Corporate Inversions: Why Are Corporations “Leaving” the U.S. and What It Means For Your Company January 28, 2016 Moderated by: Shawn Haque of Accenture Federal Services Presented by: Daniel Davidson, Christine Lane, and James Wickett of Hogan Lovells
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Corporate Inversions: Why Are Corporations “Leaving” the U.S. and What It Means For Your Company
January 28, 2016
Moderated by: Shawn Haque of Accenture Federal Services Presented by: Daniel Davidson, Christine Lane, and James Wickett of Hogan Lovells
www.hoganlovells.com
Today’s Speakers
Daniel Davidson
Partner, Washington, D.C.
Hogan Lovells
Shawn Haque
Corporate Counsel
Accenture Federal Services
2
Christine Lane
Partner, Washington, D.C.
Hogan Lovells
James Wickett
Partner, Washington, D.C.
Hogan Lovells
www.hoganlovells.com
Program Outline
1. What is an Inversion and Why Do Companies Invert?
2. Anti-Inversion or Anti-Expatriation Rules
3. Status of Inversion Transactions
4. Base Erosion, Tax Competitiveness, and BEPS
5. U.S. International Tax Reform
6. What’s Next?
7. Presenter Biographies
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“Inversion” Defined
4
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Why Invert?
• Worldwide taxation of U.S. corporations
• Relatively high U.S. corporate tax rate—
– 35% federal tax rate, plus
– State taxes (as high as 8% or 9%)
• Earnings from foreign subsidiaries of U.S.
corporations subject to U.S. tax on distributions to
U.S. parent.
– Far-reaching CFC rules (“Subpart F” rules) may cause
U.S. tax before actual distribution.
• Limitations on use of foreign tax credits
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Examples of Countries With Lower Headline
Corporate Tax Rates Than the United States
– Ireland ~ 12.5%
– United Kingdom ~ 21%
– Canada ~ 15% federal; 10%-11% provincial
– Tax havens ~ zero
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Why Invert?
• Many countries have much lower corporate income tax rates, no or less
comprehensive CFC rules and may not tax dividends received from
subsidiaries (e.g., participation exemptions).
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Overview of “Inversions”
• An inversion is the process whereby a foreign corporate entity becomes the parent entity of an established U.S. company
• Goal of an inversion is to move the ultimate parent of a U.S. company out of the U.S. global taxation system
• A “self inversion” is accomplished via an entirely internal transaction – no third party merger required but curtailed after 2004
• An “acquisitive inversion” is typically accomplished through a reverse triangular merger with a merger subsidiary of an existing foreign corporate entity
• Two key goals for many inversion transactions:
– Ability to lower effective tax rates both through accessing lower global tax rates and reducing U.S. earnings
– Access offshore cash to boost shareholder value through acquisitions, stock buybacks, and dividends
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Illustrative Example
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U.S. Co Foreign Co
U.S. Co
$25B
Foreign Co
$3M
U.S. Co
Foreign Co
Foreign Co
U.S. Co
+ =
+ =
VS
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Typical Merger Inversion
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U.S. Co Foreign Co
Subsidiaries U.S. Co
Subsidiaries
Merger Sub
(United States)
Foreign Co
U.S. Co
Subsidiaries
Shareholders Shareholders
issues new shares Shareholders
Original Structure Inversion Transaction Final Structure
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Does Inversion Eliminate U.S. Tax?
The inversion does not entirely escape the US tax net:
• U.S. Co. still subject to U.S. tax.
• Foreign IP (and associated profit) held in pre-existing
foreign IP holding company may still be subject to U.S.
tax (foreign IP HoldCo would remain under US Co in
structure, thus foreign profits must still be repatriated
through US Co).*
• Foreign subsidiaries under US Co still considered
CFCs and subject to U.S. tax on certain income.
