's suggestion
for further study of a move to a territorial system, in the interim,
companies would be able to engage in inversions and similar
transactions that produce a de facto territorial system for both active
and passive foreign income. This is an indefensible tax policy
position, and Congress should move quickly to bring a prompt end to
inversions and similar transactions by adopting the Grassley/Baucus
anti-inversion bill or some similar provision. After shutting down
these transactions, Congress and Treasury should then turn their
attention to the real issue: a thorough, effective, careful, and honest
study of the merits of both (1) a move to a territorial system, and
(2), in the words of the NFTC's June 11 Report, the ``reform of our
current deferral and foreign tax credit system.''
Mr. McNULTY. And, as usual, I ask unanimous consent that
all Members of the Subcommittee have the opportunity to submit
written statements.
Chairman McCRERY. Without objection.
Mr. McNULTY. Thank you, Mr. Chairman. I am very pleased
that you have scheduled today's hearing of our Subcommittee on
this very important subject. Since the estate tax sunset bill
was being considered before the House of Representatives at the
same time the Committee was receiving the June 6 testimony on
this most important issue, it was appropriate that we postpone
the full Committee hearing and resume today before this
Subcommittee.
I welcome all of our colleagues from the Congress who are
appearing before this Subcommittee today to discuss the
legislation they have introduced to stop corporate inversion
transactions.
We must act on this legislation with great speed. The
problem is clear, and the solution is simple. I have no
sympathy for the argument that these Benedict Arnold companies
are justified in their actions, literally turning their back on
this country because of problems they claim with our tax laws.
No one should justify tax avoidance at a time of war by
complaining about the laws. We have at least two concrete
proposals to address this issue.
First, Congressman Neal has authored H.R. 3884, the
``Corporate Patriot Enforcement Act,'' which is coauthored by
Congressman Maloney, and merits our particular attention. Their
bill would address a real and growing problem of U.S.
corporations avoiding taxes through paper reincorporation
overseas. The bill would raise $4 billion over 10 years and
eliminates any tax benefits for companies that expatriated
after September 11, 2001. Companies that expatriated before
that date would be brought back into the U.S. tax system in 2
years.
Second, Congressman Doggett has authored H.R. 4993, which
also merits our serious attention. His bill would provide a
backstop to the Neal bill by eliminating the ability of
corporations to use U.S. tax treaties to strip earnings out of
the United States for the purpose of eliminating tax. In such
circumstances, the bill would limit the availability of tax
benefits to treaty-country residents.
Corporate executives may decide that patriotism needs to
take a back seat to profits. I believe that Congress will take
a different view. At a time when we are asking our Armed Forces
to risk their lives in the war against terrorism, I find it
contemptible that corporations would renounce their allegiance
to this country in order to evade taxes. It is especially
troubling that some of these expatriating corporations have
profitable contracts with the Federal Government.
The public expects us to act and to act now. Every dollar
of tax evaded by corporations fleeing our borders must be paid
by someone else.
I want to thank you, Mr. Chairman, for holding this
important hearing and providing especially our Members and
other interested parties with the opportunity to be heard.
Thank you.
[The opening statement of Mr. McNulty follows:]
Opening Statement of the Hon. Michael McNulty, a Representative in
Congress from the State of New York
I am very pleased that the Select Revenue Measures Subcommittee is
holding today's hearing. Since the estate tax sunset bill was being
considered before the House of Representatives at the same time as the
Committee was receiving the June 6th testimony on this most important
issue, it was appropriate that we postponed the full Committee hearing
and resume today before this Subcommittee.
I welcome all of the Members of Congress appearing before the
Subcommittee to discuss the legislation they have introduced to stop
corporate inversion transactions. We must act on this legislation with
great speed. The problem is clear and the solution is simple.
I have no sympathy for the argument that these ``Benedict Arnold''
companies are justified in their actions--literally turning their back
on this country because of problems they claim with our tax laws. No
one should justify tax avoidance at a time of war by complaining about
the laws. We have at least two concrete proposals to address this
issue.
First, Congressman Neal has authored H.R. 3884, the ``Corporate
Patriot Enforcement Act,'' which is cosponsored by Congressman Maloney,
and merits our particular attention. Their bill would address a real
and growing problem of U.S. corporations avoiding taxes through paper
reincorporations overseas. The bill would raise $4 billion over ten
years, and eliminate any tax benefits for companies that expatriated
after September 11, 2001. Companies that expatriated before that date
would be brought back into the U.S. tax system in two years.
Second, Congressman Doggett, has authored H.R. 4993, which also
merits our serious attention. His bill would provide a backstop to the
Neal bill by eliminating the ability of corporations to use U.S. tax
treaties to strip earnings out of the U.S. for the purpose of
eliminating tax. In such circumstances, the bill would limit the
availability of tax benefits to treaty country residents.
Corporate executives may decide that ``patriotism needs to take a
back seat'' to profits. I believe the Congress will take a different
view. At a time when we are asking our Armed Forces to risk their lives
in the war against terrorism, I find it contemptible that corporations
would renounce their allegiance to this country in order to evade
taxes. It is especially troubling that some of the expatriating
corporations have profitable contracts with the Federal Government.
The public expects us to act and to act now. Every dollar of tax
evaded by corporations fleeing our borders must be paid by somebody
else.
I want to thank you Mr. Chairman for holding this hearing and
providing Members and interested parties with the opportunity to be
heard. Thank you.
Chairman McCRERY. Thank you, Mr. McNulty.
Our first panel today is a distinguished one, to say the
least: four Members who have been leaders in the effort to get
the Congress to take a look at this issue. Mrs. Johnson, I
remember, was taking a leading role in this issue, kind of a
side issue on insurance companies; 3 or 4 years ago, she pulled
me aside and said we have got to be concerned about this. Then
Scott McInnis, I think, was the first one this year to
introduce legislation on this subject. Mr. Neal and Mr.
Maloney, of course, have the bill that was the subject of Mr.
McNulty's opening remarks and have been leaders in trying to
get the Congress to shed some light on this issue.
So we indeed have a distinguished panel before us of our
colleagues today, and we are very thankful for you all agreeing
to come and share with the Subcommittee your ideas, your
thoughts, on this very important topic.
So with your permission, gentlemen, I will begin with the
lady amongst you, Mrs. Johnson. Mrs. Johnson, and all of you,
your written remarks will be entered into the record in full,
but as you know, we would like for you to try to summarize
those in about 5 minutes. Mrs. Johnson.
STATEMENT OF THE HON. NANCY L. JOHNSON, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF CONNECTICUT
Mrs. JOHNSON OF CONNECTICUT. Thank you, Mr. Chairman, Mr.
McNulty, and Subcommittee Members. I appreciate your convening
this hearing on a very important topic: the troubling practice
of American companies reincorporating overseas to avoid paying
taxes. I am strongly opposed to these moves, including the ones
most recently proposed by Stanley Works in Connecticut.
I have introduced legislation to impose an immediate
moratorium to stop Stanley Works and other companies from
reincorporating in tax havens like Bermuda, while giving the
Congress the time to enact broader legislation aimed at keeping
jobs and companies in America. My bill, H.R. 4756, would extend
through December 31, 2003.
My legislation will stop the destructive practice of
American companies renouncing their American identity to avoid
the taxes that provide the very services they benefit from.
American companies should act like American companies and pay
their fair share to keep our country strong.
The Treasury Department's recent report on corporate
inversions confirmed that more American companies will exploit
this tax loophole if action is not taken to address the cause
of the problem.
On June 6, 2002, in testimony before the full Committee,
the Treasury Department made clear that a ban, without taking
further steps to reform our Tax Code to keep jobs and companies
in America, is unlikely to work and could be very harmful to
our economy.
The Treasury Department points out that just plugging the
Bermuda loophole without solving the larger problem sets U.S.
companies up for foreign takeovers because foreign owners would
escape the very taxes a U.S. company dodges by moving to a tax
haven. Unfortunately, a foreign owner not only escapes taxes
but has less incentive to keep jobs in America.
The Treasury Department prefers my moratorium proposal
because we need a thorough understanding of all aspects of the
fundamental problem to ensure that the solution we adopt does
not make matters worse; in fact, does address the problem. The
problem is much greater than companies reincorporating overseas
to avoid paying taxes, and companies must make sure that we
don't plug one hole only to leave others open or create even
bigger ones.
The underlying problem is that our Tax Code is driving U.S.
companies offshore. The signs have been clear. For example, I
have been lobbying for a bill I introduced with Mr. Neal 2
years ago, and again this Congress, to stop reinsurance
companies from taking advantage of a similar Bermuda tax
loophole.
Insurers originally incorporated in Bermuda that acquired
U.S. companies are able to siphon U.S. profits offshore to a
tax haven out of the reach of our Treasury Department by
reinsuring their U.S.-owned subsidiary's reserves to Bermuda.
Congress should address both the inversion and reinsurance
loopholes, as well as any other loophole that exists if we are
going to permanently resolve the alarming exodus of U.S.
interests to offshore tax havens to avoid paying their fair
share of taxes.
And the now near total loss of the reinsurance industry to
Bermuda isn't the only sign the Committee has had of this
problem. According to testimony heard by the full Committee on
Ways and Means 2 years ago, DaimlerChrysler is German-owned
because of the U.S. Tax Code. So current downsizing decisions
are being made in Germany, not in America.
Prompt passage of my moratorium is essential. It will give
Congress the time to develop a more comprehensive solution to
keep jobs and companies in America. Without a permanent and
all-inclusive approach, loopholes will remain, and tax lawyers
will simply circumvent the legislative proposals before the
Subcommittee, inviting foreign takeovers of U.S. companies and
putting decisionmaking about U.S. jobs and research and
development (R&D) in the hands of foreign executives.
Our goal is simple: Keep companies in America; keep jobs in
America. Any proposal that does less is unacceptable. The
Treasury Department has recommended specific steps that
Congress should take to remove the tax incentives that are
driving companies to reincorporate overseas. I support taking
action on these urgent changes, but this may take time.
Unfortunately, in this politically charged climate, it is often
difficult to get the House and Senate to work in a bipartisan
way on even the simplest of legislative initiatives to save
American jobs.
Given the complexity of this corporate inversion issue and
the short amount of time remaining in this congressional
session, I urge the Subcommittee to act immediately on my
moratorium legislation to stop companies from reincorporating
overseas. There is nearly universal agreement that we must take
action to stop companies from reincorporating in tax havens.
Given this breadth of support, let us pass a moratorium to
stop them in their tracks and send a powerful message, to
others who may be looking at other possible tax loopholes, that
Congress is watching, and we will be acting as quickly as
possible to prevent the dodging of U.S. taxes in a
comprehensive way.
A moratorium will ensure that no company slips through the
cracks while Congress develops a permanent solution to keep
U.S. companies in America, keep them competitive, and protect
American jobs. We cannot afford to wait.
Thank you, Mr. Chairman.
[The prepared statement of Mrs. Johnson follows:]
Statement of the Hon. Nancy L. Johnson, a Representative in Congress
from the State of Connecticut
Mr. Chairman and Members of the Subcommittee:
Thank you for convening this important hearing concerning the
troubling practice of American companies reincorporating overseas to
avoid paying taxes. I am strongly opposed to these moves, including the
one most recently proposed by Stanley Works in Connecticut.
I have introduced legislation to impose an immediate moratorium to
stop Stanley Works, and other companies, from reincorporating in tax
haven countries like Bermuda, while giving Congress time to enact
broader legislation aimed at keeping jobs and companies in America. My
bill, H.R. 4756, would extend through December 31, 2003.
My legislation will stop the destructive practice of American
companies renouncing their American identity to avoid the taxes that
provide the very services they benefit from. American companies should
act like American companies and pay their fair share to keep our
country strong.
The Treasury Department's recent report on corporate inversions
confirmed that more American companies will exploit this tax loophole
if action is not taken to address the cause of the problem. On June 6,
2002, in testimony before the full Committee, the Treasury Department
made clear that a ban, without taking the further step of reforming our
Tax Code to keep jobs and companies in America, is unlikely to work and
could be very harmful to the economy. Treasury points out that just
plugging the Bermuda loophole without solving the larger problem, sets
U.S. companies up for foreign takeovers, because foreign owners would
escape the very taxes a U.S. company dodges by moving to a tax haven.
Unfortunately, a foreign owner not only escapes taxes, but has less
incentive to keep jobs in the U.S.
The Treasury Department prefers my moratorium proposal because we
need a thorough understanding of all aspects of the fundamental problem
to ensure that the solution we adopt does not make matters worse. This
problem is much greater than companies reincorporating overseas to
avoid paying taxes and Congress must make sure that we don't plug one
hole, only to leave others open, or create even bigger ones.
The underlying problem is that our Tax Code is now driving U.S.
companies offshore. The signs have been clear. For example, I have been
lobbying for a bill I introduced with Mr. Neal two years ago and again
this Congress to stop reinsurance companies from taking advantage of a
similar Bermuda tax loophole. Insurers originally incorporated in
Bermuda that acquire U.S. companies are able to siphon U.S. profits
offshore to a tax haven, out of the reach of our Treasury, by
reinsuring their U.S.-owned subsidiaries' reserves to Bermuda. Congress
should address both the inversion and reinsurance loopholes, as well as
any other loopholes that exist, if we are going to permanently resolve
the alarming exodus of U.S. interests to offshore tax havens to avoid
paying their fair share of taxes.
And the now near total loss of the reinsurance industry to Bermuda
isn't the only sign the Committee has had of this problem. Daimler-
Chrysler is German-owned because of the U.S. Tax Code, so current
downsizing decisions are being made in Germany, not the U.S.
Prompt passage of my moratorium is essential. It will give Congress
the time to develop a more comprehensive solution to keep jobs and
companies in America. Without a permanent and all-inclusive approach,
loopholes will remain, and tax lawyers will simply circumvent the
legislative proposals before the Committee, inviting foreign takeovers
of U.S. companies, and put decisionmaking about U.S. jobs in the hands
of foreign executives.
Our goal is simple: Keep companies in America. Keep jobs in
America. Any proposal that does less is unacceptable!
The Treasury Department has recommended specific steps that
Congress should take to remove the tax incentives that are driving
companies to reincorporate overseas. I support taking action on these
urgent changes, but this may take time. Unfortunately, in this
politically charged climate, it is often difficult to get the House and
Senate to work in a bipartisan way on even the simplest of legislative
initiatives. Given the complexity of this corporate inversion issue,
and the short amount of time remaining in this congressional session, I
urge the Committee to act immediately on my moratorium legislation to
stop companies from reincorporating overseas.
There is nearly universal agreement that we must take action to
stop companies from reincorporating in tax haven countries. Given this
breadth of support, let's pass a moratorium to stop them in their
tracks and send a powerful message to others who may be looking at
other possible tax loopholes, that Congress is watching and we will be
acting as quickly as possible to prevent the dodging of U.S. taxes in a
comprehensive way.
A moratorium will ensure that no company slips through the cracks
while Congress develops a permanent solution to keep U.S. companies in
America, keep them competitive and protect American jobs. We cannot
afford to wait.
Chairman McCRERY. Thank you, Mrs. Johnson. Mr. Neal.
STATEMENT OF THE HON. RICHARD E. NEAL, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF MASSACHUSETTS
Mr. NEAL. Thank you, Mr. Chairman. First let me acknowledge
that you and Mr. McNulty have been faithful to your word here
about keeping this issue before the Subcommittee, and I want to
thank you again personally for scheduling this hearing today
for our consideration.
The practice of reincorporating in a foreign country to
avoid paying U.S. income tax is inconsistent with American
corporate citizenship and blatantly unfair to those individuals
and businesses who pay their fair share in taxes.
Since I first wrote to my colleagues in early February
about this issue, and indeed 2 years ago with Mrs. Johnson
about the reinsurance issue, the stream of corporations signing
up to flee the United States has continued unabated. Despite
patriotic sentiments expressed around this great Nation in the
wake of the attacks of September 11, even public rebukes in
newspapers have had little impact, including today's from Allan
Sloan in the Washington Post condemning this practice as,
quote, ``the worst abuse of all, moving corporate headquarters
to places like Bermuda to duck U.S. taxes on U.S. income.''
To address the problem of corporate inversions, or
corporate expatriation, Mr. Maloney and I have introduced H.R.
3884, the ``Corporate Patriot Enforcement Act.'' This bill,
supported by both Republicans and Democrats, simply says that
companies that reincorporate overseas must pay U.S. income tax
when the new company has substantially the same assets and more
than 80 percent of the same shareholders of the former U.S.
company.
A tougher test is applied to corporate expatriates that
have no substantial U.S. business activity in a foreign country
and if its stock is principally traded in the United States.
The Neal bill currently has 104 bipartisan cosponsors. That
is almost one quarter of this body which has put their name to
this legislation. It would save $4 billion in Federal taxpayer
money, which would otherwise be siphoned off by expatriate
companies.
Earlier this month, Goldman Sachs Chief Executive Officer,
Henry Paulson, said he knew of no time before that, quote,
``business overall has been held in less repute.'' Restoring
the integrity in our corporations,'' he said, was crucial for
getting the economy back on track. With companies resorting to
expatriation schemes that have no legitimate business purpose,
it is easy to see why investors have doubts about corporate
integrity.
Preventing corporate expatriates from cheating the Federal
Treasury while their honest competitors and hardworking
Americans pay their fair share is a responsibility this
Subcommittee must assume. The solution is common sense. Stop
the corporate traitors by shutting down the corporate loophole
now and permanently.
We are fortunate today to have experts before us to testify
about this issue. We are also fortunate that several Members
have been actively engaged on this issue and all have similar
approaches to dealing with the problem.
Mr. Chairman, in addition to my written statement, I would
also request that the record include a report detailing the
more than $2 billion in government contracts won by corporate
expatriates and a preliminary list of 25 corporate expatriates
and their former U.S. headquarters.
I want to emphasize that my interest in this issue was
generated, obviously, based upon the reinsurance question. But
at the same time, it was not the American Federation of Labor-
Congress of Industrial Organizations, it was not the consumer
groups, it was not the green party and Ralph Nader who brought
this issue about. It was the business community in America who
approached me and said, ``We stay. We like America. We like
doing business here. We want an American address, and we hope
we are not to be penalized for the good work that we
undertake.''
I want to close on the note that I opened with, Mr.
Chairman. Thanks to you and Mr. McNulty, you all have attempted
to hear what we all have said on this very, very important
question. Thank you.
[The prepared statement of Mr. Neal follows:]
Statement of the Hon. Richard E. Neal, a Representative in Congress
from the State of Massachusetts
Mr. Chairman and Mr. McNulty, thank you for bringing this important
issue before the Committee today for consideration. The practice of
reincorporating in a foreign country to avoid paying U.S. income tax is
inconsistent with American corporate citizenship and unfair to those
individuals and businesses who pay their fair share in taxes. Since I
first wrote to colleagues in early February about this issue, the
stream of corporations signing up to flee the U.S. has continued
unabated, despite patriotic sentiments expressed around this great
Nation in the wake of the attacks of September 11th. My colleague, Mr.
Maloney, was the first to raise this issue in our Democratic caucus
meetings, as many workers and retirees in his district are currently
struggling with Stanley Tools' decision to leave for Bermuda.
To address the problem of corporate inversions (or corporate
expatriation), Mr. Maloney and I have introduced H.R. 3884, The
Corporate Patriot Enforcement Act. This bill, supported by both
Republicans and Democrats, simply says that companies that
reincorporate overseas must pay U.S. income tax when the new company
has substantially the same assets and more than 80% of the same
shareholders of the former U.S. company. A tougher test is applied to
corporate expatriates that have no substantial business activity in a
foreign country and if its stock is principally traded in the U.S.
The Neal-Maloney bill currently has more than 100 cosponsors, would
save $4 billion in Federal taxpayer money otherwise siphoned off by
expatriate companies, and narrowly lost on the House floor last week as
an amendment to another tax bill (Roll Call 247, 186 For, 192 Against).
Investor/Shareholder Issues
Earlier this month, Goldman Sachs CEO Henry Paulson said he knew of
no time before that ``business overall has been held in less repute.''
Restoring integrity in our corporations, he said, was crucial for
getting the economy back on track. With companies resorting to
expatriation schemes that have no legitimate business purpose, it is
easy to see why investors have doubts about corporate integrity. As one
aggressive tax practitioner was quoted a mere two months after
September 11th regarding corporate expatriation, ``maybe the patriotism
issue needs to take a back seat'' to improved corporate earnings.
One corporate expatriate even chose Flag Day as the day
shareholders voted to renounce U.S. corporate citizenship. With U.S.
corporations contemplating expatriating on patriotic holidays, it is no
wonder a new poll found that 57% of Americans do not trust corporate
executives to give them honest information and one-third of Americans
believe what happened at Enron is typical of behavior at most
companies. (Wall Street Journal/NBC News Poll, Wall Street Journal,
June 13, 2002, A4.)
Furthermore, investors and shareholders of expatriating companies
should be forewarned that this move could negatively impact their
rights. One expatriating company warned in an SEC filing, ``Our
shareholders may have more difficulty protecting their interests in
Bermuda than would shareholders'' in the U.S. These warnings are
beginning to resonate among some public investors. Consider these
comments by public officials and pension trustees, many who have now
cast votes against corporations seeking to leave the United States for
tax havens:
LH. Carl McCall, the Comptroller of the State of New York and
sole trustee of the state's Common Retirement Fund, ``We are
concerned that Nabors' reincorporation would compromise the
accountability of the company's officers and directors, and
threaten the long-term interests of shareholders.''
LBrad Pacheco, spokesman for the California Public Employees'
Retirement Fund (CalPERS), one of the largest Stanley
shareholders, ``We voted against the plan. It sets a bad
precedent and could create of flood of companies moving to
Bermuda.''
LDenise L. Nappier, Treasurer of the State of Connecticut and
principal fiduciary of the Connecticut Retirement Plans and
Trust Funds, ``While in some instances Connecticut and Bermuda
law regarding shareholder rights may be similar, the overall
weight of the differences results in a substantial reduction in
the rights of shareholders. Basic shareholder rights that we
take for granted in the United States are either non-existent
or vague in a number of critical areas.''
LThe State of Wisconsin Investment Board Executive Director
Pat Lipton, ``offshore reincorporations add risks for
shareholders, since we know it could be more difficult to
enforce our legal rights there and we're not sure how
protective the Bermuda legislature and courts will be of
shareholders.''
LThe five New York City Pension Funds Comptroller William C.
Thompson, ``These companies have offered no compelling business
reasons for reincorporating in Bermuda other than the notion
that it would reduce U.S. taxes. We are concerned about the
effect such a move would have on shareholders. I believe, on
balance, that the interests of shareholders are not served by
such a move.''
In light of the difficulties shareholders, investors, and creditors
of Enron are experiencing, this Committee should ensure that our laws
do not encourage or reward expatriates who flee to tax havens or
``judgment havens.'' I expect we will hear some expert testimony on
this today from Connecticut Attorney General Blumenthal.
Ideological Divide
Some have characterized corporate expatriation as ``rational
business decisions'' or ``sensible corporate activity.'' I find these
rationalizations absurd. The same outrage Americans feel about the
excesses of Enron and Tyco is also being expressed towards these
expatriating companies, one which rented a box in Bermuda to avoid $40
million in U.S. taxes.
Many of these defenders quote Judge Learned Hand, stating that no
taxpayer has a patriotic duty to increase their taxes. We would all
agree with that statement. Oddly enough in that case, Judge Hand ruled
against the taxpayer finding her transaction to be a tax shelter
lacking business purpose. The essence of Judge Hand's opinion, and what
should be emphasized here, is that while you need not increase your
taxes to be a good citizen, you also should not unfairly evade taxes
either. Our system of voluntary compliance depends on corporations and
citizens alike abiding by the rules and not unfairly shifting the tax
burden to others.
