The recent announcement that Pfizer Inc. has reached a merger agreement with Allergan PLC , with the combined entity being tax-resident in Ireland, is a good occasion to reconsider U.S. policy options in regard to inversions. We consider an “inversion” any transaction in which a U.S. corporation becomes foreign for tax purposes without a meaningful change to its underlying business or management activities.This short article explains what we believe to be the true motives of inversion transactions, as well as potential policy reposes, in light of the Pfizer inversion. Part I explains what is unique about the Pfizer inversion, so as to make it a case study worthy of special consideration. We use the Pfizer deal to reject the argument that inversions are driven by “competitiveness” considerations.Part II explains the true motives for corporate inversions and the limited effectives of recent Treasury notices issued in response to recent inversion transactions. We suggest that Pfizer (as well as other U.S. corporations) engaged in the inversions simply because they can, and that inversions have nothing to do with maintaining a “competitiveness” edge. Inversion is a legal, cost-effective way to reduce a corporation’s tax burden, which is enough of a reason for a corporation to engage in it. From a policy perspective, however, inversions are unjustified as they deny the U.S. tax revenue from multinational corporations that extensively use U.S. infrastructure. The burden of financing such infrastructure thus shifts from U.S. multinationals, to small and medium local businesses and individual taxpayers.Treasury’s responses to date, while commendable for their effort, fall short. The reason is that Treasury’s authority is limited, and as such Treasury’s responses only affect particular transaction structures. Only Congress can address the root causes of inversions. Congress did make an effort to do so when it enacted section 7874 in 2004, but its reliance on shareholder-level definitions of inversion made the proverbial “rod” of 7874 vulnerable to becoming a “snake” that limits Treasury’s efforts to curb second wave inversions.The third part addresses available policy options to respond to inversions. Since competitiveness is not what drives inversions, “competitiveness” based solutions to the problem – such as a move to a territorial system and a reduction of corporate tax rates – are unlikely to solve the problem in any meaningful way. A move to a territorial system to solve that inversion problem, is analogous to solving a debt-collection problem by forgiving the debt.Specifically, if the United States moves to a territorial system, inversions may indeed stop, but not because the U.S. became more “competitive”. Inversions would stop because multinational will be able to achieve the same unjustified tax outcomes, with no need to engage in inversions. Under current proposals for territorial taxation, all the United States will get to keep are the corporations’ “nationality”. Corporations will still be able to operate in the U.S. and avoid taxation in the U.S. The United States will not recuperate any of the tax base lost to inversions. It will simply give up the tax base. In this context, we use the UK’s response to its inversions problem (which included a shift to a territorial system) as a case study for a failed response to a corporate inversion problem.Instead, we suggest that the preferred course of action to eliminate inversion transactions, and at the same time maintaining competitiveness, and maintaining the U.S. tax base, is a change to corporate tax-residence rules under IRC 7701, combined with a reduced corporate tax rate. This is the only solution that will put local and multinational business at par in the U.S. market, competitively speaking. Given that such a solution is unlikely to be adopted any time soon, we explore legislative agenda targeted at preventing inversions. We also briefly outline some additional ways by which we believe Treasury may enhance its response to the inversion phenomenon.
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