In the good old daysﾗless than a year ago, in factﾗcorporate regulators and watchdogs cared little about where a company was incorporated. Then came the Tyco International scandal, a fiasco that blackened the reputation not only of accountants, auditors, art dealers, and shower curtains, but also of offshore corporations. Tycoﾴs Bermuda registration became the red cape that now infuriates the bull of public opinion.
In December 2001, six months before Tycoﾴs troubles surfaced, toolmaker and security-systems developer Ingersoll-Rand shifted its headquarters from Woodcliff Lake, New Jersey, to Bermudaﾗwith the approval of 90% of its voting shareholders. The move seemed like a no-brainer: The company estimated that it would save as much as $60 million in taxes. Moreover, the change was designed to level the playing field with international competitors, which may bring non-U.S. earnings into this country without incurring a taxﾗa fundamental flaw of U.S. corporate tax policy, according to Herbert Henkel, Ingersollﾴs chairman, president, and CEO.
Henkel has strong allies in this view, among them deputy Treasury secretary Kenneth W. Dam. Addressing the Tax Foundationﾴs 65th national conference in November, Dam concluded a speech by saying, ﾓWhen U.S. tax law treats U.S.-owned and foreign-owned firms alike, our economy will be stronger and U.S. enterprises will be more competitive around the world.ﾔ
The rationale for a corporate inversion, as going offshore is known, is obvious. By moving its headquarters to one of the 25 or so tax-friendly offshore territories, an American company can avoid paying taxes twice on foreign profitsﾗfirst in the overseas country where they were earned, then again in the U.S. Even more enticing, the company can legally shrink its U.S. tax burden by having the American subsidiary borrow money from, for example, the Cayman Islands parent, then deducting the interest payments, which the same company has pocketed. Or the parent can transfer assets such as intellectual property offshore, then license them back to the U.S. subsidiary. The license fees, like interest payments, become a deductible expense.
Cooper Industries, formerly of Houston, followed competitor Ingersoll-Randﾴs lead, acquiring a Bermuda change of address in May 2002. Around the same time, Nabors Industries, Noble Corp., and Weatherford International, all oil-drilling-equipment companies that used to call Texas home, hied off to the island. (See the box at right for other examples of outfits that have moved offshore.)
But then came the Tyco firestorm, which charred every company seeking sunnier climes. The reincorporation in Bermuda of New Britain, Connecticut, toolmaker Stanley Works barely passed a shareholder vote in late May, and the decision was promptly challenged by union leaders and employee shareholders. Connecticutﾴs attorney general leaped on the bandwagon, accusing Stanley of trying to strip shareholders of U.S. legal protectionsﾗunder Bermuda law, shareholders canﾴt seek legal redress for insider trading, for instance. More stinging, the attorney general also accused Stanley of being unpatriotic by trying to avoid $30 million in U.S. taxes. (See page 12 for more on state attorneys general who are assuming the role of shareholder-activist.)
While Stanley Works struggled to soothe shareholders, New York City-based PricewaterhouseCoopers, which had wanted to spin off its consulting arm and incorporate it in Bermuda, instead decided in July to sell the unit to IBM. One month later, battered Stanley Works decided to stay where it was.
ﾓPeople seized on Stanley as an egregious example of nonpatriotism. But it has nothing to do with that. Itﾴs just about paying less in taxes,ﾔ says Bruce Bartlett, a senior fellow at the National Center for Policy Analysis and a former deputy assistant secretary for economic policy at the U.S. Treasury Department. ﾓSuppose you got a job in Boston. Everybody knows that Massachusetts has huge taxes, but you can simply commute from New Hampshire, which has no income tax at all. Are you being unpatriotic by moving? No way.ﾔ
A number of shareholder-activists and politicians, both Democrat and Republican, disagree. ﾓItﾴs blatantly unfair to ask the average tax-paying American citizen, who can barely afford to visit these countries, to pick up the slack when these companies move offshore and cut their tax burden by $30 million,ﾔ says Lee Drutman, communications director of Citizen Works, a nonprofit organization founded by Ralph Nader that distributes lists with such titles as ﾓCorporate Tax Traitors.ﾔ ﾓSomebody has to make up that difference, especially at a time when weﾴre expanding the military.ﾔ
Although the Republicansﾴ victory in November means that many Democrat-sponsored anti-offshore bills from 2002 are dead in the water, enough political heavyweights agree with Drutman to give directors pause before they sign off on any corporate inversions. Legislation from Senator Charles E. Grassley (R-Iowa), chairman of the Senate Finance Committee, is aimed at prohibiting tax-haven reincorporation. Meanwhile, Representative Bill Thomas (R-California) seeks to modify the U.S. corporate tax code to make inversions less financially attractive. Other bills propose to tax expatriated companies as if they were still based here, penalize them retroactively, or bar them from federal contracts.
Offshore companies did get a reprieve of sorts in mid-November, when the Senate passed the Homeland Security Bill with an amendment that permits federal contracts to be awarded to expatriated companies for compelling reasons of economic or national security. Until the billﾴs passage, many legislators had argued that such companies should be ineligible. Although Trent Lott, then the Senate Republican leader, promised dissenters that the expatriation language would be revisited in early 2003, ﾓit wonﾴt be taken out, I guarantee it,ﾔ predicts Bartlett.
Thatﾴs good news for Ingersoll-Rand, which has nearly 300 federal contracts that might have gone up in smoke. ﾓThe Homeland Security Bill correctly allows our company to participate in contracts as befitting the best interests of U.S. security and operations,ﾔ says CEO Herbert Henkel. ﾓIn addition, legislators wisely understood that denying our firm federal contracts would harm American employees who manufacture and support the needed products.ﾔ
Ingersollﾴs contracts may be safe for now, but moving offshore could affect its stock price. How? Phil Angelides, Californiaﾴs state treasurer, has put offshore companies in his sights. In addition to striking Ingersoll-Rand from the list of eligible investments for the $45 billion account his office oversees, Angelides is lobbying CalPERS and CalSTRS, Californiaﾴs two biggest pension funds (Nos. 1 and 3 in the nation, respectively), to drop their offshore holdings. The two funds hold $752 million worth of investments in U.S. corporations that have expatriated.
Says Henkel: ﾓWeﾴre monitoring the CalPERS effect, but to date we havenﾴt seen a significant change in the support we get from our institutional investors. Most of them thoroughly understand the business logic of our reincorporation and remain solidly in our corner.ﾔ
Tax-watcher Bruce Bartlett agrees. ﾓCompanies are voting with their feet,ﾔ he says. ﾓItﾴs the canary-in-the-coal-mine situation, and rather than beating up on them, we should be thinking about why theyﾴre doing this.ﾔ
Still, while the debate rages on, board members considering the appeal of meeting in the Bahamas might want to think twice.
By Bonnie Azab Powell, Corporate Board Member