Taxpayers are rightly outraged when they hear of such flimsy tax
avoidance scams. I have been encouraged in my efforts by the support of
newspapers around the country, including these selected excerpts from
editorials:
L ``The simple answer to corporate flight is the one advocated
by congressional Democrats: Refuse to change the tax treatment
of companies that move their legal base abroad without changing
where their real operations are located.'' The Washington Post,
6/9/02.
L ``Tax policy of this sort is outrageously offensive, if not
masochistic. It penalizes businesses that behave ethically and
responsibly and rewards those that do not. . . . Americans
should be outraged, and so should Congress, which should move
quickly to pass pending legislation outlawing the dodge.''
Peoria Journal Star editorial, May 12.
L ``Businesses that want to enjoy the benefits and protections
provided by this country should pay their fair share of taxes.
Guess who will wind up picking up the tab as a result of
Stanley's tax avoidance? Other American taxpayers, of course.''
Hartford Courant editorial, May 14.
L ``Even in the best of times, it is outrageous for companies
to engage in offshore shenanigans to avoid paying their fair
share of taxes. Doing so after the Enron scandal, in dire
fiscal times and when the Nation is at war is unconscionable.''
New York Times editorial, May 13.
L ``American companies that have no headquarters, no employees
or operations in foreign tax havens should not be able to lower
their taxes by, in essence, acquiring an island post office
box. Basic fairness to American companies that remain
incorporated in the United States is at stake.'' Houston
Chronicle editorial, May 9.
L ``When a U.S.-based corporation decides to reincorporate,
basing its operations in, say, the Cayman Islands when the
company has little more than a mailbox there, it can legally
avoid millions of dollars in taxes. . . . There will come no
better moment than this one to right that wrong. We look
forward to the floor vote.'' Springfield Union News editorial,
May 7.
The Administration and others would prefer a ``go slow'' approach
on corporate inversions, preferring instead to study the intractable
issue of fundamental tax reform. Recently, the CEO of corporate
expatriate Stanley Tools endorsed this approach, stating that he
``favors recommendations'' by Treasury to overhaul the Tax Code, as
opposed to specific legislation to close the loophole. It is my sincere
hope that this Committee does not follow his advice.
Conclusion
Preventing corporate expatriates from cheating the Federal treasury
while their honest competitors and hard working Americans pay their
fair share is a responsibility this Committee must assume. The solution
is common sense--stop these corporate traitors by shutting down the
loophole now, and permanently. While we continue to fight for tax
simplification ensuring that U.S. businesses remain competitive
globally, we all acknowledge that this effort will take some time.
Still, it will never be right for companies to buy a file cabinet in a
tax haven to avoid paying millions in U.S. taxes, whether we keep our
current corporate tax system or switch to another. A plug to this
loophole is needed today, tomorrow, and forever.
We are fortunate today to have experts before us to testify about
this issue. We are fortunate also that several Members have been
actively engaged on this issue and all have similar approaches to
dealing with this problem. Again, I look forward to the testimony and
prompt action to shut down this offensive practice.
Chairman McCRERY. Thank you, Mr. Neal. And, without
objection, the report to which you refer will be admitted to
the record. Mr. McInnis.
[The information follows:]
Corporate Expatriates and U.S. Federal Government Contracts
This information was compiled by the Office of Rep. Richard Neal and is
based on
a sample of former U.S. companies from public information sources, and
is not
intended to be exhausive.
Accenture
Consulting business,
formerly
part of Arthur
Andersen.
Inversion to Bermuda
completed
in July, 2001.
Total Federal Contracts
in excess
of $1 billion.
LDecember 13, 2001: Two Federal contracts awarded from
the U.S. Department of Education/Office of Financial Assistance
for system redevelopment and operation. Total cost $234.6
million.
(www.washtech.com/news/govtit/14177-I.html)
LOctober, 2001: Company earnings statement released,
showing Net Revenue for government contracts topping $1 billion
in fiscal year 2001.
(www.informationweek.com/story/IWK20011011 50008)
LSeptember 17, 2001: Accenture rates among the Top 10
GSA schedule holders based on sales to the Federal Government
between July 1, 2000 and June 30, 2001, including management
consulting projects for the U.S. State Department and Defense
Department. Estimated revenues $183.7 million.
(www.fcw.com/supplements/fedList/200I/fed-acc-09-17-01.asp)
LJuly 30, 2001: Internal Revenue Service awards 5-year
contract to redesign IRS website (the Digital Daily). Total
costs expected to reach $46 million.
LAdditionally, Accenture holds numerous contracts with
state government agencies for consulting work, including as
welfare and social services contracts, among other professional
services (see e.g., Nebraska, Ohio, Texas).
PricewaterhouseCoopers
Consulting (PwCC)
Accounting firm spun-
off
consulting firm,
which completed
inversion to
Bermuda in March, 2002.
Total Federal Contracts
in excess
of $760 million.
LMay 6, 2002: PwC is listed as number 46 on the
Washington Technology 2002 list of Top 100 prime contractors in
the Federal IT market. Contracts totaled $128,328,000.
(www.wtonline.com/news/17-3/features/I 82141.html)
LMarch 25, 2002: PricewaterhouseCoopers wins a $4.5
million contract from the Defense Supply Center for management
support services.
(www.washingtonpost.com)
LDecember 15, 2001: The U.S. Army granted a $453
million contract to PwC to implement its new distant-learning
initiative.
(www.govexec.com)
LAugust 1, 2001: Listed as one of the top 200
Government Contractors (No. 125) for the fiscal year 2000.
Total Government Contracting award for 2000 was $171,752,000,
with $69,865,000 in Department of Defense contracts and
$101,887,000 in Civilian contracts.
(www.eagleeyeinc.com/pressroom/GovExecTop200-2000-2.htm)
L2000: The Federal Reserve paid PricewaterhouseCoopers
$1.4 million to audit the individual and combined financial
statements of the Reserve Banks and an additional $200,000 to
audit the Fed's pension and thrift savings plan.
(www.fmcenter.orp-,/pdf/fedauditindep.l)df)
Tyco International
Conglomerate.
Inversion to Bermuda
completed
in March, 1997.
Total Federal Contracts
in excess
of $1 billion.
LFebruary, 2001: Listed as one of the top 10 Federal
contractors for Architecture/Engineering Services for the U.S.
Department of Defense. Total Federal Contracting award for 2000
was $60,976,000.
(www.fpdc.gov/fpdc/fpr.htm, Section l of the Federal
Procurement Report)
--ADT Securities (subsidiary):
LAugust 14, 2000: ADT security systems awarded
contract from the United States Navy for alarm, signal, and
security detection systems. Total cost equaled $283,804.
(www.washingtonpost.com/wp-srv/WPlate/200008/14/1221081400-
idx.html)
LDecember 20, 1999: ADT announces contract to install
aviation security technology (Qcontrol) at Miami International
Airport. Contract price not revealed.
--Tyco Electronics Corporation (subsidiary):
LOctober 15, 2001: M/A-Com, a unit of Tyco
Electronics, awarded a 10-year contract for technology,
equipment, and services to U.S. Federal agencies for the Base
Radio System, managed by United States Army. Total award up to
$1 billion. Additionally, awarded contract for HYDRA land
mobile radio systems for Space and Naval Warfare Systems
Center. Award not to exceed $46 million.
(www.macom.com/about-macom/press.asp?ID=85)
LJuly 30, 2001: Elo Touchsystems, Inc., a unit of Tyco
Electronics Corporation, was added to the GSA schedule,
allowing Federal agencies to purchase their touchscreen
technology, used by military and civilian agencies. Unable to
estimate.
(www.fcw.com/few/articles/2001/0720/web-market-07-30-01.asp)
--Earth Tech (subsidiary):
LMarch 13, 2002: Five-year contract awarded to provide
emergency response services for the U.S. Environmental
Protection Agency (EPA) for several southwestern U.S. states
and the Mexico border, including responding to terrorist
activities as they pertain to environmental cleanup. Total
contract award $100 million.
(www.prnewswire.com/cgi-bin/stories.pl?ACCT=105&STORY=/www/
story/ 03-12-2002)
--AMP Incorporated (subsidiary):
LApril 15, 1999: Placed on GSA schedule contract.
Under schedule 70, Federal agencies may purchase AMP's cable
and wiring products for up to $500,000 without seeking
additional bids.
Foster Wheeler
Engineering,
Environmental, &
Construction Company.
Inversion to Bermuda
completed
on May 25, 2001.
Total Federal Contracts
in excess
of $600 Million.
LOne of the top 10 Federal Contractors for Civilian
government agencies in 2000: Total 2000 award $52,713,000.
--Foster Wheeler Environmental Corporation (subsidiary):
LFebruary 5, 2002: Contract awarded by the U.S. Navy,
to perform environmental cleanups at contaminated Navy and
Marine Corps installations. This was the third consecutive
award for this subsidiary. Award not to exceed $100 million.
(www.corporateir.net/ireye/ir__site.zhtml?ticker=
fwc&script=414&layout=7&item__id=255272)
LNovember 30, 1999: Contract awarded for 5-year
project by the U.S. Army Corps of Engineers to perform
environmental cleanup of ordnance and explosives at the former
U.S. Army Training and Doctrine Command Facility at Fort
McClellan, Alabama. Total award $50 million.
(www.fwc.com/news/rel-I 999/1991210b.cfm)
LNovember 11, 1999: Contract awarded to build and
operate a dry spent nuclear fuel storage facility for the U.S.
Department on Energy, guaranteed through 2009, with the option
to handle other spent nuclear fuel. Facility to be owned
privately by Foster Wheeler and licensed by the NRC. Total
award $217 million.
(http://newsdesk.inel/gov/contextnews.cfm?ID=51)
LSeptember 27, 1999: Five-year contract awarded, with
renewal option, by the Federal Supply service of the U.S.
General Services Administration to provide environmental
advisory services to Federal agencies. Total award (with
renewal) $50 million.
(www.fwc.com/news/rel__1999/19990927.cfm)
LAugust 20, 1998: Ten-year contract awarded by the
U.S. Department of Energy to handle, treat, and repackage low-
level radioactive waste at Oak Ridge National Laboratory. Total
award $212 million.
(www.em.doe.gov/em30/pvortwt.html)
Ingersoll-Rand
Industrial Equipment,
Construction, and
Security.
Inversion to Bermuda
completed
on December 31, 2001.
Total Federal Contracts
Worth:
$3.8 million.
LMarch 26, 2002: Company website lists variety of
products available for government agency purchase, including
forklifts and golf carts to the military and light towers to
the civilian agencies. Multi-year contract; award amount not
available.
(www.irco.com/corpinfo/government__01.html)
LAugust 8, 2001: Contract awarded by the U.S.
Department of Energy for research and development to provide a
refrigeration system for a new cooling, heating, and power
system as part of the Bush Administration's National Energy
Plan. Total award $2,305,469.
(www.energy.gov/HQPress/releases01/augpr/pr01138__v.htm)
--LNorthern Research and Engineering Corporation, Ingersoll-Rand Energy
Systems (subsidiary)
LJuly 25, 2000: Contract awarded by the U.S.
Department of Energy for industrial combined heating, cooling,
and power products. Total contract award $1,457,863.
(www.energy.gov/HWPress/releases00/julpr/pr00201.htm)
STATEMENT OF THE HON. SCOTT MCINNIS, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF COLORADO
Mr. McINNIS. Thank you, Mr. Chairman. I too appreciate, as
has been earlier communicated to you and the Ranking Member,
your interest in this. As previously stated, we should point
out again that even at this table as we now speak, we have two
Republicans and two Democrats.
This is a bipartisan issue. Our focus should not be a
political focus in an election year, our focus should be on
what is going on out there. The analogy, the best analogy I can
see, is that it is like out at the ranch when you have got a
bucket; you know you need a new bucket because the bucket has
got some holes in it. But before we get the replacement bucket
up to the ranch, we have got to use the one we have, and the
first thing you do is plug the holes.
When I talked with Congresswoman Johnson, her moratorium
does exactly that. And I think there are good things in all of
these bills. I am not locked in on one method. I, like the
others here, am locked in on the fact that it isn't right. That
is how you can simply put it. No matter how complicated these
tax accountants like to make it, no matter what the Chairman of
Stanley Works talks about, how it is justified to preserve jobs
and and so forth, and so forth, the fact is it doesn't feel
right, it doesn't look right, and frankly, it is not right.
I introduced the first bill on this, and my focus really on
this issue was not just on the reincorporation that we have
seen going on in Bermuda and so on. My focus was also broader
than that, and that is what is going on with intellectual
property, for example, or the earnings which the Chairman and
Ranking Member have both noted.
I will give you an example. When we talk about intellectual
property, you could have Stanley Works reincorporate in
Bermuda, and then Bermuda takes possession of the name, the
trade name Stanley Works; then license it to the American
operations. The American operations pay for the rights to use
the intellectual property or trademarked name of Stanley Works;
it gets to deduct that as a business expense, and the earnings
then go to Bermuda.
I mean, this is going on across the country, and I am
absolutely convinced that the amount of money that is leaving
the borders of this country without bearing the appropriate
share of the burden is grossly underestimated. I think there is
a lot of money that is going because of corporate greed outside
the borders of this country, and it is not just on
reincorporations.
So my hope today is that the panel looks at the issue--and
I know you have, obviously, from the statements of the Chairman
and the Ranking Member--but that we broaden this and take a
look at the earnings stripping, and we take a look at the
intellectual property and what is occurring out there.
I would like to compliment Congresswoman Johnson. I have
got some of these corporations, I am sure, in Colorado, but I
was not driven to this by a particular corporation. I was
reading an analysis on it. In fact, when I was overseas at a
North Atlantic Treaty Organization (NATO) meeting, I was so
upset by this that I actually called my staff from the NATO
meeting and told them to look into it, and find out who in our
body is kind of an in-house expert on it, and the first name
that came up was Congresswoman Johnson. I have had numerous
conversations with her. I have had conversations with Mr. Neal.
I think we are prepared to do it if we can just come in with
the right way to plug the holes in that bucket. Some of the
holes are bigger than the other holes, and some of them may
take a different type of fix, but, boy, we are leaking a lot of
water.
I would also point out the motivation behind a lot of this,
despite what they say is the noble reason they are doing this,
i.e., they want to save jobs or the tax system is unfair--I
think probably the more realistic reason was stated by an
accountant, and was earlier commented by the Ranking Member,
the Ernst & Young tax partner that said, really the earnings
are so powerful by doing this that patriotism has to take the
back seat.
I can tell you, Mr. Chairman, that when the Chairman of
Stanley Works came to my office, which was a surprise to me
that he would come to my office, but he did come to my office,
I gave him a little wallet-sized list of the soldiers, both men
and women, that we had lost to date in Afghanistan, and I asked
him to put it in his wallet. So every time he talks about this,
pull it out and give it consideration. What kind of obligation
do these corporations have in this country?
So, Mr. Chairman, in conclusion, we can get into the merits
of each of our bills. They are very similar. They are obviously
aimed at the same target. We are in agreement, and we have got
to do something.
So, Mr. Chairman, I appreciate the fact that you and the
Ranking Member have given us this time in this hearing, and
also want to publicly reacknowledge, as I have done a couple
times in this statement, your particular conversations with me
and your focus on plugging those holes, because where you come
from and where I come from, we don't want that water going out
of the bucket.
Thank you, Mr. Chairman.
[The prepared statement of Mr. McInnis follows:]
Statement of the Hon. Scott McInnis, a Representative in Congress from
the State of Colorado
Mr. Chairman, Members of the Subcommittee, thank you for holding
this hearing on inversions, transactions where companies reincorporate
offshore to avoid U.S. taxation. I had hoped to be able to offer some
questions at the hearing in the full Ways and Means Committee on June
6, but unfortunately was unable to do so. I look forward to today's
opportunity to discuss the issues. I especially look forward to working
with the Treasury Department and the Committee to address the plague of
inversions that has visited itself on our country.
Near the beginning of this year, I first became aware of inversion
transactions, and frankly became incensed. On March 6, I introduced
H.R. 3857, the first legislative proposal designed to target inversion
transactions. My proposal would treat inverted companies as U.S.
companies, ignoring the paper-thin transaction designed to avoid taxes.
This bill has bipartisan support, including support from a number of
Members of this Ways and Means Committee, including Rep. Nancy Johnson
(CT). I also cosponsored H.R. 4756, Representative Nancy Johnson's bill
that she introduced to impose a moratorium on these inversion
transactions. It is clear from those facts that this is not a partisan
issue or a political issue--and people should get over trying to make
it one. Rather this is an issue of policy, and I am pleased that the
Subcommittee will have the opportunity to discuss the policy issues
here today.
My bill is similar in design to several of the bills introduced
afterwards, applying a two-level test to the transaction. The first is
a clear bright line test based on a high level of stock ownership by
the same owners following the inversion. The second, involves a lower
level of ownership following the inversion, and sets out a three part
test to distinguish transactions with little substance. The effective
date on this legislation includes transactions completed on or after
January 1, 2002. That date was not designed to include or exclude any
particular company, but rather reflected fair warning to every company
contemplating these tax avoidance techniques.
As I have told anyone that asks me, my overriding goal is to end
these inversions, the exact means of how that happens is less important
to me than the result. I am absolutely willing to work on better ways
to go about achieving that overriding goal. I am aiming a missile at
inversions--but if that missile won't get the job done, then get me one
that will--because that's the one I want to use. My goal in this case
is about the end result, the end result that prevents these inversions
from occurring, not about how we get there and not about who gets the
credit along the way.
When I was drafting my legislation, I sat down with my staff and
sought out advice from recognized experts about how to address the
issue. My legislation reflects some of that advice, but I am the first
to admit that we have learned quite a bit about these transactions
since February and early March of this year. I have become convinced
that the most significant aspect driving these inversions is the
ability to strip out U.S. earnings, via payments to the foreign parent
for interest, dividends and the use or licensing of intangibles. On
April 11 of this year, I announced that it was my intention to work to
tighten the earnings stripping rules, so I have been on record for
several months as recognizing the need to address earnings stripping.
That earnings stripping was such a significant part of these
transactions was not well understood in February. If we can take the
financial incentive out of the transactions, then I am convinced that
companies inverting to avoid taxes will cease. Moreover, as I have
learned more about these transactions, it has become clear that if an
inverted company can strip earnings to achieve a lower tax rate, so can
an existing foreign company that owns a U.S. subsidiary. That issue
needs to be addressed as well, because it will leave a large hole in
any policy response to inversions if we just close one window but
ignore the other window next to it that is wide open. I will continue
to look into these complex transactions and work to refine and revise
my approach as new information yields new facets of these transactions.
A tax partner for a leading accounting firm, Ernst & Young,
commenting on the current climate regarding inversions, noted that ``we
are working through a lot of companies who feel that it is, that just
the improvement on earnings is powerful enough that maybe the
patriotism issue needs to take a back seat to that.'' I cannot disagree
with this sentiment strongly enough. I cannot help but view this issue
as a patriotic issue; this country provides tremendous liberties and
protections to the employees of the companies that invert and the
individuals who run these companies. We have a right to expect that
everyone shoulders a fair share of the burden. Avoiding taxes just
shifts the burden from these companies to every other American. Focus
for a moment on the young men and women who are now fighting the War on
Terrorism in Afghanistan and elsewhere. I would like to think that if
these soldiers can shoulder their burden, we can expect our companies
to shoulder their own fair share. Of course these companies should
preserve American jobs, but tax avoidance is not the way.
To give you some perspective from the common man, as I have
traveled Colorado discussing this issue, I have had small business
owners ask me how they can reduce their effective tax rates by 10%,
like the inverted companies do. You're out of luck, I tell them. I have
supported legislation that gives these small businesses lower tax
rates. I am all for reducing the taxpayers' burden, but for everyone,
not just the select few companies that have little concern for the
sacrifices made by many to allow us the freedoms we hold dear.
We should consider the competitiveness issue from the perspective
of a small or midsize business that is trying to compete with an
organization that avoids U.S. taxation by stripping out any U.S.
earnings. How is a small or midsize business to compete against that
kind of 10% margin advantage? We on the Ways and Means Committee should
stop the politics and get down to the tough business of figuring out
how to help the people who work for and own those small and mid-size
business--because the real competitiveness issue is how they can
compete to sell their products and services against some other company
with a 10% advantage.
Many have noted that inversions are a symptom of the U.S. Tax
Code's flaws, especially our international tax provisions, which I
agree are tremendously complex and burdensome. Many of the companies
which have chosen to turn their back on this country argue that the Tax
Code drove them to take the action. One response has been that the U.S.
international tax system should be reformed to address the complexity
and fairness of the Internal Revenue Code and address the problem.
The way I view this issue is best illustrated by considering a
person who has a bucket that has sprung leaks. The first thing you do
is plug the leaks, then you work on how to get a new bucket and make
decisions about what kind of bucket to get. I propose to plug the leaks
in our international tax system that are inversions, and I agree we can
and should work on fixing the larger and more complicated problem of
how the Tax Code's complexity could lead to inequities and make the
U.S. tax system less competitive.
I would also like to highlight an oversight or unclear provision
regarding the requirement that shareholders pay capital gains upon a
company inverting. That is the current law, but many shareholders may
have no idea, and that is because there is absolutely no clear
requirement that individual shareholders receive a Form 1099 that tells
them there has been some event that might trigger capital gains tax. I
have a strong suspicion that many innocent shareholders don't even
realize that the company they own some shares in has inverted. That
information reporting requirement needs to be fixed.
I would also take issue on a related point made by some companies
which claim that the U.S. taxpayer is not losing out in these
inversions. Some companies have claimed that the capital gains received
on the transaction will make up for years of reduced taxes the company
will pay--implying the U.S. taxpayer won't see any loss for years. Fact
is, this argument ignores that a large percentage of the shareholders
of these companies are held by either tax exempt or tax deferred
vehicles, like pension plans, 401(k) plans or IRAs. Those shares won't
be paying any capital gains, and in one inversion case I know of, just
over 50% of the shares were held in accounts that do not pay capital
gains on the transaction. I also would note that it is a lot easier to
get the necessary shareholder vote if such a large percentage of
shareholders aren't paying any toll charge, another reason I have
doubts about the significance of the votes that authorize these
transactions.
Finally, I am very pleased that the Treasury Department was able to
produce its report in such a short time period. The Bush Administration
has taken these transactions seriously, and worked to produce a
meaningful look at the transactions and the causes and possible cures.
In that report, the Treasury Department noted that earnings stripping
and the transfer of intangibles are both significant components of
these transactions; I don't think our current limitations on earnings
stripping are working well, otherwise, why would these companies take
these steps to take advantage of the transaction. I would like to work
with the experts who know the Tax Code inside and out, like the
Treasury Department, to fix this problem.
In conclusion, I very much appreciate Chairman McCrery scheduling
today's hearing on inversions. This is an important issue for the Ways
and Means Committee to consider. This is not a partisan issue, it is an
issue of how to ensure our tax laws are applied in a fair and
consistent manner--to everyone. I look forward to the other testimony
and to working with the Committee, the Department of Treasury and
others to address this problem.
Chairman McCRERY. Thank you, Mr. McInnis. Mr. Maloney.
STATEMENT OF THE HON. JAMES H. MALONEY, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF CONNECTICUT
Mr. MALONEY. Thank you, Chairman McCrery, Ranking Member
McNulty, and Members of the Subcommittee, and thank you for
holding this hearing.
It is my sincere hope that this Subcommittee will move
quickly to pass H.R. 3884, the ``Corporate Patriot Enforcement
Act of 2002,'' referred to as the Neal-Maloney legislation.
As I am sure the Subcommittee is aware, on June 18, the
Senate Committee on Finance passed the Grassley-Bachus bill.
Clearly, this issue has bipartisan support and deserves quick
action in the House. In fact, the Neal-Maloney bill, which is
very similar to the Grassley-Bachus bill, already--as Mr. Neal
indicated--has over 100 bipartisan cosponsors, and we continue
to add more virtually every day.