* Depending on U.S. exit costs, CFCs and foreign IP
08/26/14 12/15/14 Burger King Tim Hortons $14.5 Canada
03/28/12 09/28/12 Pentair Tyco $5.3 Switzerland
05/21/12 11/30/12 Eaton Cooper $12.2 Ireland
02/05/13 06/07/13 Liberty Global Virgin Media $22.1 United Kingdom
05/20/13 10/01/13 Actavis Warner Chilcott $8.5 Ireland
07/29/13 12/18/13 Perrigo élan $6.5 Ireland
11/05/13 02/28/14 Chiquita Fyffes $0.5 Ireland
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“… [W]e have a huge inversion problem
in this country. I mean, you look at some
of the companies that are talking about
leaving the United States and many of
these companies are run by people from
Britain, and from Ireland…. They have no
loyalty to this country. – Donald Trump*
“[Treasury and the IRS] do intend to issue
additional guidance, and we are still very mindful
of the type of planning that’s out there…” – Daniel
McCall, Special Counsel, IRS Office of Associate
Chief Counsel (International)*
"If something is legal, you should
always do it. That's why I'm going
to Japan on my next vacation to
hunt dolphins.“ – Stephen Colbert
addressing corporate inversions on
The Colbert Report*
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How Santa Got To The North Pole…
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~ Sun Sentinel
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“Anyone may so arrange his affairs that his taxes shall be as
low as possible; he is not bound to choose that pattern which
will best pay the Treasury. There is not even a patriotic duty to
increase one’s taxes.”
~ Judge Learned Hand; Helvering v. Gregory, (2d Cir. 1934)
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Pfizer-Allergan
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• One of the most recent and largest ($160
billion) corporate inversions.
• Good example of the impact of recent
rhetoric –
• the deal’s break-up fee because of a
change of law is “only” $400 million.
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Anti-Inversion or Anti-Expatriation Rules - IRC
§ 367
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• Inversion transactions are not new. Early well-known examples include
McDermott Inc. (1982) and Helen of Troy (1993).
• Congress has tightened certain provisions of the Internal Revenue Code
(IRC) periodically to address inversion transactions.
• Example, IRC § 367(a)—imposes a shareholder-level gain on transfers of
appreciated property by a U.S. person to a foreign corporation in what
would otherwise qualify for tax-free treatment under U.S. tax rules.
• Reg. §1.367(a)-3(c): U.S. shareholders who exchange domestic stock for
foreign stock generally have to recognize gain unless certain conditions
satisfied.
• Intended to allow non-recognition treatment when a larger foreign company
acquires a smaller U.S. one for business reasons, but not when the U.S.
company is larger and trying to invert.
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Anti-Inversion or Anti-Expatriation Rules - IRC
§ 367
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• Reg. §1.367(a)-3(c) Requirements:
• No more than 50% of vote and value of transferee foreign corporation
is received in the transaction by U.S. transferors;
• No more than 50% of vote and value of transferee foreign corporation
is owned immediately after the transfer by U.S. persons who are
directors, officers, or 5% shareholders of the U.S. target corporation;
• The transferee foreign corporation has been engaged in business
outside the U.S. for at least 36 months prior to the transaction, and the
FMV of the transferee foreign corporation is at least equal to the FMV
of the target U.S. company; and
• 5% shareholders of transferee foreign corporation enter into a 5-year
GRA.
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Anti-Inversion or Anti-Expatriation Rules - IRC
§ 367
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Market reaction to IRC § 367 –
• In a number of cases, companies tried to bring themselves within IRC § 367(a)
rules and in other cases, the fact that the shareholders might recognize gain did
not serve as a deterrent, for example:
• Where shareholders are tax-exempt or have a loss rather than gain on their
shares.
• Public companies where taxation of the shareholders on the transaction may
not be a deterrent if the tax or other benefits of the transaction are sufficiently
great and may result in a higher value for the stock ultimately.
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Anti-Inversion or Anti-Expatriation Rules - IRC
§ 7874
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• IRC § 7874 (introduced in 2004) is now the primary corporate-level anti-
inversion statute (IRC § 367 may still apply at the shareholder level).
