Effective Tax Rate Changes and Earnings Stripping Following Corporate Inversion

Abstract

We examine the fi nancial and valuation consequences of corporate inversion using a sample of 12 inversion fi rms and 24 matched fi rms. We fi nd that fi rms' effective tax rates (ETRs) decline substantially following inversion. Based on pre-to post-inversion changes in foreign profi t margin, U.S. profi t margin, and the geographic composition of pre-tax income, we infer that inversion-related ETR reductions are due to U.S. earnings stripping. For four fi rms, we provide evidence that intercompany debt is the mechanism used to strip earnings. Finally, we fi nd that abnormal returns at shareholder approval dates are associated with inverted fi rms' realized ETR changes.1 For example, in a November 2, 2001 letter to shareholders, Ingersoll-Rand CEO Herbert L. Henkel stated that inverting "should help enhance our business growth and cash fl ow and reduce our worldwide effective tax rate."

The effects of environmental, social and governance disclosures and performance on firm value: A review of the literature in accounting and finance

“…If we view the avoidance of corporation tax as one aspect of a firm's social performance, then it is also of relevance to question the effect it has on the firm's financial performance, and although the evidence on this issue is rather inconclusive, the consensus appears to be that there is very little link between tax avoidance and stock market performance (Austin and Wilson;2017;Brooks et al, 2016;Cloyd et al, 2003;Seida and Wempe, 2004). Firms paying the lowest industry-adjusted tax rates have higher stock market risk, however (Brooks et al, 2016;Guenther et al, 2016).…”

Firms' Off‐Balance Sheet and Hybrid Debt Financing: Evidence from Their Book‐Tax Reporting Differences

“…18 U.S. multinationals' motivations to borrow from their foreign subsidiaries to create a U.S. interest deduction are reduced by Subpart F tax rules that impose a tax on the loan as a deemed dividend because it represents an investment in U.S. property (IRC Section 956(c)(1)(C)). If, instead, a U.S. taxpayer is owned by a foreign corporation, there are incentives for such earnings stripping (e.g., seeSeida and Wempe's [2004] discussion of how earnings stripping incentives motivate U.S. taxpayers to reincorporate in tax haven countries).…”

Corporate Inversions and Economic Performance

“…Any means of reducing the profits booked by U.S. affiliates, such as paying the foreign parent tax deductible interest or royalties through a treaty jurisdiction like Barbados or Luxembourg, or using advantageous transfer pricing, will reduce U.S corporate tax liabilities once the firm has re-domiciled out the American worldwide tax system. Seida and Wempe (2004) show firm effective tax rates decline substantially after inversion, which they infer is largely due to earnings stripping. Finally, inverting can facilitate a firm's use of unrepatriated foreign earnings for the inverting acquisition or in subsequent deals.…”