So-called corporate expatriates are former U.S. companies
who set up paper headquarters in tax havens to avoid U.S.
taxes. Some of these expatriates are even using third
countries, such as Barbados, with which the U.S. Government has
tax treaties, in order to avoid paying virtually all of their
tax obligations. These companies continue in fact to reside in
the United States, take advantage of our Federal, State, and
local services such as police, fire, and public schools, and,
of course, they still rely on the protection of our courageous
armed services here at home and around the world. The only
difference is they now get it all for free, while U.S. citizens
and loyal U.S. companies are paying the bill.
This is outrageous and must be permanently stopped. These
Bermuda tax avoidance schemes are especially unpatriotic in
light of our recent and current and economic national security
situation. The Wall Street Journal reported on June 4 that the
Federal deficit could total as much as $200 billion next year.
The huge Federal surplus we had only a year ago has been wiped
out. Critical programs like Social Security and Medicare are in
serious jeopardy just as the largest generation in our history
is getting ready to retire. In addition, as our country
continues its war on terrorism, all of our citizens, elected
officials, and corporations should remain united and committed
to defending our homeland and eliminating terrorism.
Corporate expatriates are saying that profit gained from
tax avoidance is more important than the security and well-
being of our country, and they could not be more wrong.
The Treasury Department, while recognizing the problem, has
argued that we need to study the issue. Others have proposed a
temporary stop-gap measure that would only extend through the
end of next year.
We must not wait. Certainly the tax system needs to be
reformed, but there is no reason that fixing the immediate
problem needs to be contingent upon changing the entire system.
If your house, which may be in need of remodeling, also has a
fire in the attic, you don't do the remodeling first. Instead
you put out the fire immediately and then move on to the longer
range tasks.
This is precisely the case here. We need to put out the
raging fire of this expatriate tax abuse, and then move on to
remodel our Tax Code. The calls for delay or study are nothing
more but sham excuses for failing to take the action so
obviously and urgently required.
So, also in regard to any stop-gap measure, a nationally
syndicated Boston Globe columnist recently wrote, quote: ``. .
. the proposal for a moratorium is so sneaky and pernicious . .
. no one can argue why phony expatriation to avoid taxes is
good for the United States or for anyone except the executive
officers of the companies who do it. So why have a moratorium
when a flat-out ban is what is needed?''
I strongly agree. In addition, a stop-gap bill will not
ensure that all U.S. corporations are playing by the same
rules. Indeed, a stop-gap approach actually allows the
situation to get worse. It maintains the disparity in tax
treatment, while sending the wrong message--that the Congress
is not really serious about this problem, but is merely trying
to let the issues slide until after the election.
These tax schemes are a cancer on the American Tax Code.
They need to be eliminated now. Every day we wait, the
situation only gets worse. You certainly would not start
treatment for cancer and then abruptly stop after 12 months.
You work to get rid of the problem once and for all. Of course,
the stop-gap may seek to serve as an election year gimmick, but
it does not solve the problem. A stop-gap measure is a clear
breach of our responsibility to act effectively in the interest
of the American people.
In addition, the proposed stop-gap legislation would not
apply to those companies who expatriated before September 11.
Why would we allow those who expatriated before September 11 to
continue to escape their tax obligations? We certainly should
not allow expatriated companies to maintain indefinitely a tax
advantage over American companies that are loyal to our
country. In contrast to the stop-gap proposal, the Neal-Maloney
bill fixes the problem permanently and restores all U.S.
corporations to a uniform, level tax policy.
The Neal-Maloney bill will end this unpatriotic tax dodge
once and for all, and I urge immediate action on the bill.
Thank you very much.
[The prepared statement of Mr. Maloney follows:]
Statement of the Hon. James H. Maloney, a Representative in Congress
from the State of Connecticut
Chairman McCrery, Ranking Member McNulty, and Members of the
Subcommittee, thank you for holding this hearing, and thank you for
allowing me the opportunity to appear before you today.
It is my sincere hope that the Subcommittee, and in turn the full
Committee, will move quickly to pass H.R. 3884, the ``Corporate Patriot
Enforcement Act of 2002'' (commonly referred to as the Neal-Maloney
bill), bring it to the floor of the House, and end the outrageous
corporate expatriation tax dodge, both immediately and permanently.
As I am sure the Subcommittee is aware, on June 18, 2002, the
Senate Finance Committee passed The Grassley-Baucus bill, the Reversing
the Expatriation of Profits Offshore Act, S. 2119 (REPO). Clearly, this
issue has bipartisan support and deserves quick action in the House. In
fact, the Neal-Maloney bill, which is very similar to the Grassley-
Baucus bill, already has over 100 bipartisan cosponsors, and we
continue adding more.
So called ``corporate expatriates'' are former U.S. companies who
set up paper headquarters in tax havens in order to avoid U.S. taxes.
For little more than the cost of a post office box in an offshore tax
haven like Bermuda, U.S. companies are trying to avoid millions of
dollars in Federal income taxes. Some of these expatriates are even
using third countries, with which the U.S. Government has tax treaties,
in order to avoid paying virtually ALL of their tax obligations.
These companies continue to reside in the United States, take
advantage of our infrastructure, our education system, our water
systems, Federal, state, and local services such as police, fire, and
public schools, and, of course, they still rely on the protection of
our courageous Armed Services, here at home, and around the world. The
only difference is: they now get it all for free, while U.S. citizens
and loyal U.S. companies are paying the bill. Some of America's largest
corporations have engaged in such transactions, including Tyco,
Ingersoll-Rand, and Global Crossings. Ironically, some of these same
companies have large contracts to provide goods and services to the
Federal Government. Now they are saying they don't want to pay their
fair share of U.S. taxes. This is outrageous, and must be permanently
stopped.
These Bermuda tax avoidance schemes are especially unpatriotic in
light of our current economic and national security situation. We are
now seeing a major, growing budget deficit. The Wall Street Journal
reported on June 4, 2002, that the Federal deficit could total as much
as $200 billion next year. The huge Federal surplus we had only a year
ago has been wiped-out. Corporate expatriates contribute to the
growing, long-term budget deficit problem. Critical programs like
Social Security and Medicare are in serious jeopardy just as the
largest generation in the history of this country is getting ready to
retire. In addition, as our country continues its war on terrorism, and
makes efforts to improve homeland security, all or our citizens,
elected officials, and corporations should remain united and committed
to defending our homeland and eliminating terrorism. Corporate
expatriates are saying that profit gained from tax avoidance is more
important than the security and well-being of our country.
More and more companies are contemplating such abusive tax dodges,
as aggressive consultants and legal firms try to sell their clients
this unpatriotic scheme. In an effort to stem the tide, Congressman
Richard Neal of Massachusetts and I introduced legislation on March 6,
2002, to close the expatriate tax loophole. Our legislation is quite
simple. It states that if you are, in fact, a domestic U.S.
corporation, you are subject to U.S. corporate income tax, wherever you
locate your nominal headquarters. Importantly, our legislation, with an
effective date of September 11, 2001, will end this unfair tax dodge
permanently.
A second important provision of our legislation would restore the
tax obligations of those companies that expatriated before 9/11. Our
legislation would give such companies until 2004 to come into
compliance. This provision, in turn, ensures that all U.S. corporations
play by the same rules, with no one having a tax advantage.
The U.S. Treasury Department, while recognizing the problem, has
argued that we need to study the issue. Others have proposed a
temporary, stop-gap measure that would only extend through the end of
next year.
We must not wait. Certainly, the tax system needs to be reformed.
But there is no reason that fixing the immediate problem needs to be
contingent upon reforming the entire system. If your house, which may
be in need of remodeling, also has a fire in the attic, you don't do
the remodeling first. Instead, you put out the fire immediately, and
then move on to the longer range tasks. This is precisely the case
here: we need to put out the raging fire of this expatriate tax abuse--
and then move on to remodel our Tax Code. The calls for delay or a
study are nothing but sham excuses for failing to take the action so
obviously and urgently required.
So also in regard to any stop-gap measure: a nationally-syndicated
Boston Globe columnist recently wrote, ``. . . the proposal for a
moratorium is so sneaky and pernicious. . . . No one can argue why
phony expatriation to avoid taxes is good for the U.S. or good for
anybody except the executive officers of companies who do it. So why
have a moratorium when a flat-out ban is what's needed?'' (May 28,
2002). I strongly agree. In addition, a stop-gap bill will not ensure
that all U.S. corporations are playing by the same rules. Indeed, a
stop-gap approach actually allows the situation to get worse. It
maintains the disparity in tax treatment, while sending the wrong
message--that the Congress is not really serious about this problem,
but is merely trying to let the issue slide until after the election.
These tax schemes are a cancer on the American Tax Code. They need
to be eliminated now. Every day we wait, the situation only gets worse.
And you certainly would not start treatment for cancer and then
abruptly stop after 12 months. You work to get rid of the problem once
and for all! Of course, a stop-gap may seek to serve as an election
year gimmick--but it does not solve the problem. A stop-gap measure is
a clear breach of our responsibility to act effectively in the interest
of the American people.
In addition, the proposed stop-gap legislation would not apply to
those companies that expatriated before September 11, 2001. Why would
we allow those who expatriated before September 11, 2001, to continue
to escape their tax obligations? We certainly should not allow
expatriated companies to maintain indefinitely a tax advantage over
American companies that are loyal to our country. In contrast to the
stop-gap proposal, the Neal-Maloney bill fixes the problem permanently,
and restores all U.S. corporations to a uniform, level tax policy.
It should be stressed that these expatriate tax schemes are
seriously detrimental to many of the companies' own shareholders.
Corporations are supposed to act in the interests of their
shareholders; here they are not. Under these expatriation schemes,
individual shareholders will have to recognize capital gains taxes on
the value of their shares at the time of reincorporation, and make
immediate payment of those taxes to the IRS. For example, Stanley Works
has admitted that if they were to reincorporate in Bermuda it would
cost their shareholders $150 million in immediate capital gains taxes.
Thus, Stanley is merely shifting its tax burden to individual
shareholders. The New York Times recently reported on the scope of this
slight-of-hand, stating, ``[e]ven if their shares rose 11.5%, they [the
Stanley shareholders] will barely break even after taxes'' (May 20,
2002).
For the smaller investors, retirees, and those nearing retirement,
this will be an especially onerous burden--one they cannot afford. One
retired Stanley Works machinist shared with me that he would face an
estimated tax bill of $17,000. As any retiree will tell you, having to
pay a bill of that magnitude threatens their financial security when
they need it most. For those facing these payments, where will they get
the resources to pay the tax? They will be forced to borrow the money
from a bank, take out a second mortgage, dip into their 401Ks (thereby
incurring additional taxes and penalties), or take other detrimental
action. This tax shift from corporations to individuals is patently
unfair and must be stopped now and permanently.
Finally, the New York Times recently reported that the Stanley
Works CEO ``. . . stands to pocket an amount equal to 58 cents of each
dollar the company would save in corporate income taxes in the first
year.'' (May 20, 2002) That is $17.4 million of an estimated $30
million in `savings' out of the U.S. Treasury, and into the CEO's
personal checking account. In the same story, the NY Times reported
that the Stanley CEO is also eligible for additional stock options
under the current plan, and that he could gain another $385 million by
exercising those options.
Let's close this loophole and stop this unfair shift of taxes from
corporations to individuals. The Neal-Maloney bill is the solution to
the problem. The legislation is straight-forward: if you are, in fact,
a domestic U.S. corporation, you are subject to U.S. corporate income
tax, wherever you locate your nominal headquarters. Secondly, our
legislation would recapture those companies that have already
expatriated by giving them until 2004 to come into compliance. This
provision ensures that all U.S. corporations are playing by the same
rules, and that no one has a tax advantage. Our legislation will end
this unpatriotic tax dodge once and for all. I urge immediate action on
H.R. 3884, the Neal-Maloney bill.
Chairman McCRERY. Thank you, Mr. Maloney, and thank all of
you for your testimony.
As is tradition in these hearings when we have Members
testify, I am not going to ask you any tough questions. I am
going to save those for the experts that will follow, but I do
have a couple of thoughts, though, as I listen to you all. You
all may not know it, but since you have highlighted this issue,
I have taken an interest in it and done some studying, listened
to a lot of tax experts, economists, and others who have looked
at this situation. I have to tell you that in examining all of
the legislation that you all have introduced, including the
moratorium, I find flaws with each approach, and I hope that
you all will listen to the questions that I and others will ask
of the experts who follow you in the next panel, because I am
going to try to bring out some of the flaws that I see in your
legislation, not because I want to denigrate your efforts or
stop the effort to do something about the problem. As I have
said repeatedly, I think it is a problem, we ought to do
something about it, but I don't want us, the Congress, to do
something about it in a way that would have consequences that
we may not foresee without more careful examination. That is
not to say, Mr. Maloney, that I want to delay. I want to do
this as expeditiously as possible, and I want to do it this
year. But I don't know that it is necessary for us to just do
it right now before we have really fully examined all of the
consequences that may follow our actions.
For example, if we were to enact the moratorium, it would,
as Mr. Maloney said, kind of freeze in place the advantages
that some companies have gained by expatriation. On the other
hand, if we go with the Neal-Maloney bill, it seems to me that
there may be greater incentive for foreign takeover of American
corporations, which is not what we want, I don't think. That in
many respects is worse than expatriation or inversion, because
generally speaking, when foreign companies take over American
companies, we lose jobs as a result of that, and good, high-
paying jobs. We lose research and development. We lose
executives.
So I think those are the things that we all need to talk
about and examine before we come up with a solution. Again, I
want to congratulate all of you for getting out there and
putting something forward to draw attention to the problem. I
do think we ought to just go a little slow for at least a few
days and think about this as a group before we go forward.
Mr. McNulty.
Mr. McNULTY. Thank you, Mr. Chairman. And unlike the
Chairman, I think that my opening statement reveals my bias and
support on a couple of these approaches. I just wanted to
highlight something that I heard Mr. Neal say at the end of his
prepared statement, and I want to make sure that we have this
in the record. Congressman Neal, did you say that you have
identified over $2 billion in government contracts by some of
these corporations?
Mr. NEAL. That is correct.
Mr. McNULTY. How many corporations were involved in that
list you compiled, approximately?
Mr. NEAL. They are not numbered here, but I have them. We
have five on a contracting basis.
Mr. McNULTY. Okay, fine. I just think it is ironic that
these corporate expatriates are relying so heavily on
government funds. Did we get unanimous consent, Mr. Chairman,
to put that in the record?
Chairman McCRERY. Yes.
Mr. McNULTY. So make sure that list is in the record. Thank
you. I thank all of the Members for their testimony.
Chairman McCRERY. Mr. Foley.
Mr. FOLEY. Thank you very much, Mr. Chairman. I would like
to see if any of the panelists would answer the following
question. Eighty percent of the transactions valued over $300
million involve foreign companies buying U.S. firms. Do any of
your bills deal with foreign companies buying U.S. firms?
Mr. NEAL. Can I give you a little bit longer answer to
that, Mr. Foley?
Mr. FOLEY. Not too long. We obviously only have 5 minutes.
Mr. NEAL. Right. Look, the argument that I have in this
instance with the question of what is wrong with the corporate
Tax Code is based upon what I heard back in 1994 from the
election season. When I came to the Committee at that time,
after having been out of it for 2 years, all we heard here was
what we were going to do about the corporate Tax Code. We had
leaders of this Committee saying we were going to pull the Tax
Code up by its roots. We had others saying we were going to
drive a stake through the heart of the Tax Code. We were going
to a long funeral procession for the Tax Code.
I understand there may well be problems with the corporate
Tax Code. But for those of us who are watching this train pull
out of the station, where President Bush has correctly said we
are in a state of war and war calls for a national purpose, we
all sacrifice and pull that train together, what troubles me is
that it becomes simply an excuse to study it for a while
longer.
I am happy to get into a full-scale debate about the
corporate Tax Code, but I don't see any evidence, based upon
the last 8 years, or the time that I was on this Committee
before that, that we were really about to disturb the Tax Code
in any major way to address this issue.
Mr. FOLEY. Did anybody on the panel, did you--you are a
Member of the Committee--offer legislation to change the Tax
Code from its high 35 percent----
Mr. NEAL. Mark, I stick to the position of progressivity
and have in tax debates, and I will say that we heard from the
Committee Chairman at the time, that we were going to move to a
consumption tax. The Majority Leader said we were going to move
to a flat tax. This room was packed with people who wanted to
hear where we were heading. And the truth is--I think we all
would agree on this, at least quietly, we may not be able to
agree on it publicly but we would agree on it quietly--we are
no closer today to make any structural changes in the Tax Code
than we were then.
Mr. FOLEY. Well, I think we have a significant obligation.
I would like to find out, though, if we are going to publish
lists of corporations that are apparently unpatriotic, should
we be, in the Federal Government, buying Chryslers?
Mr. NEAL. Mark, can I ask you something on that? What are
you suggesting by ``apparently unpatriotic''? Do you think they
are unpatriotic?
Mr. FOLEY. Well, I think we have allowed, through the Tax
Code, opportunities to minimize their taxable obligations.
Mr. NEAL. Do you think they are unpatriotic?
Mr. FOLEY. I don't like them leaving our shores, no
question.
Mr. NEAL. I think they are unpatriotic.
Mr. FOLEY. We can also make the claim that a citizen
leaving Connecticut to move to Florida, because we have no
income tax, is unpatriotic to its home State of Connecticut.
Mrs. JOHNSON OF CONNECTICUT. Mr. Foley, I would like to
just comment on your question. As a Member of the Committee, I
want the record to note that the Chairman of the Committee
convened a series of four quite extensive seminars in which all
Members of the Committee had an opportunity to review the
seriousness of the problems facing our country in the
international arena. It is a problem so serious, that we are as
close to a trade war with Europe as I have ever seen.
I would remind this body that when Reagan was President and
Rostenkowski was Chairman of this Committee, we did pass a tax
bill that dropped corporate taxes in such a way that our
companies were insulated from foreign takeovers, and, in fact,
foreign capital poured into America in a positive way.
So it is perfectly possible for us to do what has to be
done to defend American jobs, but what came out of that seminar
that was very concerning to a lot of us. I asked each panelist
at each meeting about the issue of permanently closing this
loophole and the moratorium, and all of them agreed that we had
to at least do the moratorium. There was tremendous
disagreement about whether we should close one loophole without
doing the others. The gist of the matter was an absolutely
startling chart that one of the people who presented at those
seminars showed us about the increased rate at which
corporations in America are being bought by foreign companies,
as opposed to American companies buying foreign companies, and
we are up to something like 80 percent of those mergers being
foreign-owned.
Now, DaimlerChrysler is foreign-owned because of our Tax
Code. They sat right here 2 years ago and told us that. And now
when DaimlerChrysler is in trouble, who is making the decisions
about what jobs are going to be cut, what R&D is going to be
eliminated? It is the Germans, not the Americans. So this is a
very big issue, and that is why I suggested a moratorium.
I don't want companies to reincorporate in Bermuda. It is
not right. They need to pay their fair share of American taxes.
We may need to be sure that we stop them in a way that doesn't
expose our companies to foreign takeovers, because foreign
companies who buy American companies don't have to pay those
taxes. This is a big and important issue. This is about
American jobs. It is about the strength of our economy, and I
don't--I hope that this Subcommittee will move on all fronts,
and that is why I introduced the moratorium. Thank you.
Chairman McCRERY. Before I move to Mr. Brady, let me make
clear to my good friend, Mr. Neal, this Chairman of this
Subcommittee is not proposing, as much as I would like to, a
massive overhaul of our tax system. I agree with you. It is not
going to happen any time soon. I think it should, but I am not
going to waste a lot of time urging it. That is not what I am
talking about when I say we need to examine together
opportunities to change the Tax Code that will not only
discourage or stop the inversions, the corporate inversions,
but also guard against foreign companies taking over American
companies and not only taking tax revenue out of this country
but jobs out of this country. We can do that, I think, without
a massive overhaul of the Tax Code. So let us get together and
try to agree on some commonsense, smaller changes than the ones
you referred to, and then I think we can make some progress.
Mr. Brady.
Mr. BRADY. Thank you, Mr. Chairman. I appreciate this
important hearing, and the testimony of all four Members of
Congress, who are here for the right reasons.
A number of companies headquartered in our region, the
Houston region, most of them oil and gas service businesses,
have announced or completed corporate moves to be incorporated
overseas. I may not like it, but the hard truth is that Houston
companies have incorporated overseas in order to compete fairly
and to endure. As a result, a lot of good manufacturing and
research jobs in the Houston region have been preserved and
created as a result of corporate inversion.
Let me say that again. Corporate inversions have saved good
jobs in Houston and will create more of them. That doesn't make
me like it any more. In fact, I think we need to address this.
The fact of the matter is that they have been driven overseas
but have kept the jobs here.
It seems to me the Congress has a choice. We can ignore the
root cause, which is Washington's backward Tax Code, and we
could leave very solid American companies vulnerable to foreign
firms, or we can create a smarter, fair way to tax these
companies that keeps American jobs in towns here.
Mr. Maloney, I know you talked and used a good analogy
about it is time to put the fire out, but the fact of the
matter is this is about the tenth fire in the kitchen, and
while we are putting it out, we probably ought to look at what
is causing these fires. That is what this Subcommittee is
intent to do: both address the short term, but use common sense
and think through the long-term reason for this.
This is a lot like, unfortunately, our seniors who have to
go overseas--to Mexico or Canada--to buy prescription drugs
they can afford. I don't like the fact they have to go there,
but I know there is a reason for it. I know there is a reason
these companies are reincorporating overseas.
I am real impressed that this Subcommittee is taking a
good, thoughtful approach in looking at this, because I think
in the end, like most of our tax issues that deal with America
versus other countries and that competition, Republicans,
Democrats, we are going to have to put our best heads together
to work this out.
With that, I would yield back the balance of my time.
Mr. MALONEY. Mr. Chairman, if I could just respond to Mr.
Brady's comment on the issue of the need for fundamental change
and fundamental reform, I could not agree with you more.
Absolutely, I agree with you. I hope and trust that the
Subcommittee proceeds in that direction.
I thought the Chairman's comments were very appropriate in
terms of addressing some of the other issues that arise because
of these corporate expatriations. My point is simply that we
cannot put off doing that work. We cannot put off looking at
foreign takeovers, and we cannot put off looking at structural
reforms of the Tax Code. We can't use the corporate inversion
situation as an excuse to put it off.
We have to still address the corporate inversion, the
corporate expatriation problem. That has to be addressed. If we
address the other issues simultaneously, that is fine, but
doing one shouldn't be an excuse for failing to do the other.
Mr. BRADY. I agree. And what is important, too, that we not
rush into a bill. For example, I look at your bill and I think
it has got some good parts to it, but it has got real flaws. I
think we hand a huge advantage to foreign companies under this
bill. but I think if we work together to think through and pick
out the best parts of the different approaches, we might have a
chance at really putting this fire out, once and for all.
Thank you, Mr. Chairman.
Chairman McCRERY. Thank you, Mr. Brady. Mr. Ryan.
Mr. RYAN. Thank you, Mr. Chairman. I think it is important
that we do look at these structural problems.
You know, Nancy, when you talked about the Rostenkowski-
Reagan tax bill, what they did then was lower our corporate tax
rates so that our companies were more competitive, and then we
kept jobs. What has happened since then is that our competing
nations have since lowered their tax rates, so U.S. tax rates
are higher than our competitor's now. So this thing has come
around full circle.
The concern I have with each of these bills--not as much
with the moratorium, but with each of these bills--is you are
going to go out and you are going to ban one form or one kind
of inversion. That may be a headline grabber, but the problem
is you can always get an intelligent tax lawyer to find a way
around the ban you just drafted.
And the other problem is, rather than trying to try and
stop inversions at the consequence end and at the result end,
you are going to simply set up more foreign takeovers. It has
already been mentioned a few times, but if we try and put up
barriers to inversions, penalize inversions, you are simply
going to make it easy for our companies to be purchased and
acquired by foreign countries, foreign competitors.
