If you want to see specific stocks take a hit then stop corporate inversions. Corporate inversions are the relocation of a U.S. company’s corporate domicile, (its formal headquarters) to a lower tax jurisdiction. Inversions are a form of “profit shifting”. Profit shifting occurs when a company effectively isolates non-U.S. income and profits from U.S. taxation, whether through intellectual property cost shifting or other means. The OECD has a project targeted at what is known as Base Erosion and Profit Shifting which has support of the major G-20 countries, but is yet to be supported by India and China or many emerging states.
The U.S. operates on a worldwide taxation system, meaning it taxes all U.S. taxpayers on income earned anywhere in the world. For privately held companies which are owned more than 50% by U.S. taxpayers, any stockholder who owns 10% or more of the company may have to include a pro rata share of the company’s international income in its personal income (See Form 5471). Public company shareholders face a different issue from anti-inversion legislation, reduction in share value.
Tax rates directly affect corporate earnings. Most investors look at Earnings Per Share (EPS) as part of their investment due diligence. By lowering the tax rate the earnings can increase and therefore the EPS can increase, all other factors being equal. Therefore, it is incumbent on public company management in seeking to maximize shareholder value, to seek out low tax jurisdictions. It is not a big stretch of the imagination to expect stock values of public companies to fall if earnings are stripped by high tax rates. The current legislative proposals and anti-inversion comments from legislators and the administration seem to disregard this fact, and investor risk.
Populist support for anti-inversion tax strategies is in part based upon the belief that it is “patriotic” to pay higher U.S. tax rates in an uneven playing field, thereby, giving non-U.S. competitors, some state supported, a distinct advantage. But who really suffers? The shareholders. Anyone who has a retirement plan, life insurance policy, annuity mutual fund or who has specific stock investments, will find that efforts to maintain high corporate tax rates, will likely affect the value of their investments (a direct hit) while having no measurable impact on U.S. tax collections (indirect benefit). So what is the answer?
The solution to corporate inversions is to rationalize the corporate tax rates so that U.S based companies, both public and private do not have incentives to re-domicile or shift profits. The result could be positive for all parties concerned, with more competitive companies generating higher sales, and paying more in net taxes even at lower rates. The good news is that the Congress is not likely to pass anti-inversion legislation in the near future. The administration’s actions are yet to be seen.