Question

In June 2014, Medtronic, a Minneapolis-based medical device manufacturer, announced that it would join the tax-inversion acquisition parade. A tax-inversion acquisition occurs when a corporation acquires a target firm based in a lower-tax country and, as part of the transaction, moves its legal headquarters to the target firm's nation. After making this move, the combined corporation's taxes are based on the lower rate of its new home country. This move is perfectly legal according to U.S. law as long as the target firm's shareholders own at least 20 percent of the combined firm. About 50 U.S. corporations have undertaken tax inversions over the last 10 years, but the rate of occurrence appears to be increasing.

Medtronic acquired Covidien, an Irish-based medical equipment manufacturer, in January 2015 for S49.9 billion, and moved its legal home to Ireland. Not much else changed. Medtronic kept its corporate headquarters in Minneapolis. But Medtronic benefits from the move in two primary ways. First, while the tax rate on profits of U.S_ corporations is 35 percent, the tax rate on Ireland-based corporate profits is only 12.5 percent. Additionally, the United States is one of only six developed economies that tax the global profits of corporations. If a multinational corporation makes profits in a foreign country, the firm pays taxes on those profits to the foreign government at the rate the foreign country charges. For corporations based in most countries, that is the end of their tax obligations. However, if a U.S. -based firm wants to bring those profits back to its home country either to invest in new facilities or to distribute dividends to its stockholders, it has to pay income tax on the profits earned in foreign markets. The rate the firm pays is the difference in the tax rate in the foreign country and the U S. rate. For example. if Medtronic earned income in Ireland and then repatriated the profits to the United States, it would face a 22.5 percent additional tax rate, the difference between the U.S. and Irish corporate tax rates. Since Medtronic has accumulated S13 billion in earned profits abroad, it could face S-3_5 billion to S4 billion in taxes if it brought those profits home. Thus, corporations, such as Medtronic, undertake tax inversions to save on taxes and, by extension, benefit their shareholders by being able to invest more in the firm to help it grow and/or return higher levels of dividends to shareholders.

Critics, however, point out that these firms are choosing not to pay taxes at the U.S. rates even though they have benefited and will continue to benefit from being American corporations. While inverters change their legal residence, they typically keep their corporate headquarters in the United States and stay listed on a U.S. stock exchange. As a result, they benefit from America's deep financial markets, military might, intellectual property rights and other legal protections, intellectual and physical infrastructure, substantial human capital base, and national research programs. For example, Medtronic won $484 million in contracts with the US. government in recent years and plans to complete these contracts even though it will no longer be an American company, it hires students from top-notch American universities; and it files patents for all of its new technologies in the United States. Critics see the decision to move to a lower-tax country as unethical and unpatriotic. Jack Lew, the former U.S. Treasury secretary, echoed this perspective when he stated, "We should prevent companies from effectively renouncing their citizenship to get out of paying taxes. What we need is a new sense of economic patriotism, where we all rise and fall together."

Discussion Questions

1. Was Medtronic justified in moving its legal home to Ireland?

2. How should firms balance the desire to limit taxes to maximize cash generation with the need to be a good corporate citizen?

3. How should the US. government respond to the increasing frequency of tax inversions?

Answer 1

1) The US government has a policy of taxing the profit earned by the US companies in foreign in the case of repatriating that profit. So the company pays corporate income tax to the foreign company and then have to pay equivalent to the difference in the foreign and the US corporate tax rate. Most of the countries do not collect tax for the profit repatriation. Medtronic has used legal way to lower the tax by moving to Ireland which has a lower tax rate.
This will save their money and they could also reinvest into the business or raise the returns for shareholders.
The move is perfectly legal and justified by business perspective.

2) The business should work to satisfy the stakeholders and main stakeholders are investors, customers, society and government. However, there tend be the conflict of interest because customers may want products to less costly but investors might want higher profit. Similarly, the government wants to raise as much revenue possible by taxing the corporate but investors might want higher profit and higher income.
The firms will need to balance this in legal and ethical manner. Tax inversion or tax avoidance using legal means is not wrong but tax evasion is completely wrong and that should not be the firm's objective.

3) The US policy of taxing the firms for profit repatriation is seems to be causing the firms to shift their legal base in low tax countries. This is natural and obvious since firms want to lower the tax bill and increase their earnings.
The US will have change their policy and will have to lower the difference up to the point that the firms will find the gain of moving to another country and difference paid almost equal.
The US could increase its revenue by targeting the financial market such stock market where companies raise funds. The US stock market is very big and robust and so it is attractive. The government can extract a premium from that.