The other problem that I see is we need to address the
``juice,'' we need to address the source of these things. So
that does not mean fundamental tax reform, as much as many of
us would like to engage in that, that means writing intelligent
legislation that can be done this year, that can really address
the source of these inversions, so that you don't have to go
around chasing the consequence, the end result. That is, I
think, the more intelligent approach that I hope all of us can
come together.
I think the four of you have done a great service in
bringing the issue to fruition. I think that your bills are
intelligently written, in some ways. However, I am concerned
that there are a lot of unintended consequences that will
result from this, but I would invite comments.
Sure. I think Mr. Neal, first, wanted to. Then, Scott.
Mr. NEAL. Thanks, Paul. Just briefly, I am glad Mrs.
Johnson highlighted Reagan and Rostenkowski. Is there anybody
sitting up there today that believes in this atmosphere that a
Reagan-Rostenkowski bipartisan deal could be done? That was a
different era in the Congress. That was an entirely different
era.
One of the things that Rostenkowski did here--and I had
dinner with him the other night, he is as proud of that tax act
as anything that ever happened on his watch here. Rostenkowski
had a lot of Republicans that voted with him. He could
regularly get Republicans on this Committee to vote with him. I
haven't seen many Democrats that are even asked on this
Committee to vote with them, or even allowed once in a while to
have a victory on this Committee.
Mr. RYAN. You know, Richie, to allow a Democrat to vote for
a Republican tax bill, it just means the Democrat has to vote
for a Republican tax bill. It just means that you want to
participate in reforming the Tax Code. So I think this
Subcommittee--and I am the new guy on the Subcommittee--has
become so much more partisan, but I think that the
partisanship, not just in this Committee but in the Congress,
has been absolutely opposed to fundamental tax reform.
So, yes, while you have heard the Majority speak about
fundamental tax reform, tried to act on it, you have had every
door closed by the Minority on that issue, and, therefore, we
haven't reached much progress on this.
Mr. McInnis.
Mr. McINNIS. Thank you, Mr. Ryan.
I would like to point out to Mr. Neal, there has been a
politically driven attack against Representative Johnson's
moratorium and that is coming from one side of the aisle.
Frankly, we heard in our opening comments from the gentleman
that sits to my left, who does not sit on the Committee on Ways
and Means, has not come to the intense briefings that we have
had on this, and I think it is an unfortunate reflection. So
you are right. You bring up one side, I will bring you the
other one.
I think this moratorium has some sense to it, because this
issue is extremely complicated. The more I got into it, the
more I found more ways that they could go around the very
mission that we were trying to accomplish, and, you know,
whether it is corporate takeovers, I think the foundation here
is our earnings stripping. I think that is where the biggest
issue is.
So I just want to comment on your statement, does a
Democrat ever get to do this? I mean, the whole assault on the
moratorium is coming from one side of the aisle. Not from you,
Mr. Neal; you and I have been able to work together. But I
think it is going to require some bipartisan--from some people
who deal with it on a daily basis, a bipartisan effort. We can
do it, and we can move fairly quickly on it.
Mr. RYAN. I yield.
Chairman McCRERY. Before I recognize Mr. McNulty for
another round of questions, let me repeat, we are not going to
do a 1986 Tax Act. So forget about it. You can put your mind at
ease. We are not going to undertake that. Mr. Neal is right. We
couldn't do it right now, but we do need to fix this problem.
So let us just cool it and start talking about some things that
we can do, rather than things that we can't do, and maybe we
will get something accomplished together.
Mr. McNulty.
Mr. McNULTY. Thank you, Mr. Chairman. Before I ask just one
more question, I think there is another thing we ought to cool
it on, and that is questioning the motives of Members who
testify before this Subcommittee, whether they are Members of
the Committee or not. I note, Mr. Chairman, that under your
watch, that has never occurred before. In my opinion, all four
of these Members came before this Subcommittee today with very
sincere and strongly held views, and expressed them quite
admirably. I will defend their right to do that, whether they
are a Member of the Committee or not.
I just had one other question for Mr. Neal. The question
was brought up about possible foreign takeovers. Mr. Neal, in
your opinion, were any of the companies that were cited on your
list in danger of being taken over by a foreign company?
Mr. NEAL. No. I think it is kind of interesting that in the
press release--I think the four of us, by the way, agree about
Stanley Works. I think the four of us are in total agreement
about Stanley Works. I want to say that I think that what
strikes me about Stanley Works is the press release. They said
they were leaving because of corporate taxes. They weren't
leaving because they were in danger of being taken over.
The second thing I was party to last week, as I did a TV
interview with Bloomberg News on this, Stanley Works went out
and hired a PR firm to explain this and to parade the
leadership of that company around this town to the radio and TV
stations, and then tried to back away when they found out the
questioning was so hostile to what they were attempting to do.
So I am not aware of anybody that was endangered on this,
and I think that for a press release to say, hey, we are
leaving because of corporate taxes or we are leaving because of
our tax burden, that was the suggestion that was clearly put in
front of all of us. I have got to tell you, that press release
really got me worked up, as you can tell.
Mr. McNULTY. Thank you, Mr. Neal. Thank you, Mr. Chairman.
Chairman McCRERY. Mr. Weller.
Mr. WELLER. Thank you, Mr. Chairman, and thank you for
conducting this hearing. You have held a very worthwhile series
of hearings this year on looking at international aspects as
well as things we should be doing to make the corporate Tax
Code more user-friendly and helping make the United States a
better place to do business; to grow and prosper and create and
produce, as well as a place to work. I commend you for this
series of hearings, and I recognize this is just one more in a
series of hearings on issues that we on the Subcommittee are
here to address.
I also want to thank my colleagues on the panel today for
participating. Three of you I serve with on this Committee are
all very thoughtful and hardworking Members and represent your
point of view and work very hard. The other gentlemen I don't
know quite as well, but I appreciate your participating as well
as in this hearing.
The concern I have got is as we look at this issue, I think
that the whole issue of inversions really illustrates a problem
we have. Why is it that the United States is no longer an
attractive place to do business or to headquarter your company?
I think that is a fair question to ask. If it is really to your
advantage to go somewhere else, something is wrong. I think we
have millions of loyal Americans who are entrepreneurs and
create new businesses and are proud to build their business and
hope to pass on the family business to their kids, and we
certainly want to create the kind of climate that gives
everyone an opportunity to achieve that.
But the question is: What is it about our Tax Code that
actually drives business decisionmakers to want to relocate
their headquarters elsewhere? Some clearly have made a decision
we don't like, which is the issue that is before us today, and
legislation has been introduced in response to that. Of course,
it is an election year. I think we have to be very careful as
we look at this issue that we choose not to make a political
response to the issue, but we very thoughtfully and very
carefully come forward with good policy that, frankly, makes
the United States a more attractive place to do business. We
want to do business here.
Mr. Maloney, you indicated in response to one of my other
colleague's questions that you are a supporter of overhauling
the corporate Tax Code, and since you are not a Member of the
Committee, I thought I would give you an opportunity. If we
look at overhauling the Tax Code to make the United States more
competitive, what is the first thing you would do to our Tax
Code to make the United States a more competitive place to do
business?
Mr. MALONEY. Mr. Chairman, am I required to use all 5
minutes to answer that question?
Mr. WELLER. No, just 1 minute.
Mr. MALONEY. What I would say to you is, you may or may not
be aware of this, I have joined with the Republicans in
supporting the notion that in order to force this debate--this
is a debate that is highly conflicted, it has pressures from
every divergent point of view and every special interest, and
the debate needs in fact to be forced--I have supported the
Republican efforts to sunset the tax cut. I have been a sponsor
of this legislation, and I have voted for it on many, many
occasions, precisely because we do need to grapple with this
issue. We need to take it on.
So I would say to you, the very first thing I would do is
bring that legislation forward and try to get it passed, and
perhaps you could get it passed in the House and in the Senate.
Mr. WELLER. Reclaiming my time, you would sunset the Tax
Code. I personally believe we either need to scrap how we
depreciate assets and move to full expensing, or eliminating
the corporate alternative minimum tax I believe would help
quite a bit.
Let me direct my next question to Mrs. Johnson.
You have talked about your proposal which would provide a
moratorium, essentially put up a wall, stop it for a period of
time, while we very thoughtfully put forward a proposal that
does solve the problem. What do you feel is the basic reason a
moratorium would work better than some of the alternative
legislation that is before the Subcommittee today?
Mrs. JOHNSON OF CONNECTICUT. I think the advantage of the
moratorium is that it could be done fast. You can get that
through. You can send that signal very clearly in law but you
can't do this, and during the year that you have them you can
get together the bill that will address the causes of why
companies want to do that.
Now, it may be that we can get together a bill that will
address the causes and then we just need a moratorium to
prevent this from happening until those bills go into effect,
or those tax changes goes into effect. The community, the
business community in America understands that they are going
to be back on a level playing field. So I think the moratorium
has some very real advantages.
Second, the moratorium, which is structured very much like
the Neal bill, is also circumventable. It is just that for a
moratorium it will work. As a permanent fix it won't; because
as a moratorium it isn't worth the companies going to the
expense of trying to circumvent it. If it is permanent law,
there are lots of reasons why then they would just figure out
how to circumvent it.
So the moratorium, I would remind you, does have, and I am
well aware, has the same weaknesses that the Neal bill has, but
on a short-term basis there wouldn't be the motivation to pay
tax lawyers to find the way around. A moratorium combined with
the bill that addresses the causes is what this Nation needs to
keep American jobs here and to keep American taxes in America
to support the vital services on which we all depend.
Mr. WELLER. May I have--just do a quick follow-up, Mrs.
Johnson. As a quick follow-up, the Treasury Department when
they testified 2 weeks ago on that abbreviated hearing that we
had that day raised concerns about Mr. Neal's legislation, and
you know their concern was that it would actually cause greater
opportunity for foreign takeover by foreign corporations taking
over American companies, and with the moratorium would we run
that same risk?
Mrs. JOHNSON OF CONNECTICUT. They did mention that they
would support the moratorium as an immediate and short-term
solution, and in those seminars I alluded to, both sides,
people who had all spectrums of the concerns about the American
Tax Code in terms of the position that it leaves American
business in and the competitive world, all of those people,
whether they were for or against the Neal bill--and many of
them were for it. Some of them were against it, but all of them
agreed that we needed to stop that action. All of them also
agreed that this whole approach of inversion is being shopped
in board rooms; that there are groups of lawyers who are making
this a specialty, who are making it their business to sell this
alternative to companies. So this could turn into a torrent.
In the other areas that we have faced this possibility,
both with the reinsurance when we did the reinsurance bill 3
years ago, nobody believed us, and it was being shopped but in
a very limited portion of the business community. This has
clearly now taken on a life of its own and has the potential to
be a real deluge of activity which would have a very harsh
impact on revenues as well as on our economy.
Mr. WELLER. Thank you.
Mr. NEAL. Mr. Chairman, could I just close on one note?
Just 2 seconds.
Chairman McCRERY. Yes.
Mr. NEAL. In general reference to Mr. Weller's comments,
you and I worked on subpart (F) together and section 809. Mr.
Weller and I did that expensing bill. Mr. Foley and I have a
Hospital Preservation Act, which in the end is going to be what
the hospital fix is. So I think I have demonstrated every
effort to try to find common ground on these issues and that is
what I want to do in this instance as well. But I need a little
help from the other side.
Thank you.
Chairman McCRERY. Thank you, Mr. Neal, Mrs. Johnson, Mr.
McInnis, and Mr. Maloney. I will say one thing I think has
already been accomplished by Mrs. Johnson's moratorium bill,
the Neal-Maloney-Bill-McInnis bill, and that is we put
corporations on notice that something is afoot here, and I
think you have seen some corporations delay their plans to
expatriate because of the bills that all of you have introduced
and the hearings that we have held. So you are to be
congratulated for being leaders on this.
Now with that, I will excuse the first panel and invite our
second panel to come forward. On the second panel we have Mr.
Steven C. Salch, Partner in Fulbright & Jaworski, and the
Honorable Richard Blumenthal, Attorney General of the State of
Connecticut. Welcome, gentlemen.
We are told we are going to have a vote in about 10 minutes
on the Floor, so we will attempt to get your testimony in and
then we may have to recess and come back for questions, if that
is okay with you all.
Our first witness on the last panel of the day is Mr.
Steven C. Salch, who is a Partner with Fulbright & Jaworski in
Houston, Texas, and Mr. Salch has worked on international tax
issues for a number of years. He has worked with the American
Bar Association and other organizations in trying to figure out
and bring some sense to our international tax laws, and so he
indeed is an expert on these matters and we look forward, Mr.
Salch, to hearing your testimony. Your entire testimony will be
admitted into the record, and we would like for you to
summarize that in about 5 minutes and you may begin.
STATEMENT OF STEVEN C. SALCH, PARTNER, FULBRIGHT & JAWORSKI,
L.L.P., HOUSTON, TEXAS
Mr. SALCH. Thank you, Mr. Chairman. My name is Steven
Salch. I am an attorney, and I am appearing before you today in
my individual capacity. The views I express are my own.
I appreciate the opportunity to appear and testify
regarding corporate inversions. In my written statement, I have
tried to provide you with one example of the tax factors that
can cause a U.S. business with substantial foreign business
operations to conclude that an inversion transaction will be
beneficial for its business and those who invest in it. I hope
that if you understand that basic model you can better
understand the policy issues that underlie the inversion
decision, the systemic factors that create those issues, and
then some of the recent embellishments.
Let me make it clear, my testimony today does not relate to
U.S. operations of foreign businesses. My testimony does
address the situation of a U.S. business with U.S. shareholders
that has significant business operations and revenues from
outside the United States.
It is a very competitive world, and U.S. businesses need to
be able to compete effectively in that world. Differences in
the tax environment in which a business and its competitors
operate can make a difference in the ability of the business to
compete. That is why it is important for the Congress and the
Treasury Department to consider the competitive impact of tax
legislative policy alternatives as they make policy decisions.
It is also important to understand that if there are
winners and losers when tax policy judgments are made, the
losers may feel compelled to explore a different environment in
which to operate. To some extent, I think the case can be made
the competitive pressures arising from prior tax policy
judgments may have led companies to consider the possibility of
engaging in what I call classic inversions. Other
industrialized countries of the world have taken a different
approach than the United States for the taxation of the foreign
business operations of their companies.
The example in my written statement is an effort to
illustrate some ways in which a territorial or exemption system
differs from the worldwide system of taxation of business
operations utilized by the United States. That example also
tries to illustrate some of the ways in which those differences
can translate into economic consequences. While I have tried to
keep the example simple, these are not simple issues and they
have no simple solutions. They are issues that are interwoven
with other tax issues, including the taxing export income issue
that this Subcommittee has been studying this year. They
implicate treaties to which the United States is a party and
which we ought not to unilaterally override.
In the classic form, inversions do not reduce the U.S. tax
on U.S.-sourced business revenue, except insofar as section 482
of the Internal Revenue Code effectively requires an arm's-
length charge for inter-company transactions in which the
foreign affiliate is a provider to the U.S. business. I am
aware that some inversions go beyond the classic example and
have embellishments that do reduce the U.S. tax on U.S.-sourced
business revenue. In those transactions not all the benefit
achieved is attributable to elimination of the systemic
problems. Benefits flow for other reasons. Those situations are
clearly matters that warrant legislative and administrative
consideration. In that regard, while I may have some
reservations about certain aspects of the Treasury Department's
proposals announced on June 6, I believe those proposals are a
good place to begin addressing the non-classic inversions.
Mr. Chairman, thank you again for the opportunity to appear
today. I will be pleased to respond to any questions you or the
Subcommittee Members might have.
[The prepared statement of Mr. Salch follows:]
Statement of Steven C. Salch, Partner, Fulbright & Jaworski, L.L.P.,
Houston, Texas
Mr. Chairman and Members of the Committee:
My name is Steven C. Salch. I sincerely appreciate the invitation
to appear before you today and discuss with you the subject of
corporate inversions. The statements and views I will express today are
my own personal views and do not represent the views of the law firm,
its clients, or any association or professional organization of which I
am a member.
Later this month, I will celebrate my 34th anniversary as a lawyer
with the Houston, Texas office of Fulbright & Jaworski L.L.P. Prior to
joining that firm, I was a tax accountant for a major energy company
then located in Dallas, Texas. I am a former Chair of the Section of
Taxation of the American Bar Association and am currently the Fifth
Circuit Regent of the American College of Tax Counsel. I have been
involved with international commercial, regulatory, and tax issues
since I entered into the private practice of law in 1968. As you might
expect from a Texas lawyer, a good deal of my practice has focused on
the energy industry and financial and service sectors relating to that
industry. However, over the years I have represented both domestic and
foreign clients in the agriculture, construction, manufacturing,
distribution, financial, and service sectors regarding their operations
in this country and abroad. My testimony today is predicated on that
experience and background.
This Committee and its Subcommittee on Select Revenue Measures have
undertaken a formidable task: rationalizing the U.S. income tax
system's treatment of foreign operations in an era of globalization of
business and financial resources and the enhanced competition that
creates for contracts, sales, financial services, and jobs.
Looking back today, it is hard to imagine that the United States
once imposed restrictions of direct foreign investments by U.S.
businesses and an interest equalization tax on foreign borrowings.
Forty years ago, the Congress, at the urging of the Kennedy
Administration, enacted Subpart F of the Code,\1\ which in its original
form essentially eliminated deferral for U.S. businesses that utilized
certain foreign business structures to reduce their foreign tax
liability while simultaneously deferring the lower-taxed foreign income
from current U.S. income tax. Starting a decade later in 1971, the
Congress and the Executive Branch have endeavored to level the playing
field between U.S. businesses and their foreign competitors within the
constraints presented by our income tax system, multilateral
international agreements, and bilateral treaties, while concurrently
endeavoring to preserve the U.S. income tax base, through a variety of
statutory mechanisms.
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\1\ Unless otherwise noted, references to the ``Code'' are
references to the Internal Revenue Code, 26 USC, then in effect, and
references to ``section'' are to sections of the Code.
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As we all know, the export incentive elements of those efforts have
consistently been found to be contrary to GATT or WTO, in large measure
because of the different manner in which those trade agreements regard
the application of territorial tax systems employed by most other
countries, as contrasted to the worldwide tax system the United States
employs to tax the income of resident business taxpayers. Consequently,
a U.S.-based business with multinational operations today generally
faces a higher rate of worldwide income taxation of its net income than
does a foreign-based competitor with the same operations, business
locations, and employee locations. The reason for this difference
generally is that the foreign competitor will not be subject to U.S.
Federal income tax on its income from sources without the United States
that is not effectively connected with a U.S. trade or business or
attributable to a U.S. permanent establishment and also will not be
subject to income taxation in its base country on foreign business
income (income from business operations outside its foreign base
company).
Under a pure territorial tax system the business revenues derived
from outside the foreign residence country of the foreign business do
not sustain taxation by its country of residence. More significantly,
perhaps, many foreign countries do not share the same concern about
external structures that permit their resident businesses to minimize
their business income tax burden in other countries in or with which
they do business.\2\ Over two decades ago, one of my foreign friends
from what was then a fairly popular base country characterized his
country's exemption of income from direct foreign business investments
as ``pragmatic'' and intended to ``facilitate the expansion of both the
base country revenue and employment by attracting base companies and at
the same time permit resident companies to be extremely competitive in
foreign markets.''
---------------------------------------------------------------------------
\2\ That low level of concern about business taxation does not
extend to individual taxation or passive investment income taxation,
however.
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For over 34 years, I have worked with U.S. businesses seeking to
minimize their cost of capital and maximize their net after-tax
earnings by managing the combined U.S. and foreign effective tax rate
on their business income. During that same period, I have worked with
foreign businesses seeking to achieve the same goals by minimizing the
U.S. income taxation of their U.S. operations or foreign taxation of
their third-country business operations. On one hand, the latter group
of clients is generally easier to serve since in many instances their
U.S. and foreign business revenues were not taxed in their home
countries, while on the other it is somewhat more challenging to
explain that the U.S. will tax foreign operating revenues of their U.S.
subsidiaries or foreign subsidiaries of those subsidiaries. It doesn't
take foreign clients a long time to appreciate that, as a general rule,
they should not have operating foreign subsidiaries below their U.S.
subsidiaries or conduct non-U.S. operations through U.S. subsidiaries.
At the same time, it has always been trying to explain to a U.S.
businessperson or entrepreneur that they will be competing with foreign
businesses that enjoy the benefits of VAT rebates on exports and what
are explicitly or effectively territorial systems with largely
unrestricted opportunities to minimize foreign taxation of their
business income. As economies become more intertwined and competition
increases around the globe, these experiences have become more trying.
Here is an example of a typical situation and concerns that the
Code's approach to income taxation of foreign business operations
produces.
Company X and its subsidiaries, domestic and foreign, are in a
service industry. Over the years, their customers' activities have
become increasingly focused on foreign business opportunities. As a
result, the percentage of the gross revenue and income that Company X
and its subsidiaries derive from performing services outside the United
States has grown. It now is more than 50% of their gross revenue from
operations and generally is projected to either remain at that level or
increase over the foreseeable future. Company X competes with other
U.S. firms and with foreign-based companies. Within the last six
months, Company X was unable to achieve an acquisition of substantially
all the assets of Company A, a domestic company whose business would
complement Company X's operations with over 60% of its operating income
from foreign operations, because foreign Company Z offered a cash price
that was substantially more than the price Company X thought was
feasible based on its targeted goals for return on capital and concerns
about maintaining share value in an equity marketplace environment that
is becoming increasingly discriminating. Company X's Board asks its
management to analyze the situation and report back on the failed bid.
Company X's analysis indicates that Company Z has a lower tax rate
on operations than Company X, or indeed any of Company X's U.S.
competitors. One of the reasons is that Company Z does not pay tax in
its home country on income from foreign operations or foreign
subsidiaries. Another reason is that Company Z's home country's
exemption of Company Z's foreign operational income from tax permits
Company Z to conduct its foreign operations in the manner that
minimizes taxation by other countries. While other factors, such as
higher employment taxes and office rental, partially offset the tax
savings, Company Z has a higher rate of return on invested capital than
Company X, largely because of the tax differential.
When Company X's personnel applied Company Z's after-tax rate of
return from operations to Company A, the result was a price that was
actually higher than the price Company Z paid for Company A. Thus, if
Company Z is able to achieve its pre-acquisition rate of return with
respect to Company A's business, the acquisition should actually
increase the value of Company Z since the acquisition price, though
higher than Company X could pay, was based on a lower rate of return
than Company Z actually achieves. Company X's analysis showed that
under Company Z's ownership the only portion of the operations of
Company A that would continue to pay U.S. corporate income tax were
those that served the U.S. market exclusively.
In that regard, since Company Z had purchased Company A's assets,
all the intellectual property of Company A was now owned by a foreign
corporation that would charge and receive an arm's length royalty from
Company A's U.S. operations (determined pursuant to the section 482
regulations) that would be deductible for Federal income tax purposes
and be exempt from U.S. withholding tax by virtue of a bilateral income
tax treaty. The income derived from the foreign operations of Company A
would no longer by subject to U.S. Federal income tax or state income
tax.
Company X's CEO reported to the Board that Company Z was in the
process of downsizing Company A's U.S. workforce by terminating
personnel in the research, engineering and design, procurement, and
administrative areas because those tasks would be performed by existing
staff of Company Z in foreign locations for a fee paid by the U.S.
operations. Manufacturing jobs in Company A would remain in the U.S. as
needed to serve the U.S. plants. What was not known was how long those
plants would all remain active to provide goods for foreign markets, as
well as the domestic U.S. market. The CEO commented that it was likely
Company X would see a decline in sales to what was Company A as Company
Z's foreign engineers and procurement specialists began specifying
foreign supplier's components, including those of Company Z and its
affiliates, whenever customers did not specifically request open
sourcing or Company X components.
