Note: This scenario is related to your reading, “International Strategy: Creating Value in Global Markets.”
In June 2014, Medtronic, a Minneapolis-based medical device manufacturer, announced that it would join the tax-inversion acquisition parade. A taxinversion acquisition occurs when a corporation acquires a target firm based in a lower-tax country and, as part of the transaction, moves its legal
headquarters to the target firm’s nation. After making this move, the combined corporation’s taxes are based on the lower rate of its new home country. This
move is perfectly legal according to U.S. law as long as the target firm’s shareholders own at least 20 percent of the combined firm. About 50 U.S.
corporations have undertaken tax inversions over the last 10 years, but the rate of occurrence appears to be increasing.
Medtronic acquired Covidien, an Irish-based medical equipment manufacturer, in January 2015 for S49.9 billion, and moved its legal home to Ireland. Not
much else changed. Medtronic kept its corporate headquarters in Minneapolis. But Medtronic benefits from the move in two primary ways. First, while the
tax rate on profits of U.S_ corporations is 35 percent, the tax rate on Ireland-based corporate profits is only 12.5 percent. Additionally, the United States is one
of only six developed economies that tax the global profits of corporations. If a multinational corporation makes profits in a foreign country, the firm pays
taxes on those profits to the foreign government at the rate the foreign country charges. For corporations based in most countries, that is the end of their tax
obligations. However, if a U.S. -based firm wants to bring those profits back to its home country either to invest in new facilities or to distribute dividends to
its stockholders, it has to pay income tax on the profits earned in foreign markets. The rate the firm pays is the difference in the tax rate in the foreign country
and the U S. rate. For example. if Medtronic earned income in Ireland and then repatriated the profits to the United States, it would face a 22.5 percent
additional tax rate, the difference between the U.S. and Irish corporate tax rates. Since Medtronic has accumulated S13 billion in earned profits abroad, it
could face S-3_5 billion to S4 billion in taxes if it brought those profits home. Thus, corporations, such as Medtronic, undertake tax inversions to save on
taxes and, by extension, benefit their shareholders by being able to invest more in the firm to help it grow and/or return higher levels of dividends to
shareholders.
Critics, however, point out that these firms are choosing not to pay taxes at the U.S. rates even though they have benefited and will continue to benefit from
being American corporations. While inverters change their legal residence, they typically keep their corporate headquarters in the United States and stay
listed on a U.S. stock exchange. As a result, they benefit from America’s deep financial markets, military might, intellectual property rights and other legal
protections, intellectual and physical infrastructure, substantial human capital base, and national research programs. For example, Medtronic won $484
million in contracts with the US. government in recent years and plans to complete these contracts even though it will no longer be an American company, it
hires students from top-notch American universities; and it files patents for all of its new technologies in the United States. Critics see the decision to move
to a lower-tax country as unethical and unpatriotic. Jack Lew, the former U.S. Treasury secretary, echoed this perspective when he stated, “We should prevent
companies from effectively renouncing their citizenship to get out of paying taxes. What we need is a new sense of economic patriotism, where we all rise
and fall together.”
Discussion Questions
1. Was Medtronic justified in moving its legal home to Ireland?
2. How should firms balance the desire to limit taxes to maximize cash generation with the need to be a good corporate citizen?
3. How should the US. government respond to the increasing frequency of tax inversions?