Burger King-Tim Hortons deal: 5 questions answered
Burger King could be the next company to leave the United States to avoid paying higher taxes. The Miami-based burger chain is in talks to acquire Tim Hortons, a Canadian-based coffee and doughnut shop. If a deal is reached, the partnership would create the world's third-largest quick-service restaurant, worth $18 billion.听
In the deal, Burger King would move its base out of the US and join Tim Hortons in Canada using a method called corporate or tax inversion, which is becoming trendy among US companies. In moving its economic base to Canada, Burger King would save a bundle in taxes, paying a 26.5 percent rate rather than up to 39.1 percent in the US.
What is corporate inversion, why is it becoming popular, and what could it mean to the US economy? Here are five questions on the hottest new business practice in the US, answered.听
What is corporate inversion?
Corporate inversion is when an American company reincorporates overseas by having a foreign company buy its assets. If a company is based in the US, the company can owe up to 39.1 percent on its domestic and foreign profits. But if they move to say, Ireland, they only pay Ireland's 12.5 percent corporate tax rate. 聽
For example, Unilever moved its bases to Britain and the Netherlands. In both of those countries, Unilever only pays taxes on profits made in those countries. So Unilever, a multinational corporation, pays much lower taxes than it would if it were based in the US.
But it's not quite so straightforward. The US corporate tax code is riddled with exceptions and companies use various strategies to lower their taxes. Burger King's overall effective tax rate was 27.5 percent last year.听
Nevertheless, over the past three decades, 52 companies have used corporate inversion,聽聽The practice has become more common in recent years: Twelve companies have left the US since 2012, including five in 2014, and another eight are planning to do so next year,聽.听Fortune has compiled a聽.听
Why do they do it?
US businesses argue that the corporate tax rate is too high, making them uncompetitive globally. Although the US corporate tax rate hasn't changed since 1986, when it moved from 46 percent to 32 percent (it ticked up slightly again later that year to its current 35 percent rate), corporate tax rates in other countries have continued to decline. Britain, an ally and trading partner, is only at 20 percent. (Counting state taxes, the US rate moves up to about 39.1 percent.)
Also, unlike some other countries, the US taxes worldwide profits, not just profits the company makes domestically. Corporate executives have a fiduciary duty to their shareholders, and a lower tax rate can boost corporate profits. If they can leave the high taxes of the US, they say, the company can compete better on the world market and make more money for its shareholders.
"They are responding to systems," says Kent Wisner, an adjunct professor at the University of California, Berkeley Law School, in a phone interview. "There are ways to change that if you change the economic incentive. No one is doing anything illegal. They are doing it because it makes business sense and they operate in the global environment."聽
Why is it becoming so popular?
"[T]hese strategies聽might simply be becoming more acceptable ways for multinational corporations to achieve lower聽global tax burdens. As other multinational corporations have demonstrated success with聽inversion strategies, more and more corporations are lured by similar deals," Kimberly Clausing, professor of economics at Reed College,聽. She added that another reason for the rise in corporate inversion is that unrepatriated cash is nearing $1 trillion and companies don't want to bring it back because of high taxes.
"Corporations are looking at the current situation, are probably thinking it is going to get harder to get out of the US and tax rates might rise, maybe it would be better if we get out now," said 聽Michael Knoll, co-director of the Center for Tax Law and Policy at the University of Pennsylvania
How much does the US stand to lose?
The Joint Committee on Taxation estimates the US could lose $19.5 billion in tax revenue over the next 10 years because of corporate inversion, though many believe that number is too low given the recent affinity for inversion. That's enough to pay for programs to help homeless veterans and conduct research on prosthetic arms and legs for wounded warriors, . Ms. Clausing notes that if nothing is done to stop the trend then "corporate inversions are likely to undermine the US tax base." 聽
The percentage of revenue the US gets from corporate taxes is going down, Clausing says, and the loss in tax revenue will come from somewhere. "If [corporate inversion] continues, the government will have to raise taxes, and that is hard," she said in a phone interview. "People don鈥檛 want their taxes to go up. Keeping the tax base healthy is why Americans should care. Otherwise they will have to cut spending or have a higher deficit."聽
Is something being done to stop it?
President Obama has come out publicly against corporate inversion, calling companies who move abroad 鈥渦npatriotic鈥� and 鈥渃orporate deserters.鈥�
The Monitor's Linda Feldmann聽reported on the president's comments on the issue in July:
鈥淓conomic patriotism says it鈥檚 a good thing when we close wasteful tax loopholes and invest in education, and invest in job training that helps the economy for everybody,鈥� said Obama, speaking on the final day of a three-day trip to the West Coast that included six fundraisers.
The Obama administration wants to close the loophole in stand-alone legislation. Under the Democratic legislation Obama supports, any company that does half of its business in the聽United States聽would be deemed 鈥淯S-domiciled.鈥� Republicans want to address the matter as part of a larger overhaul of the corporate tax code and showed little sympathy for Obama鈥檚 plea Thursday.
Before 2004, if a company wanted to avoid paying taxes in the US, it put money in a shell company abroad, says Mr. Knoll. But in 2004, a law was passed requiring the foreign company in such an arrangement to get at least a 20 percent stake in the newly created firm. But it isn't doing much to stop the companies. Rep. Sander Levin (D) of Michigan and brother Sen. Carl Levin (D) of Michigan introduced legislation that would require foreign companies to own at least 50 percent of the combined company, but it hasn't made it past the House.听
Under the proposed deal, Burger King and Tim Hortons would continued to operate as separate brands 3G, but have joint corporate operations in Ontario. Brazilian-based聽3G Capital, an international investment firm that purchased Burger King four years ago for $3.3 billion, would still own a majority of shares in the new company.