Company X's Board quickly grasped the concept that Company X's rate
of return on invested capital, and presumably its share price, would
increase if Company X could restructure so that it's income from
foreign operations was not subject to U.S. corporate income taxation.
The question was whether that could be achieved. That's when the
outside tax and investment banking experts were brought into the
picture.
They suggested to Company X's Board that it should effectively
reincorporate itself as a Bermudian company and utilize a domestic
holding company to own its U.S. operations. The transaction would
involve the U.S. shareholders exchanging Company X shares for shares of
a Bermuda company (``BCo''). That exchange would trigger realization of
any built-in gain in the Company X shares, but not loss. While precise
data were not obtainable, in view of the decline in the stock prices
over the past several years, the investment bankers advised that it was
probable that there were a great many shareholders who had losses and
the amount of gain for stockholders who had held Company X shares for
more than three years would be relatively low.
Company X's foreign subsidiaries would be held by a foreign
subsidiary of BCo. The existing intercompany pricing policies of
Company X and its affiliates would continue to be observed by BCo and
its foreign subsidiaries and the U.S. holding company. The U.S. holding
company would continue to operate the U.S. fixed facilities. With
proper attention to the Code provisions regarding effectively connected
income, the income produced by BCo and the foreign subsidiaries should
not be subject to U.S. corporate income tax, other than withholding on
dividends distributed by the U.S. holding company. The savings achieved
by eliminating U.S. corporate income taxation on BCo and its foreign
subsidiaries significantly enhance BCo's return on capital and
hopefully, its share price. It also makes BCo more competitive with
Company Z and other foreign firms.
This example is what I refer to as the classic or straight
inversion. It was employed for the first time approximately 70 years
ago. Approximately 30 years ago I obtained from the IRS a private
letter ruling that dealt with inversion issues. For various non-tax
reasons that transaction did not go forward. Subsequently McDermott did
invert and Congress tightened the Code to assure that there was an exit
fee for similar transactions. Subsequent inversions have likewise
generated legislative amendments designed to prevent others from
pursuing a similar transaction without additional cost.
The recent increase in proposed inversion transactions and
corresponding publicity have caught the attention of the Treasury
Department and both the House and the Senate. One result is that a
number of Members and Senators have proposed legislation to address or
suppress inversions in several different ways.
I respectfully submit that one of the problems with several of the
pending anti-inversion legislative proposals is that they have
effective dates that would extend to transactions that were done
decades ago. Not all inversion transactions in the past were undertaken
solely or perhaps even principally for U.S. tax reasons. To go back
into the past and attempt to determine which ``old and cold''
inversions that were entirely legal when they were implemented, should
now be penalized, strikes me as unfair, unsound, and overkill.
I also submit to you that the classic or straight inversion is not
a ``tax shelter,'' ``abusive transaction,'' ``job loser,'' or
``unpatriotic.'' As the foregoing example illustrates, the classic
inversion generally is motivated by systemic features of the Code and a
discontinuity between those features of our law and comparable features
of the tax laws of other countries. The classic inversion does not
reduce U.S. tax on U.S. source business revenue, except insofar as
section 482 dictates that there be an arm's length charge for
intercompany transactions in which the foreign affiliate is a provider
to a U.S. business.
The example also shows that in the simplest terms, the classic
inversion is all about numbers that investors and investment bankers
translate into stock prices or purchase prices of businesses. In that
context, preserving U.S. ownership of business, a classic inversion can
also directly and indirectly save U.S. jobs and business that would be
lost if the same business came under foreign ownership.
I realize that Congress needs time to study and develop solutions
to the systemic issues, including the export issue and the WTO.
However, I am concerned that unless Congress can also enact a
moratorium on foreign purchases or acquisitions of U.S. businesses, a
moratorium on inversions that precludes U.S. businesses with
substantial foreign operations from engaging in the classic inversion
will merely provide foreign purchasers an opportunity to extend their
present competitive advantage in purchasing and operations during the
moratorium period. No matter what your views may be on inversions, I
hope you can all agree that result would not be desirable.
If classic or straight inversions were the only type of inversion
transaction that we are seeing, I'm not sure we would all be here today
for this purpose. We are also seeing transactions that are derivative
of the classic inversion in some respects but go beyond it. One such
derivative generally involves companies that do not have or reasonably
anticipate substantial business income from foreign sources. A simple
inversion does not produce a tax benefit for those companies because
the systemic issue is not present in the absence of foreign source
income. Thus, any tax savings that are achieved are a result of
something else and are achieved with respect to U.S. source income.
Transactions that fit that description are the transactions I believe
the Committee and the Treasury Department should scrutinize carefully.
However, any solutions should apply equally to both domestically and
foreign owned U.S. businesses, in order to avoid the inadvertent
creation of an additional competitive advantage for foreign owned
businesses.
Some inversion transactions implicate bilateral income tax
conventions to which the United States is a party. If in scrutinizing
those transactions, the Congress determines that there are issues that
require action, I hope the Congress will provide the Treasury
Department with an opportunity to address those issues in negotiations
with the other countries that are parties to the treaties in question,
rather than unilaterally overriding those treaties. Treaties work for
U.S. businesses and are beneficial to international business and
financial transactions. Thus, it is in everyone's best interest to
permit the normal treaty negotiation or renegotiation process to occur
in an orderly fashion, rather than jeopardize an entire treaty over any
single issue or transaction.
It is a part of our American culture that we will compete on a
level playing field with anyone, anytime, and anyplace. Once the
playing field was local. Then it became regional, and later it became
national. Today the playing field is international, and our rules are
not the only rules in play. Thus, we need to be vigilant that others do
not adopt rules that unfairly penalize our businesses seeking to
operate abroad. We also need to be vigilant that our rules neither
penalize U.S. businesses operating abroad nor grant an unfair advantage
to foreign businesses operating here.
Mr. Chairman, classic inversions are not ``the problem.'' They are
symptoms that indicate a systemic problem exists. I urge the Committee
and the Congress to seek a solution that cures those systemic problems
as the best means of alleviating the symptoms. At the same time,
Congress and the Treasury should also address variations of classic
inversions that achieve savings by reducing taxation of U.S. source
business income and assure that any remedial measures apply equally to
domestic and foreign investors.
Mr. Chairman, thank you again for the opportunity to appear today.
I will be pleased to respond to any questions.
Chairman McCRERY. Thank you, Mr. Salch. Our next witness is
the Attorney General of the State of Connecticut, Mr. Richard
Blumenthal. Thank you very much for coming, and now we will
hear your testimony.
STATEMENT OF THE HON. RICHARD BLUMENTHAL, ATTORNEY GENERAL,
CONNECTICUT ATTORNEY GENERAL'S OFFICE
Mr. BLUMENTHAL. Thank you very much, Mr. Chairman. I am
honored to be before this Subcommittee, and I thank you and
other Members of the Subcommittee for demonstrating the
interest and the diligence to pursue this very, very critically
important topic. I agree with some of the other speakers who
have appeared already, and I would request permission to enter
my full statement in the record and to summarize it very
briefly.
Chairman McCRERY. Without objection.
Mr. BLUMENTHAL. Extemporaneously if I may.
I agree with a number of the other speakers that this
loophole is unfair, unpatriotic and really does great harm to
the credibility of our Tax Code. I believe also it does great
harm to the credibility and trust of the American public in
corporate management because it operates as a kind of a stealth
weapon used by management to evade corporate accountability. I
have focused my remarks on the issue of corporate governance
and the way that reincorporation to Bermuda seriously weakens
and dilutes the rights of shareholders to hold management
accountable in the event of self-dealing or malfeasance.
The impacts on corporate accountability are not technical
or hypothetical or speculative. They are real and immediate.
They are demonstrated, for example, by some of the corporations
that have already moved to Bermuda, such as Tyco and Global
Crossing, which are using these obstacles to corporate
accountability to evade responsibility for management self-
dealings and malfeasance.
I appear before you as the chief law enforcement officer of
a State who has gone to court to stop a reincorporation that
would have been done in a way that was severely misleading to
many of its shareholders, the 401(k) shareholders in our State,
and as one who is responsible for protecting the public
interest and the rights of shareholders in our State, including
the rights of the State as a shareholder. So I have a very
direct and immediate interest in a topic that is real and
urgent.
Corporations often portray the impact on corporate
accountability as nonexistent or inconsequential. In fact,
these effects go to the core of the body of law we have built
to protect shareholder rights, and I would simply offer as an
example the reversal that has been done by Stanley Works in its
revised statement to the Securities and Exchange Commission
(SEC) where it was compelled by pressure from my office, by the
threat that we would ask for a SEC investigation, to
acknowledge, and I would quote from the revised proxy statement
that was submitted only last Friday and came to my office only
this morning, and the quote is in the revised proxy statement:
``Your rights as a shareholder may be adversely changed as a
result of the reorganization because of differences between
Bermuda law and Connecticut law and differences in Stanley
Bermuda's and Stanley Connecticut's organizational documents.''
We still have problems with that statement because it,
along with other representations in the revised proxy
statement, minimizes the effects which may be more for
reacting. They are real, and they are in areas where Bermuda
law is extraordinarily opaque. Their legal opinions are not
published or officially reported, very difficult to access. In
the books and records of Bermuda corporations there is a lack
of meaningful limits on the insider transactions, the very kind
of self-dealing that we have seen in Enron and many other
corporations which have recently come to light. There are no
requirements for shareholder approval of substantial sales or
exchanges of the corporate assets such as there are in most
States, including Connecticut. There are severe limits on
derivative actions brought in the name of the corporation, one
of the central tools of enforcing accountability, the right of
a shareholder to protect the corporation, all of the
shareholders, not just his or her own interests. There are
serious questions about the enforceability of U.S. judgments
against a corporation that reincorporates in Bermuda. As you
well know, there is no treaty of reciprocity. There are very
severe burdens in time and cost, not to mention the possible
burden of a defense raised that a judgment is inconsistent with
Bermuda policy, whatever that may be in specific instances. So
the rights of creditors, as well as shareholders, may be
adversely impacted.
Let me just summarize, if I may, Mr. Chairman, by saying
that I am always interested in hearing from corporations, from
all of us. I think have used the term that we want a level
playing field, and certainly a level playing field is greatly
to be desired and sought. I simply urge that these corporations
be on our side of the field and that we seek and achieve a
result that enforces stability, transparency, and
predictability in the requirements that apply to these
corporations.
Thank you very much.
[The prepared statement of Mr. Blumenthal follows:]
Statement of the Hon. Richard Blumenthal, Attorney General, Connecticut
Attorney General's Office
I appreciate the opportunity to speak on the issue of corporate
inversions, a hyper-technical term for corporations exploiting tax law
loopholes and corporate directors and management profiting and
protecting themselves from proper accountability.
I urge your support for legislation such as H.R. 3884, the
Corporate Patriot Enforcement Act that would permanently close a
loophole in our laws that permits corporations to abandon America and
abrogate their moral responsibility to this country.
When I was first scheduled to speak on June 6, 2002, I intended to
quote at length from a speech delivered only the day before by Henry
Paulson, chairman of Goldman, Sachs, who expressed alarm that American
business has never been held in lower repute. Now, even more clearly,
we know that one major reason for such low repute is this type of tax
avoidance loophole.
Long-time American corporations with operations in other countries
can dodge tens of millions of dollars in Federal taxes by the device of
reincorporating in another country. How do they become a ``foreign
company'' and avoid taxes on foreign operations? They simply file
incorporation papers in a country with friendly tax laws, open a post-
office box and hold an annual meeting there. They need have no
employees in that country or investments in that country--in short, no
financial stake there at all. It is a sham, a `virtual' foreign
corporation--and our tax laws not only allow this ridiculous charade,
they encourage it. This loophole is a special exception run amok. It is
a tax loophole that must be slammed shut.
Bermuda may seem close geographically and familiar in language and
customs, but it might as well be the moon in terms of legal rights and
protections for shareholders. In pitching reincorporation, management
has repeatedly misled shareholders--failing to reveal the real long
term costs, and concealing even the short term financial effects.
Connecticut has learned this lesson the hard way from Stanley
Works--the most recent and potentially most notorious corporation to
attempt to avoid taxes through this corporate shell game. Stanley Works
is a proud American company that is based in the industrial town of New
Britain, Connecticut. For more than 150 years, it has manufactured some
of the best-known American-made tools.
Over the past 20 years, sadly, it has moved much of its
manufacturing overseas where cheaper labor means more profits. In fact,
it has moved so much of its operations that it was in danger of losing
its ability to claim that its products were made in America, a major
selling point. Several years ago, it supported an attempt to weaken the
standards for claiming products are ``made in the U.S.A.'' This
proposed rule would have allowed corporations to use the ``made in the
U.S.A.'' label on products that were mostly made in other countries,
with only the finishing touches applied here. It was nothing less than
an attempt to create the `veneer' of American craftsmanship. Along with
others, I strongly opposed this weakened standard and it was eventually
withdrawn.
Now, this same company is seeking to sell its American citizenship
for $20-30 million pieces of silver. Reincorporating in Bermuda would
render hundreds of millions of dollars in profits from foreign
divisions tax-exempt in the United States. Stanley Works, of course, is
not the only company to use this tax law loophole. Cooper Industries,
Seagate Technologies, Ingersoll-Rand and PricewaterhouseCoopers
Consulting, to name but a few, have also become pseudo-foreign
corporations for the sole purpose of saving tax dollars.
While profits may increase as a result of this foreign
reincorporation gimmick, there are some significant disadvantages to
shareholders that may not be readily apparent to them. Shareholders
must exchange their stock in the corporation for new foreign
corporation shares--generating capital gains tax liability. So while
the corporation saves taxes, employees and retirees who hold shares are
now unexpectedly facing significant capital gains tax bills. Some must
sell many of the new shares in order to pay the capital gains tax--
reducing the dividend income they were counting on for their
retirements.
At the same time, corporate executives and other holders of
thousands of shares of the corporation will receive huge windfalls from
stock options as the stock price rises because of increased profits.
Stanley Works estimates that its stock may rise by 11.5% after
reincorporation in Bermuda. That increase produces a $17.5 million gain
in CEO John Trani's stock option value while shareholders are facing
$150 million in capital gains taxes. Smaller shareholders, of course,
do not have huge stock option gains that they can use to pay the
capital gains tax.
Incorporating in another country may also restrict shareholder
rights and protections because foreign laws are far weaker than ours.
This issue is not apparent to many shareholders because they may look
at reincorporation as a merely technical move with only corporate tax
implications. The company's headquarters remains in the United States
so shareholders may think that American laws will still apply.
Management has hardly rushed to clarify the weakening, even
eviscerating of shareholder rights.
Taking advantage of corporate tax loopholes, corporations like
Stanley Works typically reincorporate in Bermuda. Bermuda law differs
from the corporate law of most states in several very important
respects.
First, there is the simple problem of the opacity of Bermuda law.
Even sophisticated shareholders may have extreme difficulty in
obtaining information about Bermuda law and evaluating the impairment
of their rights under Bermuda law. Bermuda does not even maintain an
official reporter of its court decisions. We have learned from the
Enron scandal the danger for shareholders, employees and regulators of
shielding important corporate information from public scrutiny. The
movement of corporations to a place where the legal rights of
shareholders are severely constrained and confused--indeed at best
unclear--is a matter of grave concern.
Corporations proposing to reincorporate to Bermuda, such as
Stanley, often tell shareholders that there is no material difference
in the law. But what we have learned about Bermuda law--and divining
Bermuda law is no easy task--shows this claim is certainly not
accurate. There are several important aspects of Bermuda law that
greatly diminish shareholder rights.
For example, Bermuda law lacks any meaningful limitations on
insider transactions. Like most states, Connecticut imposes significant
restrictions on corporate dealings with interested directors of the
corporation--the kind of restrictions that appear to have been violated
in the Enron debacle. Those protections appear to be absent under
Bermuda law.
Bermuda law also fails to provide shareholders with decisionmaking
authority on fundamental changes in the corporation. Connecticut law,
like statutes of most states, requires that shareholder approval be
obtained before the corporation may sell or dispose of a substantial
portion of the assets of the corporation. Bermuda law contains no such
requirement.
Similarly, Bermuda law permits shareholder derivative lawsuits in
only very limited circumstances. Derivative lawsuits are an essential
protection for shareholders. In the United States, shareholders may
bring actions on behalf of the corporation against officers and
directors seeking to harm the corporation. The availability of
derivative lawsuits is a profoundly important tool to protect
shareholders from the malfeasance and self-dealing by officers and
directors. It is a central tenet of American corporate governance. This
form of protection is apparently all but unavailable under Bermuda law.
In addition, there are serious questions about the enforceability
of U.S. judgments in Bermuda. There is presently no treaty with Bermuda
that ensures the reciprocity of judgments. Thus, a person who has
successfully prosecuted a Federal securities claim or products
liability lawsuit in the United States against the corporation, for
example, may be unable to enforce that judgment against the corporation
in Bermuda. Bermuda courts have the right to decline to enforce an
American judgment if they believe it is inconsistent with Bermuda law
or policy. Bermuda may be not just a tax haven, but also a judgment
haven.
Finally, a Bermuda incorporation will greatly impede my office or
any state Attorney General in protecting the public interest and
safeguarding shareholder rights including the state's financial
interests--stopping a shareholder vote, for example, if shareholders
are provided with misleading information. Earlier this year in
Connecticut, Stanley Works issued conflicting statements to 401k
shareholders. The first statement said that failure to vote would be
counted as a ``no'' vote. The second one said that failure to vote
would allow the 401k administrator to cast a ballot consistent with the
401k plan. My office, representing the state of Connecticut as a
shareholder, filed an action in state court that halted the vote
because of the tremendous confusion caused. Whether I could have taken
a similar action had Stanley Works been incorporated in Bermuda is at
best unclear.
The misstatements made by Stanley Works management were so
misleading and potentially deceptive that I requested a full
investigation by the Securities and Exchange Commission (SEC) and an
order delaying any revote until such an investigation is complete. I
further requested that the SEC review the May 28, 2002 Stanley Works
proxy statement to determine whether Stanley Works has accurately
explained the impact of the Bermuda move on shareholder rights. The SEC
expressed interest in reviewing the proxy statement.
As a result of my complaint and SEC interest in this matter,
Stanley Works issued a revised proxy statement on June 21, 2002 which
was just made available to me this morning. The revised statement
contains--for the first time--a clear concession by Stanley Works that
a Bermuda reincorporation will restrict shareholders' rights. The
revised proxy statement states: ``Your Rights as a Shareholder May be
Adversely Changed as a Result of the Reorganization Because of
Differences between Bermuda Law and Connecticut Law and Differences in
Stanley Bermuda's and Stanley Connecticut's Organizational Documents.''
I am hopeful that continued SEC pressure--along with legal
challenges to the adequacy of similar proxy statements by other
corporations proposing a reincorporation in Bermuda--will compel
clearer and more truthful descriptions in proxy statements concerning
the severe weakening of shareholder ability to hold management
accountable under Bermuda law.
Some corporation proxy statements may seek to assure shareholders
that the new corporation bylaws will restore some of these lost
shareholder rights. This substitute is simply inadequate. If corporate
bylaws were sufficient to protect shareholder rights, we would not need
Federal and state securities laws.
In sum, reincorporation in another country like Bermuda undermines
the interests and rights of American shareholders. Corporate CEOs,
whose compensation is typically tied to short-term gains in stock price
or cash flow, often gain millions in additional pay stemming directly
from the tax savings obtained by these moves and are better able to
engage in insider transactions. They are less exposed to shareholder
derivative lawsuits and Federal securities action. They are shielded
from shareholders seeking to hold them accountable for misjudgments or
malfeasance. The incentive for corporate officers to make the move to
Bermuda is obvious. But the interests of ordinary shareholders and the
United States are gravely disserved.
If American corporations seek a more level playing field--fairer
tax burdens so they can better compete globally--they at least ought to
stay on our side of the field. They ought to pay their fair share of
the financial cost of American services and benefits that also aid
them. And they should be required to show a specific need or
disadvantage compared to some foreign competitor that threatens
American jobs or economic interests.
I urge the Committee to first approve legislation that will
permanently close this loophole and then determine whether our tax laws
need to be changed to address inequity concerns that have been raised.
The Treasury Department's preliminary report listed several areas for
review, including rules limiting deduction for interest paid on foreign
related debt, rules on valuations on transfers of assets to foreign
related parties and cross-border reorganizations. I do not endorse any
specific proposal for tax law change, or even necessarily general
change itself. What I endorse strongly and unequivocably is the need
for closing this destructive loophole, as H.R. 3884 would do. The
measure should be permanent so as to assure credibility and certainty.
The status quo is unacceptable.
Chairman McCRERY. Thank you, Mr. Blumenthal. So, Mr.
Blumenthal, your primary concern, at least judging by your oral
remarks, is the diminution of shareholder power by virtue of a
corporation leaving our shores and reincorporating offshore.
Then I take it that you would favor anything, any legislative
solution to that. You are not tied to Mr. Neal's bill, although
you endorse that, I think, in your written testimony. Is that
an accurate statement? I mean, are you tied to Mr. Neal's bill
or would you be willing to look at other things that would
accomplish the same thing?
Mr. BLUMENTHAL. Mr. Chairman, I appreciate that question
because it fills a gap that unfortunately I left out in the
summary that I presented. I very strongly support Congressman
Neal's bill; that is, H.R. 3884. I believe that closing this
loophole should be done permanently because of the certainty
that it provides. First, as to shareholders, they have a right
to know what the future means in terms of the tax laws that
apply to their corporations, and management has an interest in
that certainty as well. To provide for a moratorium in 1 year I
think undercuts the interests of the corporation in terms of
certainty and also the credibility of the Tax Code itself.
Chairman McCRERY. I am not talking about a moratorium. I am
talking about a different approach to solve the problem. You
are not adverse to hearing other approaches to solving the
problem legislatively, setting aside the moratorium?
Mr. BLUMENTHAL. If the problem is to make sure that there
is in fact a level playing field and there are other reforms
that the Committee, the Committee on Ways and Means, wishes to
consider, I certainly wouldn't foreclose them. I have focused
here on the corporate governance issue because I believe, with
all due respect, that it has been largely ignored or
disregarded by many of the public comments, well intentioned
and correct as they have been, in concentrating on the fiscal
impact, on the equities involved. I am seeking simply to draw
on my own personal experience in enforcing these laws.
Chairman McCRERY. I appreciate that. I think it is a very
important point, and I am glad that you emphasized that during
your remarks. Since you have endorsed the Neal bill, I assume
you have looked at it, you have studied it, and I want to ask
you a few questions about it and get your response.
If a company with manufacturing operations in Ireland, for
example, decided to invert to Ireland, would H.R. 3884, the
Neal bill, prevent that transaction?
Mr. BLUMENTHAL. Would it prevent reincorporation in
Ireland?
Chairman McCRERY. Right.
Mr. BLUMENTHAL. Well, I don't know that any of the measures
that close the tax loophole would bar reincorporation per se.
What the impact would be on tax treatment of foreign earnings
would depend on how the bill were adopted and what specific
form. Of course, I say all this with deference and respect to
the author of the bill, who happens to be on this panel, and
would yield to him if he has an answer that contradicts mine.
Mr. NEAL. A friend of Ireland as well.
Chairman McCRERY. Well, the answer is if that company, the
resulting company, based in Ireland, had less than 80 percent
of the shareholders who were the same as the American company
that preceded the Irish company, then the Neal bill would have
no impact on that inversion because there are substantial
operations in Ireland.
Mr. BLUMENTHAL. I am aware of the limits so far as
shareholder--numbers of shareholders are concerned.
Incidentally, although I have endorsed the Neal-Maloney bill,
if there are improvements that can be made by this panel or the
full Committee or the Congress, I certainly am not wedded to
these specific provisions. The basic point is that shareholders
need to be protected.