• For IRC § 7874 to apply, two tests must be met:
• The shareholders of the U.S. target must end up with at least a certain
specified percentage of the foreign acquiring corporation’s shares (the “Stock
Ownership Test”); and
• The resulting corporate group must fail to have “substantial business
activities” in the country of the foreign acquiring corporation (the “Substantial
Business Activities Test”).
• Congress intended these criteria to distinguish “legitimate” business
transactions from ones engineered primarily to reduce U.S. tax.
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Anti-Inversion or Anti-Expatriation Rules – IRC
§ 7874 Stock Ownership Test
• Sets out two different levels of stock ownership and
establishes separate and distinct consequences at
each level.
– 60% stock ownership: Do the former shareholders of the
U.S. target own at least 60% of the shares (by vote or
value) of the foreign acquiring corporation?
• If so – and if the Substantial Business Activities Test is NOT
satisfied – the consequence is:
– Certain gain recognized by the U.S. target (“inversion gain”) in
connection with the acquisition or for 10 years thereafter cannot be
sheltered from U.S. tax (e.g., by NOLs or foreign tax credits).
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Anti-Inversion or Anti-Expatriation Rules – IRC
§ 7874 Stock Ownership Test
• 80% stock ownership: Do the former shareholders
of the U.S. target own at least 80% of the shares (by
vote or value) of the foreign acquiring corporation? • If so, the foreign acquiring corporation is treated as a U.S.
domestic corporation.
• This creates a severe risk of double taxation.
• For purposes of the 60 and 80 percent ownership
tests, it does not matter how many shareholders of
the U.S. target corporation were themselves U.S.
persons in contrast with IRC § 367.
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Anti-Inversion or Anti-Expatriation Rules –
Substantial Business Activities Test
• IRC § 7874 only applies if, after the acquisition,
– the expanded affiliated group (“EAG”) “does NOT have
substantial business activities in the foreign country in
which, or under the laws of which, the entity is created or
organized, when compared to the total business activities”
of the EAG.
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Anti-Inversion or Anti-Expatriation Rules –
Substantial Business Activities Test
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Facts and Circumstances
Safe Harbor/SBAT met if > 10% of each of the following are located in foreign
country: (i) employees (measured by headcount and compensation), (ii) value of
assets, and (iii) sales. 2004-June
2009
June 2009-June
2012
Facts and Circumstances
Safe Harbor/SBAT met if > 10% of each of the
following are located in foreign country: (i)
employees (measured by head count and
compensation), (ii) value of assets, and (iii) sales.
Post June 2012 Facts and Circumstances
Old Safe Harbor, but (1)
raised 10% to 25%, and
(2) made it substantive
test (no longer safe
harbor)
Notices 2014-52
and 2015-79
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Inversion Transactions v. Legislation
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McDermott
(§1248(i))
Helen of
Troy
§7874
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Anti-Inversion or Anti-Expatriation Rules –
Substantial Business Activities Test
• Now, to meet the Substantial Business Activities
Test all of the following must be satisfied with
respect to the relevant foreign country–
– 25% of employees, both by headcount and compensation;
– 25% of the total value of all group assets; and
– 25% of all group income.
• Note – even if a foreign jurisdiction has more of
each of these categories than the U.S., the foreign
jurisdiction will fail to satisfy this test if it does not
meet the 25% minimum in each category.
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Substantial Business Activities Test – Illustrative
and Recent Example
• Texas-based Waste Connections Inc. (“WC”) inverting
into Canada (after merger with Canadian-based
Progressive Waste Solutions Ltd. (“PWS”)).
• Headquarters will remain in the United States, but
sizable operations in Canada.
– In 2014, approx. 33% of PWS’ assets and 37% of PWS’
revenue was attributable to Canada.
• According to parties:
– combined effective tax rate of the companies will be approx.
27% compared to WC’s 39.5% effective tax rate for 2014.
