Corporate Research E-Letter No. 25, June 2002
Duty Free: U.S. Corporations Move Their Legal Headquarters to Bermuda to Avoid Paying Federal Taxes
by Philip Mattera
“Unpatriotic.” “Unconscionable.” “Akin to treason.” Members of Congress and newspaper editorialists have of late been hurling these epithets not at John Walker Lindh or other Americans sympathetic to al Qaeda or the Taliban. The new turncoats, instead, are the likes of Tyco International, Ingersoll-Rand and other large companies that have shifted their legal headquarters to Bermuda to avoid paying federal income taxes.
The controversy over this practice – known euphemistically in the accounting world as corporate inversion – is in some ways more intense than the uproar over the transgressions of Enron and Arthur Andersen. Since September 11, patriotism has been paramount in the United States, and the image of Fortune 500 companies sneaking offshore to avoid paying their fair share for homeland security does not go over well.
In a recent Congressional hearing, Rep. Scott McInnis, a Colorado Republican, described what he did during a visit from John Trani, chairman of Stanley Works, a Connecticut-based hardware company that has been seeking shareholder approval to reincorporate in Bermuda. McInnis said he gave Trani a card with the names of all the U.S. soldiers killed during the fighting in Afghanistan. “I told him to keep it in his wallet,” McInnis said, “and to take it out and look at those names each time he talks about” the Bermuda move.
Stanley shareholders voted in May by a thin margin to approve inversion, but the company voided the vote after Connecticut Attorney General Richard Blumenthal brought suit charging that Stanley management had provided misleading information to employees about the way in which unvoted shares in the company’s 401(k) plan would be counted.
Recent vilification of corporate tax turncoats began in February, when the New York Times published a front-page story reporting that more and more large companies have been heeding the advice of financial advisors and shifting their domicile to Bermuda, which does not tax corporate profits. The tax savings cited in the article were enough to make a chief financial officer salivate: Tyco International said it saved more than $400 million last year; Ingersoll-Rand increased its net income by at least $40 million; and Stanley Works anticipated that its move would cut its tax bill by $30 million.
Corporate inversions had not suddenly materialized when the Times was preparing its article. The process originated two decades ago, but it remained a rare procedure. Companies were more inclined to set up subsidiaries in offshore tax havens and use accounting tricks to shift profits to those entities, which would be taxed lightly or not at all. Parent company “expatriation” began to appear in the property and casualty insurance industry a few years ago, led by carriers such as the ACE Group. Reincorporating in Bermuda provided an added boon for insurers: less stringent financial regulation.
WHO IS US?
Refreshing as it is to hear Republicans and Democrats together denounce big business for putting profits before patriotism, these statements of indignation are quite disingenuous or at least naive. For decade there has been mounting evidence that many large U.S.-based multinational companies have expanded abroad to the point that they cannot be called American in any meaningful sense.
Fortune 500 companies did not conceal this fact: They bragged about it to highlight their commitment to globalization. Thirteen years ago, a Top executive of Colgate-Palmolive Co., which by then was selling more toothpaste, soap and other toiletries overseas than domestically, told a New York Times reporter: “The United States does not have an automatic call on our resources. There is no mindset that puts this country first.”
The willingness of large companies to open and shut factories around the globe in the quest for the cheapest possible labor costs is a well known phenomenon. Jack Welch, the former chief executive of General Electric, was obsessed with the process. In a now legendary comment to a reporter, he said: “What’s important is that you’re agile….Ideally, you’d have every plant you own on a barge.”
In 1990, amid a widespread debate on U.S. industrial competitiveness, Robert Reich published an article in the Harvard Business Review entitled “Who is Us?” His question referred to a policy dilemma: Should the federal government assist U.S.-based companies such as Texas Instruments that shifted much of their investment and employment abroad? Or should the help be offered to foreign corporations like Honda that were expanding manufacturing operations in the United States and whose fortunes were thus of much greater consequence to ordinary Americans? Reich opted for the latter, arguing that the interests of the domestic workforce should be put first.
That view, of course, never really prevailed during the Clinton Administration, in which Reich served for a time as Secretary of Labor, despite some measures taken to thwart corporate tax avoidance. Instead, the ruling consensus, then and certainly now during Bush II, seems to be to make life easier for all corporations, regardless of where they are based, and to leave workers everywhere to fend for themselves. Lonely are voices such as that of William Greider, who wrote in an essay in The Nation last November: “If companies are truly global and without responsibility to this particular nation, then why are U.S. taxpayers expected to subsidize their success and bail them out of failure?”