Chairman McCRERY. Well, that is the answer I am looking
for, that you are not wedded to the Neal bill. You are willing
to explore other approaches. I think it is appropriate that we
point out some flaws in the Neal bill, and I hope that when we
get through examining it we can agree that we need to look
further and improve upon the Neal approach.
For example, if a company issued an initial public offering
(IPO), they issued IPO stock as part of the inversion
transaction, the Neal bill wouldn't stop that if the result of
that were to dilute the shares of stock of the previous
shareholders below 80 percent, which could easily be done. If
the new parent, for example, issued stock to the U.S.
subsidiary, a so-called hook stock transaction, as done by
Ingersoll-Rand, again the Neal bill wouldn't affect that
because the probable result would be that the U.S. subsidiary
would own more than 20 percent of the new shares.
So those are just a few examples of how a company intent on
inversion could easily circumvent the provisions in the Neal
bill.
Mr. Salch, can you--you talked in your written testimony
about some of the provisions in our Tax Code that make U.S.
companies less competitive in the global marketplace. Can you
list some of those for us, just tick some off that are
particularly egregious to American companies with foreign
operations?
Mr. SALCH. Mr. Chairman, it is going to vary depending from
company to company.
Chairman McCRERY. Is your mike on?
Mr. SALCH. It is going to vary based on company to company,
but in broad general terms we start out with the fact that we
have two competing systems of income taxation. Ours is
worldwide. Many of our major trading partners and competitors
are territorial or use a participation or an exemption system
to get there with respect to business profits.
Now, let's be sure we are talking about business profits
rather than so-called passive income. You have to worry about
what that is. From a business profit perspective, if a Dutch
company operates in a particular jurisdiction and has an active
business in that jurisdiction, it doesn't pay tax on the
profits of that operation, whether they are held by a
subsidiary or by the Dutch company. That is different.
Initially, it also gives that parent company the
opportunity to take profit from this business to another
business and reinvest it without having to pay tax on it, which
lowers its cost of capital and gives it an opportunity to
leverage its business better. If we had a U.S. company that had
two foreign subsidiaries, you get the profit from one
subsidiary and invested it in the other subsidiary, you would
have to pay tax coming through the United States as a dividend.
So, it is that type of a situation that begins to bring
this into focus. Some aspects of subpart (F), if you have a
Dutch company that has a Swiss subsidiary and a subsidiary in
Latin America that grows commodities, agricultural commodities,
and the Latin America subsidiary sells those to the Swiss
company which then markets them worldwide, the Dutch company
doesn't pay tax on any of those profits. Well, our U.S. company
might not pay tax on the profits of the producing country, but
it will pay tax on the profits of the Swiss company because
that is foreign base company sales income. It is active
business income. There are 35 people in that office in
Switzerland that are actively marketing those commodities and
actively arranging the shipment and everything else. It is not
passive. But it is subpart (F) foreign base company sales
income.
Chairman McCRERY. Thank you for that short recitation of a
few provisions in the Tax Code that make our companies less
competitive in the international marketplace.
Now, are these companies that are inverting, that are
expatriating, moving offshore, does that make life better for
them from a tax standpoint? Do they suddenly step into the
shoes of that Swiss company you were talking about and not have
to pay taxes on some of those transactions?
Mr. SALCH. Actually, in my example, Mr. Chairman, the Swiss
company would pay 5-percent tax in Switzerland on its profits.
The companies that are inverting to Bermuda are inverting to a
country which imposes no tax, no income tax, period. So they
automatically go into a tax-free environment that is totally
independent of the participation type exemption or territorial
tax system. They also, however, by acquiring foreign status,
avoid subpart (F). Subpart (F) no longer applies to their
foreign subsidiaries if the foreign subsidiaries go out in the
inversion and that is the hook stock that you were talking
about. Typically that is used to purchase the stock or the
assets of the foreign subsidiaries of the existing U.S.
operation and then move that underneath the new inverted
foreign parent.
Chairman McCRERY. Likewise, they would not be subject to
the foreign base sales and service requirement.
Mr. SALCH. That is correct. That is correct.
Chairman McCRERY. Thank you, Mr. Salch. Before I go to Mr.
McNulty, let me just say, Mr. Blumenthal, again I appreciate
your highlighting the issue of shareholder rights.
One thing you didn't mention which I think maybe the
Members of this Subcommittee ought to talk about before we
finish our examination of this subject is the question of
executive pay, stock options, and so forth, and how they might
be treated differently from shareholders' stock when these
inversions are made.
Mr. BLUMENTHAL. If I may, Mr. Chairman, I made that point
in my written testimony, that very often there are not so
hidden or disguised rewards in terms of executive compensation.
I agree that that is an area that may deserve further scrutiny.
Chairman McCRERY. Thank you. Mr. McNulty.
Mr. McNULTY. Thank you, Mr. Chairman. I thank both of our
distinguished witnesses for their testimony, and I yield to Mr.
Neal.
Mr. NEAL. Thank you, Mr. Chairman, and thank you, Mr.
McNulty.
Mr. Salch, do you think that Stanley Works did the right
thing?
Mr. SALCH. In what respect do you ask that question, Mr.
Neal? I should say I am not as familiar with Stanley Works as
you are, but I will try and answer your question. What do you
mean, did the right thing? In what respect?
Mr. NEAL. Do you think in this atmosphere where President
Bush has asked for $48 billion more for our national defense,
where he has asked for $38 billion more for the establishment
of a Homeland Security Department, do you think Stanley Works
is doing the right thing by shedding their responsibility?
Mr. SALCH. What responsibility have they shed?
Mr. NEAL. To contribute to the payment of the request that
the President has made for the common defense. He has stated
that the national purpose here is war.
Mr. SALCH. Well, they haven't moved anywhere yet, Mr. Neal.
Mr. NEAL. They certainly are trying very hard.
Mr. SALCH. My understanding is that they would continue to
pay U.S. tax on their U.S. business operations and their U.S.
business income.
Mr. NEAL. Let me ask you, do you think that their decision
to move their corporate address to Bermuda is the right thing?
Mr. SALCH. Mr. Neal, that goes to a matter of corporate
governance, which is beyond the purview of a poor old tax
lawyer like me.
Mr. NEAL. Mr. Blumenthal, do you think that Stanley Works
is doing the right thing?
Mr. BLUMENTHAL. No, I don't, Mr. Neal. I believe very
strongly that they are doing the wrong thing, beyond the issue
of patriotism or allegiance to country. I happen to think that
this move has proved to be a disaster to Stanley Works' image.
You know, my first experience with Stanley Works as
Attorney General was to defend this corporation against a
hostile takeover. We literally, and I personally, went to court
when a major national corporation in effect wanted to pursue
it, and we stood shoulder to shoulder. We believe in Stanley
Works as a company. It is a well-established American
corporation, and I think this entire experience has given it an
enormous black eye, certainly costing it way beyond the $30
million that it would have gained in tax savings, and I believe
very strongly, with the fundamental point that you have made,
that it has enjoyed and benefited from services that are
provided by this country. It should be required to pay its fair
share of those services and that is one of the fundamental
reasons I think this loophole should be closed.
Mr. NEAL. Mr. Blumenthal, are you knowledgeable about why
Barbados was included with the inversion decision of Stanley
Works?
Mr. BLUMENTHAL. Barbados is the means by which additional
tax savings are achieved if foreign income in effect is
funneled through the Barbados. My understanding is that there
are additional savings to the corporation. In fact that may be
one of the pivotal means by which the savings are achieved
following the reincorporation to Bermuda.
Mr. NEAL. Mr. Salch, would that be your understanding as
well?
Mr. SALCH. My understanding is that Barbados was used
because of the Barbados-U.S. treaty.
Mr. NEAL. For the purpose of sheltering vs. income?
Mr. SALCH. Also a reduced withholding rate on interest.
Mr. NEAL. Okay, thank you.
Mr. Blumenthal, given the number of lawsuits that have been
filed against Enron, what conceivably could be done in this
instance by a company taking on a new corporate address in
Bermuda to shareholder rights?
Mr. BLUMENTHAL. I think many of the shareholder lawsuits
that have been brought against Enron could not be brought under
Bermuda law or would encounter much greater obstacles in cost
and time if Enron were a Bermuda corporation instead of a
company incorporated in this country, and judgements obtained
against Enron in this country would face very severe hurdles in
enforceability in another country. All of the kinds of self-
dealing, malfeasance, violation of shareholder interests and
rights I think would be much more difficult to pursue, if they
could be pursued at all, if Enron were a Bermuda corporation.
Mr. NEAL. Well, based upon your good work and the work of
other Attorneys General across the country, where some would
argue that it was perhaps the responsibility of boards of
directors and others to have taken a harder look at some of
these decisions, do you think that it is legitimate that
individuals like yourself who hold these offices should be
having to make these decisions about pursuing those who have
neglected their responsibilities as boards of directors, as
members of boards of directors?
Mr. BLUMENTHAL. I think in representing our pension funds
as well as a parens patriae action defending our citizens'
interests, we have a right and responsibility to be in court
pursuing wrongdoing when it occurs among boards of directors or
officers. So I think it is an obligation, as well as an
opportunity to use laws of our States and to seek to make those
laws as transparent and enforceable as possible. I think it is
part of the job of being in law enforcement.
Mr. NEAL. Thank you. I think my time has expired, Mr.
Chairman.
Chairman McCRERY. You can have another round.
Mr. NEAL. Okay.
Chairman McCRERY. Mr. Brady.
Mr. BRADY. Thank you. First of all, I want to make it clear
no one on this panel that I know of is defending corporate
inversions. On the other hand, we recognize there is no more
dangerous combination than an election year, a lot of political
rhetoric, and U.S. jobs at stake. What we are trying to find
here are solutions to this problem, a problem, by the way, that
rather than pointing fingers at companies we probably ought to
be pointing fingers at ourselves. They are following U.S. tax
law created by Congress and hopefully solved and addressed by
Congress.
Mr. Salch, the introduced inversion bills disregard a
company's inversion and continues to treat the company as a
domestic U.S. corporation. From your experience, and you have a
lot, does this approach make U.S. companies even bigger targets
of foreign takeovers or smaller targets of foreign takeovers?
Mr. SALCH. It is always difficult to tell looking down your
crystal ball, but I think if I had to be an odds maker, I would
say that the odds are more likely than not that it would make
them bigger targets rather than smaller targets. It just takes
some people out of the marketplace.
Mr. BRADY. Sure. From a policy standpoint and a job
standpoint, isn't making--isn't foreign acquisition, foreign
takeovers of all U.S. companies a potentially large threat to
U.S. jobs? I mean, when these takeovers occur decisions are
made elsewhere. Sometimes they can be a benefit to us when the
situation is right, but isn't that also a real live threat to
U.S. jobs?
Mr. SALCH. Mr. Brady, that is stretching my tax lawyering a
little bit, too. Let me just say that from some experience
dealing with U.S. and foreign firms, there may be a tendency to
think if you are a U.S. firm and you are in your own hometown,
if that is where your business and your people are, you may
think long and hard about dismissing those people, whereas if
your business is someplace else it might be an easier decision
to make. I mean that is just human nature.
Mr. BRADY. Sure, and I think the point of all of this is as
we look for solutions, very thoughtfully, as we put our best
heads together on this, we need to look at those consequences.
I am not interested in making U.S. companies more attractive to
be taken over by foreign firms. I want them to keep U.S. jobs
and their U.S. headquarters here and do it in a good thoughtful
way.
I yield back the balance of my time.
Chairman McCRERY. Thank you, Mr. Brady. Let me just follow
up very quickly, Mr. Salch, to try to give you an example along
the lines Mr. Brady was talking about.
Let's assume that there were two companies interested in
acquiring a U.S. company. One of those companies was a U.S.
company. The other company is a foreign company. Now, both of
those corporations look at the transaction, and at least on a
tax basis which one would have the clear advantage, assuming
that that U.S. corporation that they are wanting to acquire has
foreign operations, foreign income.
Mr. SALCH. That last assumption, that the U.S. corporation
has foreign operations and foreign income, I think illustrates
the point I have tried to make in my written statement. If that
foreign company is based in a country which has a territorial
system, whether it is exemption or participation or whatever,
they have an advantage in terms of rates of return, in economic
theory, that would allow them to price that acquisition
differently than the domestic corporation looking at the same
transaction from its perspective, and I think that is one of
the concerns that is illustrated in the example in my written
statement.
Chairman McCRERY. Thank you. Mr. Ryan.
Mr. RYAN. Thank you, Mr. Chairman. Gentlemen, thank you for
coming here today because this is really a fairly new issue for
our Subcommittee.
We have had, I think, on record 25 inversions over the last
25 years, or something to that effect, and about 8 of those
occurred in the last 2 years. So it is a relatively new issue
that Congress and the country are considering. As I see this
thing unfold, there are basically two ways to look at it. An
inversion is a unique isolated problem that needs to be banned
or abolished in tax law, or an inversion is a symptom of a
larger problem, which is our tax structure is much, much less
competitive relative to our competing nations. I think that
that broader view captures the whole picture much more
accurately, so we need to hear more from experts like yourself,
Mr. Salch, as we look at how we fix and address these changes.
I wanted to ask you a couple of quick questions.
Have you reviewed the Treasury Department's corporate
inversion study?
Mr. SALCH. Yes.
Mr. RYAN. I had a couple of concerns about that. Again, as
we react quickly, which I think we are going to do in this
Congress, we want to make sure we don't involve some unintended
consequences, make someone pay more taxes than they otherwise
were paying for no reason. My questions are in these two areas.
One, if we go from a 1.5 to 1 ratio, safe harbor debt to equity
ratio, safe harbor regime to a worldwide debt to equity ratio,
where we compare a domestic holding company or domestic
subsidiary's debt to equity to the worldwide debt to equity
ratio, do you think we are going to get some people we
shouldn't be getting? Meaning, aren't there a lot of businesses
like a manufacturing business that may have in the U.S.
operation a credit, high capital intensive or financial
services business, but because of their structure has higher
debt in the United States than they otherwise would on the
worldwide basis, and aren't we going to in effect capture those
people with safe harbor rules that will in effect raise their
taxes for no good reason?
Mr. SALCH. It gets to be a very complicated question to
answer because you have to decide what your view of money is,
is it fungible and can it flow? If money is fungible and it can
flow, then the next question is, is the decision on financing
made on a businesswide, expanded, affiliated group basis? If it
is, then the Treasury Department's position on 163(j), which is
what you are talking about, doesn't seem to me to be a bad
policy decision with which to begin, because what it says to
the business is you can make your decision where you want to
deploy your resources and in what relationship you do that. We
are going to sort of level that playing field around the world
wherever you operate as far as we are concerned, and then the
issue is will our trading partners follow suit, and most of
them probably would, in my judgment.
Mr. RYAN. So, you think if we tighten up 163(j) along the
lines of the Treasury Department that there will be residual
actions by our foreign competitors?
Mr. SALCH. To some extent there already are. They are
already there. This is not a new and novel technique
necessarily. To the extent that they are not already there, if
you want to say that from a global sense everyone is concerned
about preserving what they believe to be their tax base, which
is their domestic base outside, even in the so-called
territorial regimes you are looking at their own domestic tax
base, then they will be interested in measures which eliminate
stripping of that tax base or eroding that tax base.
Mr. RYAN. Well, again on 163(j), do you think that there
are legitimate business reasons why a foreign owned company
group may choose to place more debt in a U.S. subsidiary
because of more readily access to our U.S. capital markets? I
mean, our capital markets in the United States are very
efficient. Money is cheaper in the United States. To me that is
a good thing for our economy. We want our capital markets to be
accessed. We want people to borrow more money in our capital
markets than in, say, foreign capital markets. Are there or are
there not legitimate reasons why a company that is held foreign
but has a large U.S. subsidiary would want to increase their
debt load in the United States because of cheaper capital
markets or access to these capital markets?
Mr. SALCH. Well, understand, Mr. Ryan, that 163(j) doesn't
have to do with bank debt or capital market debt. It has to do
with related party debt.
Mr. RYAN. If it is intercompany debt or if it is
indebtedness guaranteed by the foreign parent, doesn't that
include whether or not they are going to have more access or
less access to the U.S. capital markets? If we follow through
with this, this idea that we need to tighten this up on 163(j).
Mr. SALCH. Again, if you believe that money is fungible and
that there are markets within which a multinational can borrow
around the world, then I don't think that a global base that
the Treasury Department proposed is going to necessarily
prejudice access to U.S. markets for that business to borrow as
it would any foreign market. The business may borrow wherever
it is cheapest and able to borrow and then deploy it wherever
it wishes to do so. All this does is say for in terms of
preserving our tax base on U.S. revenues with interest payments
that are moving outside, here is where we draw the line, and it
is a line that is drawn worldwide without regard to where you
borrow.
Mr. RYAN. Okay. So as we draw that line, would it be safe
to conclude that in seeking to, you know, stop the juice on
inversions we will also cut back on the ability for a company
to access U.S. capital markets and raise its indebtedness by
intercompany debt or guaranteed debt in their U.S. subsidiary
relative to where they are today?
Mr. SALCH. No. It is not reasonable because 163(j) has
nothing to do with capital market access. It has nothing to do
with where you borrow or at what rate you borrow or where you
deploy the borrowed funds.
Mr. RYAN. Won't it raise--don't you believe it will raise
the cost of borrowing if their taxes are increased?
Mr. SALCH. No. Well, it raises the cost of borrowing in the
sense that you are not going to necessarily be able to deduct
interest if your rate of borrowing is above your worldwide rate
of borrowing.
Mr. RYAN. That is right. That is what I am trying to get.
Mr. SALCH. So to that extent it becomes more expensive for
you to leverage in the United States than it does to use equity
in the United States.
Mr. RYAN. Thank you. It took me a while to get there, but
that is what I was trying to get at. Appreciate it.
Chairman McCRERY. I think Mr. Ryan raises some interesting
points and ones that we ought to consider. I am not sure that
the conclusion he reaches is one that we ought to embrace right
now without further examination. I think Mr. Salch's remarks
were right on point, that there are a lot of different
motivations for accessing capital markets, both here and
abroad, and we ought not conclude that just because a guarantee
by the foreign parent would bring that under 163(j) and
preclude them from deducting that interest would necessarily
preclude them from accessing our capital markets.
Mr. RYAN. If the Chairman would yield.
Chairman McCRERY. Sure.
Mr. RYAN. I am not drawing a conclusion. I am trying to get
some answers, and this is thick stuff and I think it is
important that we dig as far as we can to see if there are some
unintended consequences that might result from passing these
recommendations, and that is really where I am trying to go.
Chairman McCRERY. Well, I agree. I think we ought to
examine this very carefully to try to make sure that there are
not unintended consequences that would be deleterious to job
creation here in the United States, and that was the whole
point I tried to make in the opening in our discussion with Mr.
Neal and the other panelists.
Mr. Weller.
Mr. WELLER. Thank you, Mr. Chairman, and again I want to
express gratitude to our distinguished panel here, our second
panel, two experts in important areas. In building on some of
the points that were made by colleagues, particularly Mr. Brady
and Mr. Ryan, the flaw that I hear the greatest concern about,
the Treasury Department illustrated it a few weeks ago and I
hear it from others, regarding Mr. Neal's proposal regarding
the issue of inversions is that it would make American owned
and headquartered companies more attractive for foreign
takeover. I was wondering, Mr. Blumenthal, does that concern
you about the proposal? Are you concerned about that as well?
Mr. BLUMENTHAL. It would concern me certainly, if I thought
that this kind of proposal would have a dramatic or a material
effect on foreign takeovers of American companies. I think
there are a variety of factors that affect these kinds of
takeovers. I am not a mergers and acquisitions lawyer, but the
reasons for foreign takeovers involve a great many complex and
sometimes changing financial issues just as access to foreign
or domestic capital markets is more complex than perhaps we can
summarize.
Mr. WELLER. Mr. Blumenthal, you had indicated your primary
premise is you are here as an advocate of shareholder rights in
the presentation that you made. If a company is taken over by a
foreign company, an American company is taken over by a company
that is headquartered in a foreign nation, does that concern
you on the impact of shareholder rights and how it impacts the
rights of American shareholders of that company?
Mr. BLUMENTHAL. Very much so.
Mr. WELLER. As we discuss this, I think, you know, as Mr.
Ryan pointed out, that inversion really is--a growing course of
inversions really illustrate a symptom of our complicated Tax
Code and now that we are in a global economy and, of course, we
want to be more competitive in a global economy, our Tax Code
is one of the issues out there and the inversions clearly are
illustrating that we have a problem. I asked Mr. Maloney, what
would be the first step he would take to make our Tax Code more
competitive, and he suggested sunsetting the Tax Code. Do you
agree?
Mr. BLUMENTHAL. I do agree.
Mr. WELLER. So you feel that that--and what would you do
from that point of sunsetting the Tax Code, what would you do
from that point once you end it?
Mr. BLUMENTHAL. Well, I am not prepared, with all due
respect, to talk in detail about what I would do on the Tax
Code. I agree that there ought to be real reform. I take from
the Chairman's remarks that far-reaching reform is probably not
going to happen in the remainder of this year or in this
session of the Congress, that it will be the subject of further
study. I do think that for the sake of the credibility of the
American business as well as our Tax Code, this measure makes
sense now.
Mr. WELLER. Mr. Salch, now, the concern that Mr. Neal's
proposal would actually encourage or leave American
corporations vulnerable for foreign takeover, how would you
change his proposal to address that issue? Have you put any
thought into that?
Mr. SALCH. I guess I have to start out by saying I don't
think his proposal will work. There are ways to deal with this
proposal and that is why people like me make a living. If I
told him how I could fix his proposal then I probably would
really get fixed. I am not really sure because, as I said in my
testimony, the concern I have is that we have a level playing
field and Mr. Neal's bill, well thought, takes a slice and in
that one little slice it says you can't do these things. Then
there is everything else that is left un touched. I am not so
sure--as a matter of fact, I am reasonably sure that we can
develop methodologies to deal with the other things and still
keep them moving forward for these people who are within the
slice.
Mr. WELLER. Mr. Salch, the feeling is we need to put a stop
to inversions. We need to put a stop right now. Would a
moratorium be more effective in quickly bringing a halt to any
future inversions that are being considered right now in
corporate America?
Mr. SALCH. Not the way the bill is written, no. It takes
Mr. Neal's definitions, and quite honestly, there are a lot
smarter people than I am and I am sure who can drive a bigger
truck than I could build through it.
Mr. WELLER. So there is a lot of--this is something that is
going to take a tremendous amount of thought; we can't rush
into is what you are saying?
Mr. SALCH. Mr. Weller, as I sit here I am reminded that
then Treasury Secretary George Shultz told this Committee in
1969, when the Committee was considering limitations on
artificial losses and the Chairman asked Mr. Shultz if he could
guarantee that if the Committee enacted that measure it would
stop all the abuses then perceived. Mr. Shultz thought about it
and said, Mr. Chairman, it is the best mousetrap we can build
right now but there are 10,000 lawyers and certified public
accounts (CPAs) out there trying to build a better mouse while
we are talking about it, and now there are probably about
30,000 lawyers and CPAs in this country and then another 50,000
outside. I think that is, I guess, the nature of the beast that
we have to deal with. I am not sure there is a perfect way to
stop inversions without stopping all business dead in its
tracks, and that is certainly not desirable.
Then I think we have all learned over the years that
whatever lines are drawn there is always a two-edged sword and
somebody will find some way to work the other side of the line.
That is the problem with section 482 and earnings stripping. It
works great when you are trying to get income flowing into the
United States with respect to services and goods that are
exported, but it doesn't work so well sometimes when the flow
is coming this way.
Mr. WELLER. I have run out of time. Thank you, Mr.
Chairman.
Chairman McCRERY. Thank you. Mr. Neal.
Mr. NEAL. Thank you, Mr. Chairman. Mr. Salch, do you favor
inversion?