– Transaction taxable to WC shareholders, but not taxable to
shareholders of PWS.
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Anti-Inversion or Anti-Expatriation Rules –
Notice 2015-79
• Notice 2015-79 tightened the substantial business
activities test even further:
– IRS will issue regulations under which EAG cannot have
“substantial business activities” in a foreign country unless
the foreign acquiring corporation is a tax resident of that
country.
• In many countries, a corporation incorporated in that country won’t
be treated as a resident of the country for tax purposes if the
center of management is elsewhere.
• Also targets situations where the foreign acquiring corporation is a
reverse hybrid – treated as a corporation by the U.S. but as a
partnership by the foreign country.
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Anti-Inversion or Anti-Expatriation Rules –
Notice 2015-79
• IRS will also issue regulations restricting transactions in which a U.S. and a foreign corporation are acquired by a foreign acquisition company in yet another foreign country, e.g., where a company in a tax-favored jurisdiction is utilized to acquire both a U.S. company and a company in another high tax jurisdiction.
• If certain requirements are met, the regulations will disregard the shares of the acquiring company that are held by former shareholders of the foreign target company in determining whether the transaction comes within IRC § 7874.
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U.S. Parent
Public
Shareholders
FMNC Public
Shareholders
Foreign
Multinational
(FR)
Foreign
Merger Sub
U.S. Parent
(US)
SHs receive
>20% shares
Merger
(U.S. Parent
Survives) U.S. Merger
Sub
Non-U.S.
TopCo
(UK)
Combined
Public
Shareholders
Merger
(FMC
Survives)
SHs receive
<80% shares
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Anti-Inversion or Anti-Expatriation Rules,
Continued
32
• IRS has issued a number of rules affecting the calculation of
whether shareholders of a U.S. target have received 60% or
80% of the stock of the foreign acquiring company.
• Most of these rules make it more likely that those percentage
thresholds will be met or exceeded. Examples include —
• IRC § 7874 disregards stock sold in a public offering related to the
inversion transaction.
• IRS interprets “public offering” to include stock issued in a private
placement.
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Anti-Inversion or Anti-Expatriation Rules,
Continued
33
• Rules intended to combat efforts to “artificially” increase the size of the foreign
acquiring corporation in an effort to reduce the percentage of stock owned by the
former shareholders of the U.S. target company.
• Stock issued by the foreign corporation is “disqualified stock”—and excluded
from the denominator—if it is issued for “nonqualified property”—i.e., generally
cash, marketable securities, obligations owed by certain related persons, or
“any other property acquired in a transaction (or series of transactions) related
to the acquisition with a principal purpose of avoiding the purposes of IRC §
7874.”
• Notice 2014-52 and Notice 2015-79 expanded the scope of this rule.
• Notice 2014-52 – a portion of the stock of the foreign acquiring corporation will
be excluded from the denominator if more than 50% of all of the foreign
group’s assets consist of nonqualified property even if this property was not
acquired by the foreign acquiring corporation in a transaction related to the
inversion transaction.
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Anti-Inversion or Anti-Expatriation Rules,
Continued
34
• Alternatively, taxpayers may reduce the percentage of shares of the foreign
acquiring corporation owned by former shareholders of the U.S. target company by
“artificially” reducing the size of the U.S. target company prior to the inversion
transaction.
• Notice 2014-52 states that, certain non-ordinary course distributions by the
U.S. target company during the 36-month period ending on the date of the
inversion transaction will be disregarded for purposes of IRC § 7874 (and IRC
§ 367(a)).
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Status of Inversion Transactions post Notices 2014-52
and 2015-79
Status (as of January 2016)
U.S. Company Foreign
acquisition target
New incorporation
Not going forward AbbVie Shire Jersey
Not going forward Salix Pharmacenticals Cosmo Ireland
Not going forward Pfizer AstraZeneca/Actavis U.K.