PERILS OF CORPORATE PERSONHOOD
As much as capital yearns to be borderless, the fact remains that a corporation has to be incorporated somewhere. Large companies may like to view themselves as natural creations, but they are actually social constructs—entities created under a particular legal system to serve a particular purpose. In the United States, the restrictions on corporate purpose and behavior became much more difficult to exercise when the Supreme Court in 1886 granted legal personhood to corporations, thereby giving them equal rights with human persons (or in effect greater rights, given their superior resources in most cases). The problem was compounded when large companies began shifting their legal headquarters to Delaware, which had molded its commercial law to be especially friendly to management.
Over the past decade, a small but growing movement has emerged that seeks to challenge the concept of corporate personhood and to revive true popular rule. Richard Grossman, co-director of the Program on Corporations, Law and Democracy and one of the main instigators of this movement, has written: “How long shall We the People, the sovereign people, stand hat in hand outside corporate boardrooms waiting to be told our fate?”
Attempts to restore popular sovereignty will become all the more difficult if large numbers of companies reincorporate in offshore tax havens, where such a movement is not very likely to emerge. In other words, what is ultimately at stake in the controversy over inversions is not simply tax compliance or patriotism, but rather the hope of ever effectively challenging corporate rule.
ENFORCING CORPORATE PATRIOTISM
Such considerations certainly are not at the forefront of the current debate over inversions. The wave of bills introduced in the past few months have names like the Corporate Patriot Enforcement Act , Reversing the Expatriation of Profits Offshore (REPO) Act and the Uncle Sam Wants You Act.
All of the legislation is designed to allow the IRS to treat an offshore firm as a domestic company for tax purposes if a large portion of its shares are held in the United States or if most of its assets are held by its U.S. affiliate. Both Democrats and Republicans are avoiding the bolder alternative of treating any company as having U.S. domicile for tax purposes if it is managed and controlled here, since that might also pull into the U.S. tax net the offshore subsidiaries that corporations have set up in tax haven countries.
If it takes concern about tax receipts or patriotism to stem the tide of corporate expatriation, so be it. The problem, however, is that Congress may end up doing nothing at all about inversions. A number of prominent Republicans have not jumped on the corporate patriotism bandwagon. House Majority Leader Dick Armey has defended inversions, saying that the real issue was one of “problems in our tax code that inhibit U.S. companies’ ability to compete globally.” The Bush Administration has taken a similar position, with Treasury Secretary Paul O’Neill calling the code “an abomination.” Republican leaders also began to use procedural moves to impede action on the bills.
The Senate Finance Committee did manage to approve a bill (S2119) on inversions introduced by Republican Charles Grassley of Iowa, but it is not clear when the measure might reach the full Senate. Meanwhile in the House, Rep. Jim McCrery of Louisiana, who chairs the Ways and Means subcommittee assigned to deal with this issue, said that Congress should “go slow” on the inversion question.
If Congress fails to act on this issue, the decisive battle may take place outside Washington, with the key role being played by institutional shareholders that are unhappy about changes of domicile to a country that may afford less protection to stockholders. Signs of shareholder unrest were seen this spring in connection with an inversion plan announced by Nabors Industries, a provider of oil and gas exploration services. The AFL-CIO and trustees of various Taft-Hartley and public employee pension funds spoke out against the company’s Bermuda move, arguing that management had not provided sufficient information about the financial benefits. A federal judge refused to issue a restraining order, and a majority of shareholders approved the inversion. This, however, may have been only the opening skirmish in a protracted corporate governance war.
Whether the trickle of companies to Bermuda turns into a flood of expatriations will depend on the general public mood as well as that of institutional shareholders. In the past, Americans have been relatively tolerant of corporate financial shenanigans--not too many CEOs have ended up with their head on a pike--but the seemingly endless wave of business scandals may be altering the zeitgeist. Corporate leaders may decide that the savings from the Bermuda tax dodge are not worth the risk of elevated anti-business sentiment.
Program on Corporations, Law and Democracy <www.poclad.org>
Citizen Works <www.citizenworks.org>, a new progressive organization founded by Ralph Nader, is focusing on the inversion issue as part of its Campaign for Corporate Reform.
Citizens for Tax Justice <www.ctj.org> is the leading progressive organization dealing with federal tax policy.