Mr. SALCH. Mr. Neal, I don't favor or disfavor inversions.
I don't like the embellishments that I see to some of the more
recent inversions, which are based strictly on transactions. I
have serious policy reservations about that, but what I call a
classic inversion I don't think is unpatriotic.
Mr. NEAL. You don't think it is unpatriotic?
Mr. SALCH. No, sir.
Mr. NEAL. Do you do any inversion work?
Mr. SALCH. Pardon.
Mr. NEAL. Do you do any inversion work?
Mr. SALCH. I have done inversion work. I don't have any
currently in process, now, sir.
Mr. NEAL. I have a list here of 25 companies, and I don't
think that any one of these companies was threatened with
takeover as they went to Bermuda. Could I send these companies
along to you because the suggestion has been made here by some
Members of the Committee that the reason that these companies
might be leaving is because of American taxes that conceivably
also threaten them with merger or takeover or--but I have got
25 companies here, and I am not aware of any of them that were
being threatened with takeover.
[The information follows:]
Corporate Expatriate List \1\
----------------------------------------------------------------------------------------------------------------
Company Name Date of Inversion U.S. Headquarters
----------------------------------------------------------------------------------------------------------------
Accenture (ACN) July 2001 Chicago, IL
----------------------------------------------------------------------------------------------------------------
Amerist Insurance 1999
----------------------------------------------------------------------------------------------------------------
APW (APWLF) Waukesha, WI
----------------------------------------------------------------------------------------------------------------
Cooper Industries (CBE) May 21, 2002 Houston, TX
----------------------------------------------------------------------------------------------------------------
Everest Re (RE) 2000 Liberty Corner, NJ
----------------------------------------------------------------------------------------------------------------
Foster Wheeler Ltd. (FWC) May 25, 2001 Clinton, NJ
----------------------------------------------------------------------------------------------------------------
Fruit of the Loom (FTLAQ) March 4, 1999 Bowling Green, KY
----------------------------------------------------------------------------------------------------------------
Gold Reserve (GLDR under the OTC) 1999 Spokane, WA
----------------------------------------------------------------------------------------------------------------
Helen of Troy (HELE) February 16, 1994 El Paso, TX
----------------------------------------------------------------------------------------------------------------
Ingersoll Rand (IR) December 31, 2001 Woodcliff Lake, NJ
----------------------------------------------------------------------------------------------------------------
Leucadia National Corp. (LUK) Yes vote May 15 (move New York, NY
postponed)
----------------------------------------------------------------------------------------------------------------
McDermott International (MDR) 1983 New Orleans, LA
----------------------------------------------------------------------------------------------------------------
Nabors Industries (NBR) June 14 vote Houston, TX
----------------------------------------------------------------------------------------------------------------
Noble Drilling (NE) May 1, 2002 Sugar Land, TX
----------------------------------------------------------------------------------------------------------------
Playstar (PLAYF) 1998
----------------------------------------------------------------------------------------------------------------
PriceWaterhouseCoopers (PWCC) May 2, 2002 New York, NY
----------------------------------------------------------------------------------------------------------------
PXRE Group Ltd. (PXT) 1999 Edison, NJ
----------------------------------------------------------------------------------------------------------------
Seagate Technology 2002 Scotts Valley, CA
----------------------------------------------------------------------------------------------------------------
Stanley Works (SWK) pending New Britain, CT
----------------------------------------------------------------------------------------------------------------
Transocean Inc. (RIG) May 1999 Houston, TX
----------------------------------------------------------------------------------------------------------------
Triton Energy 1996 Dallas, TX
----------------------------------------------------------------------------------------------------------------
Tyco (TYC) March 1997 Exeter, NH
----------------------------------------------------------------------------------------------------------------
Veritas DGC (VTS) Houston, TX
----------------------------------------------------------------------------------------------------------------
Weatherford International Inc. (WFT) June vote Houston, TX
----------------------------------------------------------------------------------------------------------------
White Mountain Insurance Company 1999 White River Junction,
(WTM) Vermont
----------------------------------------------------------------------------------------------------------------
XOMA (XOMA) 1999 Berkeley, CA
----------------------------------------------------------------------------------------------------------------
\1\ Information compiled from various news sources, by the Office of Representative Richard Neal.
Mr. SALCH. I don't have the benefit of your list, sir, so I
can't comment.
Mr. NEAL. I am going to send it along to you.
Mr. SALCH. Okay, that is fine. That is good.
Mr. NEAL. Maybe you can take a look at it and if you could
get some evidence for us here.
Mr. SALCH. Sure.
Mr. NEAL. Okay. I would appreciate that.
[The information follows:]
Fulbright & Jaworski, L.L.P.
Galveston, Texas 77551-5719
July 9, 2002
Hon. Jim McCrery
Chairman
Subcommittee on Select Revenue Measures
Committee on Ways and Means
House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman McCrery:
During the Subcommittee Hearing on June 25, 2002, Representative
Neal stated he would forward to me a list with the names of 25
businesses and asked if I would indicate whether I knew any of them
were takeover candidates at the times stated in the list. I have
received that list. Most of the businesses named on the list are
clients or former clients.
The Texas Disciplinary Rules of Professional Conduct, the ethics
rules mandated by the Texas Supreme Court for attorneys licensed in
Texas, preclude me from unauthorized disclosure of confidences of
clients or former clients. Because of those ethical constraints, it
would not be ethically appropriate for me to comment in response to Mr.
Neal's request.
I apologize for any inconvenience this may occasion for the
Subcommittee.
Very truly yours,
Steven C. Salch
Partner
Mr. NEAL. Mr. Blumenthal, do you think that the
shareholders were aware of the fact that Stanley Works' Chief
Executive Office John Trani conceivably would have received 58
cents on every dollar, I guess up $30 million or so, based upon
their decision to relocate?
Mr. BLUMENTHAL. They certainly weren't told about it. If
they knew they had information that the majority of them, in
fact the vast majority of them, didn't have and weren't told
that kind of information really should have been given to them
along with the fact that many of them would have to pay capital
gains taxes. They weren't told, for example, that $150 million
in capital gains taxes would have to be paid by shareholders.
Mr. NEAL. Many of these employees are retired.
Mr. BLUMENTHAL. Are retired and many are in 401(k) plans.
Mr. NEAL. 401(k) plans.
Mr. Chairman, could we have a copy, if Mr. Blumenthal would
provide it for us, of the newest proxy statement included in
the record?
Chairman McCRERY. Without objection.
[The information follows:]
RISK FACTORS
Certain Stanley Connecticut Shareholders Will Recognize a Taxable Gain
as a Result of Exchanging their Stanley Connecticut Common Stock for
Stanley Bermuda Common Shares in the Reorganization
Our tax advisor, Ernst & Young LLP, has advised us that generally
for U.S. Federal income tax purposes shareholders who are U.S. holders
will recognize gain, if any, but not loss, on the receipt of Stanley
Bermuda common shares in exchange for Stanley Connecticut common stock
pursuant to the reorganization. Such a holder will generally recognize
gain equal to the excess, if any, of the trading price of the Stanley
Bermuda common shares received in exchange for Stanley Connecticut
common stock in the reorganization over the holder's adjusted tax basis
in the shares of Stanley Connecticut common stock exchanged therefore.
Generally, any such gain will be capital gain. Shareholders will not be
permitted to recognize any loss realized on the exchange of their share
of Stanley Connecticut common stock in the reorganization. In such
case, the aggregate adjusted tax basis in the Stanley Bermuda common
shares received would equal the aggregate adjusted tax basis of their
shares of Stanley Connecticut common stock. Thus, subject to any
subsequent increases in the trading price of Stanley Bermuda common
shares, any loss would be preserved. The holding period for any Stanley
Bermuda common shares received by a U.S. holder recognizing gain with
respect to the reorganization should begin the day after the effective
date of the reorganization. The holding period for any Stanley Bermuda
common share received by U.S. holders with a loss on their Stanley
Connecticut common stock will include the holding period of the Stanley
Connecticut common stock exchanged for those shares.
WE URGE YOU TO CONSULT YOUR TAX ADVISORS REGARDING YOUR PARTICULAR
TAX CONSEQUENCES OF THE REORGANIZATION.
The Benefits of the Reorganization Could be Reduced or Eliminated if
There Are Unfavorable Changes in or Interpretations of Tax Laws
Several Members of the U.S. Congress have introduced legislation
that, if enacted, would have the effect of eliminating the anticipated
tax benefits of the transaction. On March 6, 2002, Representative
Richard E. Neal (along with 18 cosponsors) introduced legislation (H.R.
3884) that, for U.S. Federal tax purposes, would treat a foreign
corporation, such as Stanley Bermuda, that undertakes a corporate
expatriation transaction such as the reorganization as a domestic
corporation and, thus, such foreign corporation would be subject to
U.S. Federal income tax. The Neal Legislation is proposed to be
effective for corporate expatriation transactions completed after
September 11, 2001. Representative James H. Maloney has also introduced
legislation that is substantially similar to the Neal Legislation,
including a September 11, 2001 effective date (H.R. 3922).
Representative Scott McInnis has also introduced legislation that is
substantially similar to the Neal Legislation, except that it is
proposed to apply to transactions completed after December 31, 2001
(H.R. 3857). Representative Nancy Johnson has also introduced
legislation that is substantially similar to the Neal Legislation,
except that it is proposed to apply to transactions completed after
September 11, 2001 and beginning before December 31, 2003 (H.R. 4756).
Furthermore, Senator Charles Grassley, the Ranking Minority Member of
the Senate Finance Committee, along with Senator Max Baucus, the
Chairman of the Senate Finance Committee, also introduced legis1ation,
which was approved by the Senate Finance Committee on June 18, 2002,
that is substantially similar to the Neal Legislation, except that it
is proposed to apply to transactions completed after March 20, 2002 (S.
2119). If any of the Neal Legislation, the Maloney Legislation, the
McInnis Legislation, the Johnson Legislation or the Grassley
Legislation were enacted with their proposed effective dates, the
anticipated tax savings from the reorganization would not be realized.
Senator Paul Wellstone has also introduced legislation that is
substantially similar to the Neal Legislation, except that it is
proposed to apply to tax years beginning after December 31, 2002
without regard to when such transactions were completed (S. 2050). If
the Wellstone Legislation were enacted with its proposed effective
date, the anticipated tax savings from the reorganization would be
substantially eliminated.
Several other Members of the U.S. Congress and the Treasury
Department are currently investigating transactions such as the
reorganization. On May 17, 2002, the Office of Tax Policy of the
Department of the Treasury issued their preliminary report on off-shore
reincorporation transactions which concluded:
L ``We must work to ensure that our tax system does not
operate to place U.S.-based companies at a competitive
disadvantage in the global marketplace. The tax policy issues
raised by the recent inversion activity are serious issues.
Further work is needed to develop and implement an appropriate
and effective long-term response. As an immediate matter,
careful attention should be focused on ensuring that an
inversion transaction, or any other transaction resulting in a
new foreign parent, cannot be used to reduce inappropriately
the U.S. tax on income from U.S. operations. A comprehensive
review of the U.S. tax system, particularly the international
tax rules, is both appropriate and timely. Our overreaching
goal must be to maintain the position of the United States as
the most desirable location in the world for place of
incorporation, location of headquarters, and transaction of
business.''
As a result of the increased scrutiny of such transactions, changes
in the tax laws, tax treaties or tax regulations may occur, with
prospective or retroactive effect, which would eliminate or
substantially reduce the anticipated tax benefits of the reorganization
or subject the company to material tax liability as a result of the
reorganization. If in response to any such changes the reorganized
company or its subsidiaries undertake a corporate restructuring, such
restructuring could result in additional material tax liability to the
company or its shareholders.
In addition, the IRS or other taxing authority could disagree with
our assessment of the effects or interpretation of existing laws,
regulations and treaties (including Stanley Bermuda's treatment as a
tax resident of Barbados), which could subject the company to material
tax liability as a result of the reorganization or subject the future
operations of the reorganized company and its subsidiaries to material
tax liability.
The Benefits of the Reorganization Could be Reduced or Eliminated if
the IRS Successfully Challenges the Tax Treatment of the Reorganization
We believe that Stanley Connecticut should not incur a material
amount of U.S. Federal income or withholding tax as a result of the
reorganization. It should be noted, however, that the IRS may not agree
with this conclusion. If the IRS were to challenge successfully the tax
treatment of the reorganization, this could result in the company being
liable for a material amount of taxes. Liability for a material amount
of taxes could reduce or eliminate the expected tax benefits of the
reorganization and could also have an adverse impact on the company's
liquidity and capital resources.
Stanley Bermuda May Become Subject to a Material Amount of U.S.
Corporate Income Tax, Which Would Reduce Stanley Bermuda's Net Income
Stanley Connecticut currently is subject to U.S. corporate income
tax on its worldwide income. After the reorganization, Stanley
Connecticut and its subsidiaries will continue to be subject to U.S.
corporate income tax on their operations. Stanley Bermuda anticipates
that its non-U.S. operations will not be subject to U.S. corporate
income tax other than withholding taxes imposed on U.S. source dividend
and interest income.
Stanley Bermuda and other non-U.S. Stanley affiliates intend to
conduct their operations in a manner that will cause them not to be
engaged in the conduct of a trade or business in the U.S. Stanley
Bermuda intends to comply with guidelines developed by its tax advisors
designed to ensure that Stanley Bermuda and its non-U.S. affiliates do
not engage in the conduct of a U.S. trade or business, and thus,
Stanley Bermuda and its non-U.S. affiliates believe that they should
not be required to pay U.S. corporate income tax, other than
withholding tax on U.S. source dividend and interest income. However,
if the IRS successfully contends that Stanley Bermuda or any of its
non-U.S. affiliates are engaged in a trade or business in the U.S.,
Stanley Bermuda or that non-U.S. affiliate would be required to pay
U.S. corporate income tax on income that is subject to the taxing
jurisdiction of the U.S., and possibly the U.S. branch profits tax. Any
such tax payments would reduce Stanley Bermuda's net income.
The Enforcement of Judgments in Shareholder Suits Against Stanley
Bermuda May Be More Difficult Because Stanley Bermuda is Incorporated
in Bermuda
Stanley Bermuda is a Bermuda company. As a result, it may be
difficult for you to effect service of process within the United States
or to enforce judgments obtained against Stanley Bermuda in United
States courts. However, Stanley Bermuda will irrevocably agree that it
may be served with process with respect to actions based on offers and
sales of securities made in the United States by having Stanley
Connecticut, located at 1000 Stanley Drive, New Britain, Connecticut
06053, be its United States agent appointed for that purpose.
Stanley Bermuda has been advised by its Bermuda counsel, Appleby,
Spurling & Kempe, that a judgment for the payment of money rendered by
a court in the United States based on civil liability would not be
automatically enforceable in Bermuda because there is no Bermuda law or
treaty between the U.S. and Bermuda providing for the enforcement in
Bermuda of a monetary judgment entered by a U.S. court. Stanley Bermuda
has also been advised by Appleby, Spurling & Kempe that a final and
conclusive judgment obtained in a court of competent jurisdiction in
the United States under which a sum of money is payable as compensatory
damages may be the subject of an action in the Supreme Court of Bermuda
under the common law doctrine of obligation, by action on the debt
evidenced by the court's judgment. Such an action should be successful
upon proof that the sum of money is due and payable, and without having
to prove the facts supporting the underlying judgment, as long as:
Lthe court that gave the judgment was competent to
hear the action in accordance with private international law
principles as applied by the courts in Bermuda; and
Lthe judgment is not contrary to public policy in
Bermuda, was not obtained by fraud or in proceedings contrary
to natural justice of Bermuda and is not based on an error in
Bermuda law.
A Bermuda court may impose civil liability on Stanley Bermuda or
its directors or officers in a suit brought in the Supreme Court of
Bermuda against Stanley Bermuda or such persons with respect to facts
that constitute a violation of U.S. Federal securities laws, provided
that the facts surrounding such violation would constitute or give rise
to a cause of action under Bermuda law.
Anti-takeover Provisions in Stanley Bermuda's Bye-laws and its
Shareholders Rights Plan Will Maintain Certain Existing Anti-takeover
Provisions of Stanley Connecticut
Similar to the current authority of Stanley Connecticut's board of
directors, the board of directors of Stanley Bermuda may issue
preferred shares and determine their rights and qualifications. The
issuance of preferred shares may delay, defer or prevent a merger,
amalgamation, tender offer or proxy contest involving Stanley Bermuda.
This may cause the market price of Stanley Bermuda's shares to decrease
significantly.
In addition, provisions in Stanley Bermuda's bye-laws and
shareholders rights plan, which replicate certain provisions of Stanley
Connecticut's restated certificate of incorporation, bylaws and its
shareholders rights plan, could discourage unsolicited takeover bids
from third parties or the removal of incumbent management. These
provisions include a classified board of directors and the possible
dilution of a potential acquiror's interest in Stanley Bermuda as a
result of the operation of its shareholders rights plan.
Your Rights as a Shareholder May be Adversely Changed as a Result of
the Reorganization Because of Differences between Bermuda Law and
Connecticut Law and Differences in Stanley Bermuda's and Stanley
Connecticut's Organizational Documents
Because of differences in Bermuda law and Connecticut law and
differences in the governing documents of Stanley Bermuda and Stanley
Connecticut, your rights as a shareholder may be adversely changed if
the reorganization is completed. For a description of these
differences, see ``Summary--Rights of Shareholders'' on page 11 and
``Comparison of Rights of Shareholders'' beginning on page 40.
Mr. NEAL. Would that be okay? I want to thank you both for
your testimony, and I don't have an opponent at the moment, so
for the suggestion to be made, as it has been made, that some
of this is about politics is wrong. I started on this with
reinsurance 2 years ago largely driven by corporate
considerations. One of the great things about an election is
that the election does crystallize the issue for the great
judge in the end, the American people, to decide, and I am
hopeful that this debate is going to continue. I am hopeful
that we will have good witnesses like you two to continue this
debate back home.
Most importantly, I am hoping that average taxpayers who
understand that if we are spending $48 billion more for
defense, $38 billion more for homeland security, and these
companies are leaving, I hope the average taxpayer understands
they are going to pick up the difference.
Thank you, Mr. Chairman.
Chairman McCRERY. Thank you.
Mr. Salch, do you happen to know the trend in the last few
years in terms of foreign companies taking over American
companies or American companies taking over foreign companies?
Mr. SALCH. I believe that the Associated Press (AP)
reported earlier this month that there was a study that
starting in 1998 there had been a steady increase in the amount
of merger activity or acquisition activity and investment
activity with foreign owners in the United States. So, to that
extent from 1998 forward the AP, for whatever that is worth,
reports that the trend is an up trend.
Chairman McCRERY. In fact, I believe in that same story it
said that 80 percent of the large transactions since 1998 have
been foreign takeovers of American companies. Is that--do you
recall seeing that number?
Mr. SALCH. I believe that is right, sir.
Chairman McCRERY. So even though you can't say they were
takeover targets, the fact is over the last few years the vast
majority of mergers between foreign companies and U.S.
companies have involved foreign takeovers of American
companies. There must be some reasons for that, and I would
submit that the testimony that we have heard here today
illustrates clearly that one of the reasons is the underlying
tax provisions that are the subject of this hearing.
Mr. BLUMENTHAL. Mr. Chairman, may I respond briefly to that
point, because I think it is a very insightful and thoughtful
one. I think all of us, at least on both sides of this panel,
have very, very grave concerns about foreign takeovers of
American companies, and I certainly share that concern with
you. I am not here to advocate one reform or another, whether
sunsetting or any particular measure of fundamental reform. I
think the concern about takeovers has to be seen separately
from this measure, with all due respect, and may relate to more
fundamental issues regarding our Tax Code. I think it perhaps
conceptually and practically can be separated from the reason
that we are here today.
Chairman McCRERY. Well, I appreciate your remarks but I
disagree with you, respectfully. I think they are intertwined,
because if we take away from an American company a tool to
avoid or to reduce the U.S. taxes and avoid being such an
attractive takeover target, then they have nowhere else to go
but to be taken over if they are a right target.
So I do think that the issues are intertwined and we ought
to address, to the extent that we can, both issues in a single
piece of legislation. That just seems to me to make a lot of
sense. I believe this Committee and this Congress has a duty to
try to balance our--all of our desire to make sure that
corporations in America pay their fair share of taxes with our
desire to make sure that our economy is one that is suitable
for the creation and preservation of good jobs. There is no
question that a foreign takeover of an American corporation has
a more harmful effect on jobs in America than an inversion. So,
I do think they are related, and if we don't look at both, I
think we are not doing our duty to the taxpayers and to our
constituents.
Mr. BRADY. If the Chairman will yield just a moment, I want
to point out what Mr. Salch just said, not 10 minutes ago, that
the bill as it currently is written would make U.S. companies
more likely to be taken over by foreign companies. So we cannot
separate the issue of foreign takeovers of U.S. companies from
corporate inversion--again, known as defending these actions--
but we also don't want to create another very unpatriotic
effect of chasing and driving U.S. companies overseas and those
jobs with them.
Mr. NEAL. Mr. Chairman, would you be so kind as to give me
the last word?
Chairman McCRERY. Sure.
Mr. NEAL. In a report here from the U.S. Department of
Commerce in June 2002, by Tom Anderson, he says: ``In 2001
outlays by foreign direct investors to acquire or establish
U.S. businesses decreased substantially.''
Chairman McCRERY. With all due respect----
Mr. NEAL. You said you would give me the last word, Mr.
Chairman.
Chairman McCRERY. I know, but since you are reading from
the report, and I just happen to have a report on the report
here, you should know that even though that is true, what you
said----
Mr. NEAL. It is basically always true, Mr. Chairman.
Chairman McCRERY. Even though what you said is true--let me
see--even with the big drop last year, the overall spending was
still higher than for any year prior to 1998, the overall
spending on foreign acquisition of American companies.
Thank you, gentlemen, very much. Excellent testimony.
Mr. BLUMENTHAL. Thank you, Mr. Chairman.
Mr. SALCH. Thank you, Mr. Chairman.
[Whereupon, at 5:50 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
American Institute of Certified Public Accountants
Washington, DC 20004-1081
June 28, 2002
The Honorable Jim McCrery
Chair, Subcommittee on Select Revenue Measures
House Ways and Means Committee
1110 Longworth House Office Building
Washington, D.C. 20515
Re: Comments for the Record of the June 25, 2002 House Ways and Means
Committee Select Revenue Measures Subcommittee Hearing on Corporate
Inversions
Dear Chairman McCrery:
The American Institute of Certified Public Accountants (AICPA) is
pleased to provide our comments for the record of the June 25, 2002
House Ways and Means Committee Select Revenue Measures Subcommittee
hearing with respect to the issue of corporate inversion transactions.
The AICPA is the national, professional organization of certified
public accountants comprised of more than 350,000 members. Our members
advise clients on Federal, state, and international tax matters, and
prepare income and other tax returns for millions of Americans. They
provide services to individuals, not-for-profit organizations, small
and medium-sized businesses, as well as America's largest businesses.
Several high-profile U.S. corporations have recently inverted or
announced plans to invert.\1\ In general, an inversion transaction is
one in which a U.S.-based company becomes a foreign-based company,
where the new foreign parent company is typically located in a low-tax
country. Although corporate inversions are not new, these recent
activities and plans have prompted both Congress and the Treasury
Department to focus on inversions and the resulting effect on the U.S.
tax base. In addition to the inversion transactions themselves, both
Congress and the Treasury Department have been examining earnings
stripping plans (e.g., through U.S. tax deductions for interest
payments by a U.S. subsidiary to its foreign parent on ``loaded up''
intercompany debt) that are often a part of an inversion plan. In
response, several bills have been introduced \2\ and the Treasury
Department issued a preliminary report reviewing corporate inversion
transactions on May 17, 2002 (the ``Treasury Report'').\3\ On June 18,
2002, the Senate Finance Committee marked-up a proposal that would
address the inversion issue in a somewhat targeted manner. Accordingly,
the AICPA believes it is appropriate to submit comments at this time.
