WASHINGTON – Burger King is drawing a lot of flak over plans to shift its legal address to a foreign country by merging with Tim Hortons, the Canadian coffee-and-doughnut chain.
The transaction is called a corporate inversion, a maneuver that is becoming popular among companies looking to lower their tax bills.
Burger King executives insist they are not trying to escape U.S. taxes. But some members in Congress aren’t buying it, mainly because the corporate headquarters of the new parent company will be in Canada.
Ten things to know about corporate inversions:
1. What is a corporate inversion?
An inversion happens when a U.S. corporation and a foreign company merge, with the new parent company based in the foreign country. For tax purposes, the U.S. company becomes foreign-owned, even if all the executives and operations stay in the U.S.
2. Why invert?
There can be many business reasons for two companies to merge. The decision to incorporate the new parent company in a foreign country can generate significant tax savings over time. The U.S. has the highest corporate income tax rate at 35 percent.
Inverted corporations must still pay U.S. taxes on the profits they earn in the U.S. However, they can lower their U.S. tax bills through a maneuver called earnings stripping.
Here is how it works: The new foreign parent company lends money to the U.S. firm, which must pay it back. The U.S. firm then deducts the interest payments it makes to the parent company, reducing its taxable profits – stripping them from its balance sheet.
Many U.S. corporations are hoarding money overseas, either to invest abroad or to shield it from U.S. taxes. Experts say the total amount could exceed $2 trillion.
If a foreign subsidiary sends profits directly to a U.S. corporation, the U.S. firm must pay taxes on it. However, if those profits are funneled through a foreign parent company that was formed through an inversion, the money can be invested in the U.S. without paying U.S. taxes.
5. How big is the issue?
Almost 50 U.S. companies have inverted in the past decade, and more are considering it, according to the nonpartisan Congressional Research Service.
6. What has Congress done?
In 2004, Congress tried to curb inversions by saying U.S. companies couldn’t escape U.S. taxes by simply reincorporating abroad, with the same shareholders and executives running the new company. Instead, Congress passed a law saying that in order to become a foreign-owned corporation, U.S. companies must merge with a foreign partner, even if the foreign partner is much smaller.
7. Will Congress do more?
Several Democrats in Congress have announced bills to make it harder for U.S. corporations to invert. Sen. Ron Wyden, D-Ore., chairman of the Senate Finance Committee, said he was working with key Senate Republicans on a bipartisan response.
8. Can Obama act alone?
The Treasury Department says it is reviewing a broad range of authorities for possible administrative actions that could limit the ability of companies to engage in inversions, as well as approaches that could meaningfully reduce the tax benefits after inversions take place. Experts are divided over how much Treasury can do without action by Congress.
9. What do Democrats say?
Obama and Democratic leaders in Congress have questioned the patriotism of corporate executives who elect to invert their companies. At the same time, they are trying to make it a political issue ahead of this year’s congressional elections, accusing Republicans of protecting corporate loopholes.
10. What do Republicans say?
Key Republicans say the only way to adequately address inversions is to overhaul the tax code, making it more attractive for businesses to locate in the U.S.
Anything short of that and you’re not going to be able to do it, said Sen. Orrin Hatch of Utah, the top Republican on the Senate Finance Committee.