Not going forward Chiquita Brands Fyffes Ireland
Not going forward Applied Materials Tokyo Electron Netherlands
Not going forward Walgreens Alliance Boots Switzerland
Not going forward Omnicom Publicis Netherlands
Completed Medtronic Covidien Ireland
Completed Civeo - Canada
Completed Burger King Tim Hortons Canada
Completed Mylan Abbott’s generics unit Netherlands
35
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Status of Pending Inversion Transactions post Notices
2014-52 and 2015-79
Announced/
Status
U.S. Company Foreign
acquisition target
New incorporation
08/11/2015 - Pending Terex Konecranes Finland
08/05/2015 - Pending Coca Cola U.S. Iberian Partners &
1/25/16 – Pending Johnson Controls Inc. Tyco International
PLC
Ireland
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What’s to Come?
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“Base Erosion” and Tax Competitiveness is a
Global Concern
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The Global Legal/Tax Landscape is Constantly Shifting
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“Base Erosion” and Tax Competitiveness is a
Global Concern
• The U.S. is not the only country that wants to:
• Clamp down on tax avoidance by multinational
corporations that shift profits, (and profit generating
assets) – without shifting corresponding business
operations – to foreign jurisdictions; and
• Encourage businesses to develop income and job-
generating activities in the home country
• Adopt tax laws that allow domestic companies to compete
around the globe
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“BEPS” – OECD’s Base Erosion and Profit
Shifting Initiative
• At the prompting of the leaders of the G-20, The OECD in 2013 issued a BEPS action plan, setting forth the guidelines of an effort to harmonize the tax laws of OECD nations around the world
• The OECD’s goal in the BEPS project is to develop model legislation, multilateral tax agreements, and information reporting mechanisms to address base erosion and profit shifting in a uniform manner
• In September, 2014 The OECD issued its first round of the BEPS project guidance and recommendations, dealing with transfer pricing and country-by-country reporting.
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“BEPS” – OECD’s Base Erosion and Profit
Shifting Initiative
• Development of guidance and recommendations in many other areas of the BEPS project are ongoing.
• It is assumed under the BEPS project that the G-20 countries will abide by and implement the BEPS recommendations.
• BEPS’ Focus: Preventing artificial profit shifting, e.g. through –
• Related party loans (and interest expense deductions)
• Relocating IP rights (and income related to these)
• Adjustment of Transfer Prices
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“BEPS” – OECD’s Base Erosion and Profit
Shifting Initiative
• BEPS seeks to align taxable profits with real activities, ie to
require that the jurisdiction where income is taxed is the
same as the one where real economic activities – jobs and
capital investment – are located.
• This will likely mean that foreign jurisdictions will impose
more tax on U.S. multinationals, (e.g. Apple, Google, drug
companies, etc.) and that U.S. companies will have to move
more capital and jobs to low-tax jurisdictions to take
advantage of their tax benefits.
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Will Congress Pass International Tax Reform?
• Probably not in 2016. (But not impossible.) The legislative calendar is
short and the politics of the presidential race makes getting anything done
in Congress this year difficult.
• What we will likely see in 2016 is continued development of international
tax reform legislation, in particular by Chairman Brady (R-TX) in the
House Ways and Means Committee, but also by House Speaker Paul
Ryan (R-WI), Ways and Means Members Charles Boustany (R-LA) and
Pat Tiberi (R-OH), and Senate Finance Chairman Hatch (R-UT) and
Ranking Member Ron Wyden (OR), and Senators Portman (R-OH) and
Schumer (D-NY).
• There is a surprising degree of bipartisan agreement on international tax
reform legislative proposals, including on the part of President Obama
and his Department of the Treasury.
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U.S. International Tax Reform Proposals
• Former Ways and Means Chairman Dave Camp, President Obama, and Senators Portman and Schumer (and many of the presidential candidates) have offered variations of proposals with consistent elements:
• One-time tax on accumulated untaxed foreign subsidiary
• Anti base erosion provisions that would apply minimum tax rates to income from IP based in tax havens, and stricter rules on deductibility of related party interest
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U.S. International Tax Reform Proposals –
Innovation Box
• Senators Portman (R-OH) and Schumer (D-NY),
and House Ways and Means members Charles
Boustany (R-LA) and Richard Neal (D-MA) have
also proposed an ‘innovation box’ (or patent box).
