Six facts to help you understand corporate inversion transactions
Corporate inversion transactions have been prominent in the news recently. The latest reported transaction getting a lot of attention involves U.S. corporation Burger King Worldwide Inc. (BKW) and Tim Hortons Inc. (THI), a Canadian corporation. Per the terms of the deal, the combined entity, one of the biggest fast-food operations in the world, will base their operations in Canada. The result will be an overall lower tax burden for Burger King.
Many politicians and government officials have insinuated that corporate inversion transactions are somehow “unpatriotic.” To understand the ins and outs of this M&A transaction structure that’s become a political hot potato, take a look at these six quick facts:
- A corporate inversion is generally a merger transaction whereby U.S. shareholders exchange shares of common stock in a U.S. C-corporation for the stock of a foreign corporation. The U.S. C-corporation is thereby merged into the foreign corporation, leaving only the foreign corporation (the combined foreign corporation and former U.S. C-corporation) as the survivor.
- The foreign corporation in these transactions will generally be a resident of a taxing jurisdiction that has corporate income tax laws that are more favorable than the U.S. Corporate Income Tax.
- Domestic (U.S.) operations of the former U.S. corporation will remain largely unchanged. Corporate executives and management will be the same.
- The United States currently taxes corporations on their worldwide income. For income that is taxed in a foreign jurisdiction, a foreign tax credit is generally available to ameliorate the effects of double-taxation. The top U.S. Corporate Income Tax rate is currently 35%. The top rate in many foreign taxing jurisdictions is much lower.
- Most other nations base corporate income taxes on a “territorial” system wherein income is taxed only where it is earned (e.g., a UK company will only pay tax on income earned in the UK).
- Thus, a UK corporation will still pay U.S. Corporate Income Tax on U.S. earnings, but all earnings outside of the United States will escape the 35% tax rate.
The current U.S. Corporate Income Tax, based on worldwide income, gives U.S. corporations with multinational operations a powerful incentive to relocate to a taxing jurisdiction with a territorial tax base and a lower tax rate. The current wave of corporate inversions is the result of this incentive.