---------------------------------------------------------------------------
\1\ For example, Ingersoll Rand, Coopers Industries and Global
Marine inverted in 2001, while Stanley Works has announced inversion
plans for 2002.
\2\ H.R. 3857 introduced by Rep. McInnis (R-CO); H.R. 3884,
``Corporate Patriot Enforcement Act of 2002'' introduced by Rep.
Richard Neal (D-MA); H.R. 3922, ``Save America's Jobs Act of 2002''
introduced by Rep. Maloney (D-NY); H.R. 4756, ``Uncle Sam Wants You Act
of 2002'' introduced by Rep. Nancy Johnson (R-CN); H.R. 4993, ``No Tax
Breaks for Corporations Renouncing America Act of 2002'' introduced by
Rep. Lloyd Doggett (D-TX); S. 2050, introduced by Sen. Paul Wellstone
(D-MN) and Sen. Dayton (D-MN); and S. 2119, ``Reversing the
Expatriation of Profits Offshore (REPO) Act'' introduced by Sen. Max
Baucus (D-MT) and Sen. Charles Grassley (R-Iowa).
\3\ U.S. Treasury, Office of Tax Policy, Corporate Inversion
Transactions: Tax Policy Implications, Doc. 2002-12218, 2002 TNT 98-49,
http://www.treas.gov/press/releases/docs/inversion.pdf.
---------------------------------------------------------------------------
The AICPA appreciates the political and policy issues that have
been expressed as part of the inversion debate. We strongly believe,
however, that an appropriate response should not focus solely on the
act of inverting, but rather on the incentives for U.S.-based
multinational corporations to invert. Such a response should include
consideration of both U.S. tax disadvantages facing U.S.-based
multinationals as well as U.S. tax advantages available to foreign-
based multinationals. The response should be broad enough to address
these concerns regardless of whether a corporate group chooses to be
foreign-based as a result of an inversion, an acquisition, or through
initial formation.
We believe the goal of a legislative response should be to ensure
that the United States remains an attractive and competitive venue both
for basing multinational operations as well as for foreign investment.
In particular, we believe that the U.S. tax treatment for multinational
groups with a U.S. parent corporation should be at least as favorable
as that for multinational groups with a foreign parent. Further, we are
concerned that any legislation narrowly focused solely on preventing
inversion transactions, or making them less attractive, will fail to
address the underlying long-term policy issues, and could have
unintended negative effects on the U.S. economy, such as potentially
encouraging the takeover of U.S.-based companies by foreign acquirers.
We would like to commend the Members of Congress and the Treasury
Department for giving this serious issue such prompt attention. We urge
caution, however, because inversions involve very complex and
fundamental tax issues that warrant careful consideration. We agree
with the Treasury Department's conclusions in the Treasury Report that
inversions are symptomatic of underlying differences in U.S. tax law
and policy with regard to U.S.-based companies and foreign-based
companies with operations in the United States. The AICPA strongly
supports the Treasury Department's recommendation that rather than
enacting measures designed simply to halt inversion transactions, the
broader question of the U.S. taxation of foreign operations should be
addressed through a comprehensive review of the causes of these
imbalances.
In view of the potential far-reaching effect of any provisions
enacted to deal with inversions, we urge the Congress to address the
underlying issues discussed below in a reasoned and carefully
considered manner. If immediate action is deemed necessary, we would
encourage the Congress to adopt a bill that would, for a period not to
exceed two years, treat a new foreign corporate parent entity, created
via an inversion in which there was no substantial change in operations
or ownership, as a domestic corporation for U.S. tax purposes (thereby
nullifying the tax benefits of the inversion). Such a measure would
provide more time for appropriate consideration of these important and
integrated matters.
We believe U.S. tax rules that treat U.S.-based companies
differently than foreign-based companies and put U.S.-based companies
at a competitive disadvantage include:
LThe U.S. anti-deferral regimes (including subpart F)
that are dated, complex, overlapping and in many respects,
overreaching; and
LThe U.S. foreign tax credit regime and the
limitations thereon, including basketing rules, and, in
particular, interest expense allocation rules that can cause
double taxation.
The Treasury Report also highlighted a need to address those
situations where the U.S. tax base is excessively eroded by
intercompany indebtedness (so-called earnings stripping). We agree that
addressing U.S. tax rules that allow foreign-based companies to strip
earnings out of the United States would help to equalize the U.S. tax
treatment of U.S.-based companies with U.S. operations as compared to
foreign-based companies with U.S. operations. Addressing these issues
will also remove many of the underlying incentives for inversions, and
prevent erosion of the U.S. tax base by foreign-based companies.
Earnings stripping itself, however, is also a complex issue and we
recognize that there will be many issues that will require
consideration as these rules are modified. In this regard we note that
the current proposed earnings stripping Treasury regulations have been
in proposed form for over a decade.\4\ In addition, we urge Congress to
be mindful of the possible effect on U.S. taxpayers if other countries
adopt mirror images of selected provisions contained in the Treasury
Report, such as the debt/equity ratio adjustment proposed for section
163(j).
---------------------------------------------------------------------------
\4\ Prop. Reg. Secs. 1.163(j)-0-1.163(j)-10 (June 13, 1991).
---------------------------------------------------------------------------
In sum, we agree with the findings of the Treasury Report that
there is a need for a methodical, well-reasoned consideration of a
complex set of issues regarding the U.S. tax treatment of U.S.-based
companies versus foreign-based companies, regardless of whether the
foreign-based company is an inverted U.S. company. In addition, we
recommend caution when considering legislation that attempts to address
corporate inversions without adequately addressing the current
disparate treatment of U.S.-based companies versus foreign-based
companies, a treatment that may have long-term adverse consequences for
the U.S. economy. As noted in the Treasury Report:
Measures designed simply to halt inversion activity may
address these transactions in the short run, but there is a
serious risk that measures targeted too narrowly would have the
unintended effect of encouraging a shift to other forms of
transactions to the detriment of the U.S. economy in the long
run.
Our goal is a healthy economy and U.S. job growth. We encourage
legislative changes that enhance U.S. competitiveness in the global
market and eliminate the current underlying advantages under U.S. tax
law for foreign-based companies.
The AICPA would be happy to offer our further assistance on this
legislation. Please contact me at (805) 653-6300 or [email protected];
Andrew Mattson, Chair of the International Tax Technical Resource
Panel, at (408) 369-2566 or Andy@ mohlernixon.com; or Eileen Sherr,
AICPA Technical Manager at (202) 434-9256 or [email protected].
Sincerely,
Pamela J. Pecarich
Chair, Tax Executive Committee
cc:
Members of House Ways & Means Committee
Members of Senate Finance Committee
Mr. Jon Traub, Legislative Director to Rep. McCrery
Mr. Bob Winters, Special Counsel, House Ways & Means Committee
Ms. Allison Giles, Majority Chief of Staff, House Ways & Means
Committee
Mr. John Kelliher, Chief Counsel, House Ways & Means Committee
Mr. James Clark, Chief Tax Counsel, House Ways & Means Committee
Mr. Greg Nickerson, Tax Counsel, House Ways & Means Committee
Ms. Janice Mays, Democratic Chief Counsel, Ways & Means Committee
Mr. John Buckley, Democratic Chief Tax Counsel, Ways & Means Committee
Mr. John Angell, Staff Director, Senate Finance Committee
Mr. Russell Sullivan, Chief Tax Counsel, Senate Finance Committee
Ms. Maria Freese, Tax Counsel, Senate Finance Committee
Ms. Anita Horn Rizek, Democratic Tax Professional Staff, Senate Finance
Committee
Mr. Kolan Davis, Republican Staff Director and Chief Counsel, Senate
Finance Committee
Mr. Mark Prater, Republican Chief Tax Counsel, Senate Finance Committee
Ms. Lindy L. Paull, Chief of Staff, Joint Committee on Taxation
Mr. H. Benjamin Hartley, Senior Legislation Counsel, Joint Committee on
Taxation
Mr. E. Ray Beeman, Legislation Counsel, Joint Committee on Taxation
Mr. David G. Noren, Legislation Counsel, Joint Committee on Taxation
Mr. Oren S. Penn, Legislation Counsel, Joint Committee on Taxation
Mr. Thomas A. Barthold, Senior Economist, Joint Committee on Taxation
Ms. Pamela F. Olson, Acting Assistant Secretary for Tax Policy,
Treasury Department
Mr. Rob Hanson, Tax Legislative Counsel, Treasury Department
Ms. Barbara M. Angus, International Tax Counsel, Treasury Department
[By Permission of the Chairman]
Statement of Ingersoll-Rand, Hamilton, Bermuda
I. Ingersoll-Rand's Corporate Reorganization Was A Lawful And
Appropriate Response To Competition
Ingersoll-Rand (``I-R'') is a world-wide manufacturer of a wide
variety of brand name industrial products with about sixty percent of
its sales in the United States and forty percent in other countries. It
is implementing a global growth strategy, with a particular objective
to encourage global cross-brand selling. To do so effectively, it is
essential that I-R be competitive with its foreign-incorporated
competitors.
As one element of this objective, I-R met every Treasury Department
requirement for a legal corporate inversion when it reincorporated in
Bermuda. The reincorporation was undertaken in full public view in the
fall of 2001 and fully reported to the SEC. It received the approval of
eighty-nine percent of I-R's voting shareholders. The transaction was
completed and closed in 2001. There was no indication from the
Congress, from any Member of Congress during this period, or from any
official of the Treasury Department or the Securities and Exchange
Commission, that the transaction should be subject to question. It was
not until March 2002 that Members of Congress raised concerns about
inversion transactions. In April 2002, the Treasury Department report
on inversions confirmed the complete compliance of this transaction
with current law.
Significantly, I-R's transaction was taxable on the date of
reincorporation, both to the corporation and its individual
shareholders. Shareholder taxes on gain from the exchange of stock are
the direct result of action taken by the Treasury in 1994 to insure
that these transactions would not escape U.S. taxation. Thousands of I-
R's individual shareholders paid millions of dollars of tax on this
transaction. In addition, I-R recognized substantial taxable income.
Labeling I-R's transaction as unpatriotic is unjust. The
reorganization will not result in the loss of any U.S. jobs or the
closure of any U.S. plants. To the contrary, the transaction will
increase I-R's ability to maintain U.S. operations and to expand U.S.
manufacturing and employment in the future.
Finally, if Congress determines that modifications should be made
to the limitation of interest expense deductibility for U.S. companies
with foreign parents, such modifications should be applicable to all
companies. This approach was adopted by the Treasury Department in its
recent proposals to this Committee with respect to foreign
reincorporation transactions. The Treasury Department recognized that
U.S.-based companies are subject to an archaic and burdensome tax
regime that creates serious problems of competitiveness for those
companies with foreign-based rivals. Imposing more restrictions on
interest expense deductibility only for certain types of U.S. companies
with foreign parents would exacerbate those problems by providing a
further advantage to other types of U.S. companies with foreign
parents.
II. A Ban on Inversions Will Be Ineffective and Will Exacerbate the
Problem of Foreign Takeovers
At best, a ban on corporate inversions, whether in the form of a
prohibition or a moratorium, applies a ``Band-Aid'' treatment to a
symptom of a fundamental problem: the Code's treatment of foreign
source income. These provisions create an unequal playing field between
U.S. and foreign global competitors and thereby encourage foreign
takeovers of U.S. companies. The vast majority of global mergers in the
past decade between a U.S. and non-U.S. company has resulted in the
corporate parent choosing the location of the non-U.S. partner as its
global headquarters. This is not a coincidence; it is largely the
result of our international tax regime. This trend has far more serious
implications for U.S. operations and U.S. jobs than corporate
inversions, which maintain U.S. management of all global corporate
operations.
Any attempt to ban inversions will further encourage foreign
takeovers, injuring American firms, their employees and their
investors. Even a relatively short-term moratorium will encourage
foreign takeovers of U.S. corporations. This is a particular concern at
this time because of the sharp reduction in the value of the dollar,
making U.S. companies prime targets for takeovers.
By far the most effective way to discourage inversions is to
correct the underlying anti-competitive flaws in the U.S. Tax Code that
place U.S. global companies at a disadvantage with their foreign
competitors. It is essential that Congress address at the earliest
possible time the Code's international tax provisions that place U.S.
companies at such a severe disadvantage.
III. Legislation That Imposes New Taxes Solely On Companies That
Inverted Should Be Prospective Only
If Congress determines that reorganizations such as that
implemented by I-R should be prohibited, or that additional taxes
should be imposed on such a reorganization, it should do so
prospectively. At the very least, such changes to the tax laws should
be prospective from the date on which legislation was introduced or
announcement of a likely change in the law was made. This, almost
without exception, is the way in which Congress changes the tax laws
governing specific transactions so as to avoid fundamentally unfair
consequences to taxpayers.
Retroactive application of any prohibition or moratorium to
transactions that were completed before March 2002 would be punitive
rather than preventative, because those transactions were completed
under and fully consistent with existing law before any Member of
Congress indicated that a change in law would occur. Such a retroactive
application would be particularly unfair to I-R's shareholders, who
relied on the benefits offered to the company when they voted to incur
taxable income from the transaction. Taxes paid by individual I-R
shareholders may have totaled $100 million. As a practical matter,
there is no way of returning to all these taxpayers the taxes paid on
this specific transaction or restoring them to their pre-tax situation.
When the Treasury Department issued its new regulations governing the
tax treatment for shareholders on inversions in 1994, it did so
prospectively. The regulations did not affect completed transactions.
Nullifying I-R's transaction retroactively could also be unfair to
the company, which made a decision to act based upon the law as it then
existed. If certain of the proposals before this Committee are enacted,
companies will have the opportunity to make choices that were not
available to I-R in seeking to satisfy the terms of the new
legislation. For example, I-R could have reorganized in a country in
which it has substantial business activities, a choice that would
improve its treatment under certain proposed legislation and which
would have had identical tax consequences to the reorganization in
Bermuda. This choice may be available to any company that has not yet
acted, but it was not available to I-R.
In addition, there are serious due process concerns with
legislation such as a prohibition on inversions that retroactively
imposes a new tax without any notice to the taxpayer. Only two types of
tax legislation are generally subject to retroactive enactment: (1)
changes in tax rates and other such adjustments to existing tax laws,
which are often enacted retroactive to the beginning of the tax year
for administrative simplicity; and (2) technical corrections to laws
that have been enacted recently but unintentionally left ``loopholes''
that Congress seeks to close retroactive to the original date of
enactment. The Supreme Court has indicated that U.S. taxpayers are on
notice that these types of changes in the tax laws may occur
retroactively, because such changes put legislative intent into effect
in a reasonable way.
The ``anti-inversion'' legislative proposals that would operate
retroactively are not amendments to existing tax law or technical
corrections seeking to close a recently-enacted loophole. Rather, these
proposals would retroactively impose wholly new tax burdens, which
could raise serious due process concerns. In 1995, the Joint Committee
on Taxation released a report analyzing the due process issues of a
proposal to modify the tax treatment of individuals that expatriated.
When applied prospectively, the proposals did not pose due process
concerns, but the Joint Committee stated that the retroactive
application of one proposal to a date long before there was any notice
would be ``an unprecedented retroactive tax law change that would reach
back and pull a non-U.S. citizen into the jurisdiction of the U.S. tax
system.'' The concerns expressed by the Joint Committee on Taxation
were heeded by Congress at that time. These concerns apply equally to
the retroactive elements of certain legislative proposals under
consideration by this Committee.
Statement of Donald V. Moorehead, Partner, and Aubrey A. Rothrock III,
Partner, Patton Boggs LLP
This statement is submitted for inclusion in the record of the
hearings held by the Subcommittee on Select Revenue Measures on June
13, 2002 concerning possible changes to the Internal Revenue Code of
1986, as amended (the ``Code''), in light of the recent decision of the
World Trade Organization (the ``WTO'') with respect to the
extraterritorial income provisions of the Code. We understand that, in
fashioning a legislative response to the WTO decision, consideration
may be given to making numerous changes to the provisions of the Code
governing the taxation of income earned by U.S.-based businesses from
their international operations. In this statement, we describe two
proposals that should be included as part of such a legislative
package.
Passive Income Attributable to Assets Held to Match CFC Pension
Liabilities
In the United States and many foreign countries, employers may
establish pension plans for their employees and fund those plans
through annual contributions to a separate trust or its equivalent.
Employees and their beneficiaries generally are taxed only when the
benefits are paid to them. In some countries such as Germany, however,
the use of a trust or similar funding mechanism would result in the
imposition of tax on the employees prior to the commencement of
distributions to them upon retirement.
Under German law, if an employer creates a pension plan for its
employees, it is required by law to establish a reserve on its balance
sheet to reflect liabilities under the plan and to make annual
additions to the reserve to reflect the discounted present value of its
future obligations under the plan. Although the basic benefits provided
under the plan are insured, the insurance is payable only if the
employer is unable to pay the benefits as they fall due. Employers may
not formally fund these plans, through an irrevocable trust or similar
arrangement without adverse tax consequences to their employees.
In some instances, both as a matter of financial prudence and to
foster good working relationships with their employees, an employer may
seek to ``match'' its pension obligations (and offset its balance sheet
liability) through the purchase of investment assets. German law
implicitly encourages such practices by providing special tax treatment
for certain types of investments.
When the employer is a controlled foreign corporation (a ``CFC''),
the purchase of assets to match pension obligations can create adverse
U.S. tax consequences. Specifically, the passive income generated by
such investments will be treated as foreign base company income under
the subpart F provisions of the Code and thus, unless it is de minimis
in amount, will taxed to the U.S. shareholders of the CFC (e.g., the
U.S. parent corporation) in the year earned by the CFC. Moreover, that
income will be allocated to the ``passive'' basket for purposes of
computing the foreign tax credit limitation, even though it is
incidental to the active business operations of the CFC.
We believe this is an inappropriate result as a matter of policy.
The investment of earnings to fund retirement plans has long been
recognized as desirable from a public policy standpoint and Congress
itself has sought to provide relief in most instances through section
404A of the Code. Where, however, the host country does not permit the
use of a trust or other similar arrangement without adverse tax
consequences to employees, section 404A provides no relief if assets
are acquired to ``match'' the liability represented by the pension
reserve.
We recommend that, in the case of a CFC engaged in the active
conduct of a trade or business, income attributable to investment
assets purchased to match pension reserves should be placed in the same
foreign tax credit ``basket'' as the income attributable to the CFC's
active business operations. We also recommend that such income be
excluded from the definition of foreign base company income and thus
not taxed to the U.S. shareholders of the CFC unless and until
distributed to them as a dividend or invested in U.S. property.
Foreign Tax Credit ``Stacking'' Rules
Because U.S. businesses are taxed on their worldwide income, the
income they earn from international operations is potentially subject
to double taxation: once by the foreign country in which it is earned
and a second time by the U.S. Depending upon the character of such
income and whether it is earned directly by the U.S. business or
indirectly through a CFC, the U.S. tax on foreign source income will be
payable either in the year it is earned or deferred until the income is
distributed as a dividend to the U.S. shareholders or invested in U.S.
property.
The foreign tax credit provisions of the Code are intended to
reduce the actual incidence of such double taxation and the
effectiveness with which this objective is achieved is critical to the
competitive position of American businesses in the world's markets. By
reason of the operation of certain of these foreign tax credit
provisions, a U.S. corporation may in fact be unable to claim credits
on a current basis for all of the foreign taxes paid with respect to
the foreign source income included in its U.S. tax return. This is true
even where the applicable foreign tax rates are less than the U.S.
corporate rate of 35 percent.
In such situations, the excess credits may be carried back to the
two preceding taxable years and then forward to the succeeding five
taxable years. If they cannot be used during this carryover period,
they expire. Under current law, however, excess credits that are
carried over to another taxable year may in fact be used only after the
credits used in that taxable year have been fully utilized. This
stacking rule thus increases the likelihood that otherwise valid
credits for foreign taxes actually paid on foreign source income that
is subject to U.S. tax will not be used and expire.
We believe this is inappropriate as a matter of policy. Credits for
foreign taxes actually paid on income that is subject to U.S. tax
should in our view be permitted to be used at the earliest possible
date and the Code should be structured so that expiration is only a
remote possibility. This is particularly true since many U.S.
corporations are in ``excess credit'' positions largely because of
provisions of the Code that reduce foreign source income artificially
(e.g., the over allocation of interest expense to foreign source
income) or otherwise make it difficult to use credits in the first year
they are available (e.g., the allocation of types of foreign source
income to different ``baskets'' and the prohibition on the use of
credits earned with respect to income in one basket to offset the U.S.
tax on income in another basket).
For these reasons, we recommend that section 904(c) of the Code be
amended to provide that, with respect to any taxable year, foreign tax
credits would be applied in the following order: (1) credits carried
forward to that year; (2) credits earned in that year; and (3) credits
carried back to that taxable year. This approach was taken in prior
proposed bipartisan international tax simplification legislation and,
is we believe, a more direct solution to the problem than that
contained in H.R. 4541. The proposed change would enable the foreign
tax credit to achieve its objective more effectively and would reduce
the incentive now inherent in section 904(c) for taxpayers to engage in
transactions principally to enable them to use foreign tax credits that
might otherwise expire.
Western Shower Door, Inc.
Fremont, California 94538
July 9, 2002
Honorable James McCrery
House Ways and Means Committee
Chairman, Subcommittee on Select Revenue Measures
Subject: International Taxation/Tax Inversion
Dear Chairman McCrery:
Thank you for holding your Subcommittee's meeting today on tax
inversion. It is an important topic for both big as well as small
companies, their employees, the long-term competitiveness of the U.S.
economy and the ownership of companies throughout our Great Republic.
Western Shower Door, Inc. (``WSD'') is a small/medium-size company.
We employ approximately 220 workers in California and Nevada.
WSD is an integrated manufacturer/distributor/specialty
subcontractor to the builder-direct marketplace. This is a highly
competitive business with thin profit margins.
We have been in business for 43 years. We always pay our taxes. We
are not looking for any special treatment.
Due to the pressure by the homebuilders and general contractors to
keep our prices low, we have had to increasingly import more and more
raw materials and finished goods, which we manufacture and sell on an
installed basis using U.S. workers. As a result, a larger percentage of
our profit is coming from overseas procurement rather what is actually
being produced in the U.S.
However, we do not think it is fair for the U.S. to tax us on the
``profit'' between the price of domestic and lower-priced international
goods. This ``profit'' is often generated when we have to go further
into debt to pay for such goods often before they arrive at U.S. ports.
We live in fear of foreign competitors. Such a competitor could buy
its goods overseas through a foreign company and then legitimately
transfer the goods at U.S. prices. Hence, it would have no ``profit''
on this segment of its business. However, it would have a significant
competitive advantage over wholly owned U.S. companies, which are
forced to pay U.S. taxes on such ``profits''.
We would prefer to remain a wholly owned U.S. company. However, we
believe we should be allowed the same tax freedom as any foreign
competitor.
Again, we are not asking for any special favors. Just give us a
level-playing field against foreign competitors.
If Congress can't do that, then don't prohibit us from acting like
our foreign competition. The long-term issue for you and other Members
is whether or not you want our sons, daughters and grandchildren
working for U.S. companies or foreign companies?
Mr. Jim Easton, who previously worked with Congressman John J.
``Jimmy'' Duncan as a House Committee Staff Person and also handled
Ways and Means Committee issues for Mr. Duncan's father (Congressman
John J. Duncan who was at one time the Ranking Republican on the House
Ways and Means Committee), will be in touch in your staff on behalf of
Western Shower Door, Inc. to share our thoughts and ideas on this
critical matter.
I look forward to an opportunity for Jim and I to work with your
staff as this issue continues to gain the close attention of the Ways
and Means Committee and the Congress.
Sincerely,
Craig McCarty
President
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