• This would apply a lower corporate tax rate to
income generated from U.S. developed IP that is
located in the U.S.
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Will Congress Pass International Tax Reform?
• The pressure for Congress to pass tax reform, including to international rules but also to the corporate tax laws as a whole, continues to build.
• This is particularly true the more high-profile inversions we see announced.
• The BEPS project also puts pressure on Congress to pass international tax reform, and a lower corporate rate, to maintain competitiveness with foreign jurisdictions with lower corporate tax rates.
• Congress may also consider stopgap measures to discourage inversions.
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Consequences of U.S. International Tax
Reform?
• Many tax law and economic experts argue that the
international tax reform proposals being discussed in the U.S.
may do little to stop the incentive for U.S. companies to
invert.
• As long as the U.S. corporate rate remains at 35% and the
average OECD rate is closer to 20%, U.S. companies will
continue to have incentives to shift income to lower tax rate
foreign jurisdictions.
• U.S. companies currently hold more than $2.1 trillion in
accumulated profits offshore.
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Conclusion
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~ Mending Wall, Robert Frost
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*Sources
49
Daniel McCall quote - “IRS Official Defends Against Anti-Inversion Notice
Criticism,” Tax Notes, Dec. 7, 2015.
Hillary Clinton quote – “Hillary Clinton Says No to Corporate Tax Inversions,”
MoneyWatch, CBS News, Dec. 9, 2015.
Donald Trump quote – “Trump on Corporate Inversion: These People Have No
Loyalty To This Country,” RealClear Politics, Meet the Press, MSNBC, Aug. 17,
2015.
Jon Stewart and Stephen Colbert quotes – “Stephen Colbert Says He'll Hunt
Dolphins In Japan Because It's Legal, Just Like Corporate Inversions,” Business
Insider, July 31, 2014.
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Presenter biographies
Hogan Lovells 51
Daniel Davidson, Partner, Hogan Lovells
Washington, D.C.
Daniel Davidson's practice encompasses a broad range of transactional, tax planning, and tax
controversy matters. He advises both foreign and domestic clients on diverse matters, including
the formation and funding of partnerships, limited liability companies and corporations, corporate
reorganizations and acquisitions, financing arrangements, intercompany pricing issues, and
employee stock ownership plans.
Dan provides cross-border tax planning and representation to foreign corporations and
individuals contemplating investments and business activities in the United States and to
domestic clients considering business opportunities overseas. He has represented clients in the
formation of substantial cross-border and domestic joint ventures in the defense and energy
industries, as well as domestic and cross-border mergers and acquisitions. Dan has represented
clients in tax controversy matters at the examination level and before the Appeals Office of the
U.S. Internal Revenue Service, as well as in state tax proceedings. He has litigated tax cases in
the U.S. Tax Court, the district courts, and the U.S. Courts of Appeals.
Before joining Hogan Lovells, Dan was a partner in the Washington, D.C. office of a major
Chicago-based law firm. Immediately following law school, he clerked for The Honorable Robert
Braucher of the Supreme Judicial Court of Massachusetts. He also served as an advisor to the
Competitiveness Policy Council, established by U.S. Congress. Dan has lectured and published
articles regarding tax-exemption issues arising in the healthcare industry, equity-based
compensation, and international taxation.
Representative Experience
• Negotiation and structuring of major joint ventures in the defense and energy industries.
• Advice to foreign governmental agencies regarding the implications of U.S. tax laws and
policies.
• Representation of major automotive and pharmaceutical companies in connection with sales
of subsidiaries to foreign purchasers.
• Representation of a publicly-traded U.S. natural resources company in acquisition of
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