VideoEmployees of Ingersoll-Rand Co.'s Bobcat division were deeply moved by a photograph of firefighters gathered around a Bobcat skid-steer loader to pay tribute to a victim of the World Trade Center collapse. Just six days after the terrorist attacks, the firm began manufacturing a special-edition "Spirit of America" loader, painted in patriotic red, white, and blue.
At the same time, CEO Herbert Henkel was putting the finishing touches on a plan to reincorporate the New Jersey manufacturer in Bermuda--a proposal that was put to shareholders six weeks later. "We urge you to join [the board] in supporting this important opportunity," wrote Henkel. "The reorganization should help enhance our business growth and cash flow and reduce our worldwide effective tax rate."
Ever since, congressional Republicans and Democrats alike have blasted Ingersoll-Rand and other companies that pursue such so-called inversions as being un-American. Says Iowa's Chuck Grassley, the ranking Republican on the Senate Finance Committee and co-author of a bill aimed at stemming the practice, "It's outrageous that some companies are willing to leave their country during a war and a recession just to save some taxes."
Yet the outcry--and the inversions themselves--are merely a skirmish in a larger international tax battle involving Congress, the World Trade Organization (WTO), and companies worldwide. At stake is whether the United States will continue to tax income earned overseas--an issue of enormous consequence. "There is hardly a U.S.-based company of any significant size that is not faced with applying the international tax rules to some aspect of its business," notes a May U.S. Treasury report, called "Corporate Inversion Transactions: Tax Policy Implications," that urges a broader policy response to the inversion issue.
Without a broader response, finance executives will remain in the precarious position of having to defend any international tax policies aimed at maximizing shareholder value against their patriotic duty. Current tax rules create "a major disparity between what is right for the country and what is right for your company," says Thomas M. Jones, in the Chicago office of McDermott, Will & Emery. "We should strive to achieve a tax system that aligns patriotism with good business sense. That is the [real] challenge that Congress needs to take on."
Island Hopping
Ingersoll-Rand's expatriation is not unique. At this year's round of annual meetings, shareholders of Cooper Industries, Leucadia National, Noble Drilling, and The Stanley Works all voted to move overseas--on paper, at least.
Inversion is largely a paper transaction, in which a U.S. corporation creates an offshore subsidiary--typically little more than a mailbox in a foreign tax haven--and then "inverts" the ownership, transforming the subsidiary into the legal parent of the U.S. corporation that created it. That instantly eliminates U.S. taxes on income earned abroad. Once established, the offshore parent can also issue intercompany debt and charge licensing fees on intangible assets, which provides deductions and reduces the remaining taxable profits of the U.S. firm.
Otherwise, there is little change besides an exchange of U.S. stock for stock of the new foreign company, which typically carries the same symbol it had before. Indeed, so nominal is the change that Ingersoll-Rand, Tyco International, and Cooper Industries--all now Bermuda firms--continue to be listed on the S&P 500, which excludes non-U.S. companies.
The recent rush to invert has been driven by the fact that the recession and lower stock values have weakened the tax code's existing deterrent to such corporate emigration. Following the February 1994 inversion of Helen of Troy, the IRS limited inversions by levying a capital gains tax on most exchanges of U.S. stock for foreign company stock. That move, until recently, made inversions relatively rare. "Over the last eight years, just a few companies would expatriate per year," explains John M. Peterson, chair of the global tax practice of Chicago-based Baker & McKenzie, which claims to have pioneered inversion by advising Helen of Troy. "But more recently, with the stock market down, there has been a flurry of activity."
It's that timing that has fueled much of the anger in Congress, where the expatriations are seen as capitalizing on the economic effect of the September 11 terrorist attacks. "Here's a company pulling up stakes when the cleanup at Ground Zero is barely done," charged Grassley on news that The Stanley Works shareholders had approved reincorporation in Bermuda.
Yet most companies with inversions in the works seem largely undaunted. The Stanley Works, for example, says it plans to proceed with its inversion, despite a warning from Grassley that it was "setting up a showdown with Congress," as well as charges of irregularities in its shareholder vote by the Connecticut attorney general that have since forced the company to schedule a revote.
Cooper Industries actually turned the September 11 argument around, noting that it had explored "every reasonable alternative that could maximize value for Cooper's shareholders, including a sale of Cooper in whole or in parts," but found no takers after the terrorist attacks. The company predicts reincorporation will reduce its effective tax rate from 32 percent to as low as 20 percent, generating $55 million annually in additional cash flow.
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