[Senate Hearing 107-811]
[From the U.S. Government Printing Office]

                                                        S. Hrg. 107-811

                          CORPORATE INVERSION



                                before a

                          SUBCOMMITTEE OF THE

                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION


                            SPECIAL HEARING

                    OCTOBER 16, 2002--WASHINGTON, DC


         Printed for the use of the Committee on Appropriations

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                ROBERT C. BYRD, West Virginia, Chairman
DANIEL K. INOUYE, Hawaii             TED STEVENS, Alaska
ERNEST F. HOLLINGS, South Carolina   THAD COCHRAN, Mississippi
PATRICK J. LEAHY, Vermont            ARLEN SPECTER, Pennsylvania
TOM HARKIN, Iowa                     PETE V. DOMENICI, New Mexico
HARRY REID, Nevada                   MITCH McCONNELL, Kentucky
HERB KOHL, Wisconsin                 CONRAD BURNS, Montana
PATTY MURRAY, Washington             RICHARD C. SHELBY, Alabama
BYRON L. DORGAN, North Dakota        JUDD GREGG, New Hampshire
TIM JOHNSON, South Dakota            LARRY CRAIG, Idaho
JACK REED, Rhode Island              MIKE DeWINE, Ohio
                  Terrence E. Sauvain, Staff Director
                 Charles Kieffer, Deputy Staff Director
               Steven J. Cortese, Minority Staff Director
            Lisa Sutherland, Minority Deputy Staff Director

            Subcommittee on Treasury and General Government

                BYRON L. DORGAN, North Dakota, Chairman
MARY L. LANDRIEU, Louisiana          RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              MIKE DeWINE, Ohio
ROBERT C. BYRD, West Virginia        TED STEVENS, Alaska
  (ex officio)                         (ex officio)

                           Professional Staff

                              Chip Walgren
                        Nicole Rutberg Di Resta
                         Pat Raymond (Minority)
                        Lula Edwards (Minority)

                            C O N T E N T S

Opening statement of Senator Byron L. Dorgan.....................     1
Prepared statement of Senator Ben Nighthorse Campbell............     4
Statement of Pamela Olson, Assistant Secretary for Tax Policy, 
  Department of the Treasury.....................................     4
    Prepared statement...........................................     6
Statement of Hon. Richard Blumenthal, Attorney General, State of 
  Connecticut, Hartford, CT......................................    16
    Prepared statement...........................................    17
Statement of Reuven S. Avi-Yonah, Professor of Law and Director, 
  International Tax LLM Program, University of Michigan Law 
  School, Ann Arbor, MI..........................................    20
    Prepared statement...........................................    22
Introduction: A brief history of inversions......................    22
Why inversions now?..............................................    23
The competitiveness excuse.......................................    24
A short-term solution: Redefining corporate residence............    25
A long-term solution: A modified source-based regime.............    26
Statement of Robert S. McIntyre, Director, Citizens for Tax 
  Justice, Washington, DC........................................    28
    Prepared statement...........................................    29
The scope of the corporate tax shelter problem...................    29
The Bermuda reincorporation loophole.............................    31
The specious arguments for the Bermuda loophole and other 
  offshore shel- 
  ters...........................................................    32
Relentlessly, companies seek even more offshore shelters.........    33
What we should do to curb abusive corporate offshore tax 
  sheltering.....................................................    33
Statement of Martin A. Regalia, Vice President for Economic 
  Policy and Chief Economist, U.S. Chamber of Commerce, 
  Washington, DC.................................................    34
    Prepared statement...........................................    36
The impetus for corporate inversions.............................    36
Congressional response...........................................    37
Asserted rationale for the congressional proposals...............    37
Response to congressional rationale..............................    37
A more appropriate and beneficial solution.......................    38
Statement of William G. Gale, Senior Fellow and Deputy Director 
  for Economic Studies, The Brookings Institution, Washington, DC    38
    Prepared statement...........................................    40
Analysis.........................................................    41
Additional submitted statements and questions and answers........    61
Prepared statements of:
    The AFL-CIO..................................................    61
    Accenture Ltd................................................    63
Questions submitted:
    To Patricia Olson............................................    65
    By Senator Ben Nighthorse Campbell...........................    65
    To William Gale..............................................    65
    By Senator Richard C. Shelby.................................    65
    To Reuven Avi-Yonah..........................................    66
    By Senator Richard C. Shelby.................................    66

                          CORPORATE INVERSION


                      WEDNESDAY, OCTOBER 16, 2002

                           U.S. Senate,    
                   Subcommittee on Treasury and    
                                General Government,
                               Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 10:08 a.m., in room SD-192, Dirksen 
Senate Office Building, Hon. Byron L. Dorgan (chairman) 
    Present: Senator Dorgan.

              opening statement of senator byron l. dorgan

    Senator Dorgan. I am going to call the subcommittee to 
order and begin the hearing today.
    First of all, good morning to all of you. This hearing is 
to look at the issue of reincorporation into offshore tax 
havens by American corporations.
    In the last decade, about 20 major U.S. corporations have 
reincorporated or, on paper, set up shop in offshore tax havens 
like Bermuda or the Cayman Islands. Companies such as Tyco, 
Fruit of the Loom, and others are among those that have used 
this tactic.
    This tactic is described in many cases as something called 
``corporate inversion,'' and it is happening largely for one 
reason--because some companies are feeling that if they involve 
themselves in a ``corporate inversion,'' they can reduce 
substantially the share of U.S. taxes that they are paying. In 
the aftermath of 9/11 last year, who these kinds of practices 
raise questions of patriotism.
    Let me show a couple of clippings of stories that have been 
written about this in recent years as some large and high-
profile companies have used this tactic.
    This is a Washington Post story. Alan Sloan wrote a column, 
``Uncle Sam Gets Shorted by the Bermuda Bye-Bye.'' I will not 
read it, but it talks about companies playing tax games and 
moving to Bermuda from New Britain, CT--this is Stanley Tools, 
and they have since changed their mind about that--but it talks 
about the incentive for that company wanting to move offshore.
    One of the paragraphs in this article reads: ``One of the 
problems I have with all of these companies going to Bermuda in 
a time of war and budget deficits is that it amounts to a 
selective repeal of the corporate income tax. It is available 
to Stanley''--in this case, he was talking about Stanley 
Tools--``but not to the local hardware store that sells Stanley 
Tools. It is available to Monday''--again, referring to another 
corporation--``but not to a computer consultant working out of 
his or her house.''
    Another piece by Jonathan Weisman in the Washington Post 
raises questions that I think many on Capitol Hill have also 
given voice to, including myself: ``Patriotism Raining on Tax 
Paradise--Lawmakers Chafing at Firms that Exist Offshore Only 
on Paper. Is it the right time to be migrating a corporation to 
an offshore location? Kate Barton said, `A lot of companies 
feel that the improvement on earnings is powerful enough to say 
that maybe the patriotism issue should take a back seat.' '' 
That was a statement by Ernst and Young partner Kate Barton, 
and I have a clip of that that I will use in a moment.
    All of this raises significant questions, and we will hear 
today from Pamela Olson, Assistant Secretary of the Treasury 
for Tax Policy. I will be interested to hear assessment of this 
    We are interested in this issue especially from the side of 
tax enforcement--how much money is needed for tax enforcement 
issues when a corporation engages in an inversion and 
effectively renounces its U.S. citizenship and becomes a 
citizen of another country? This poses, I think, some unique 
tax enforcement issues--income stripping, transfer pricing, and 
a range of issues that I think are interesting and also 
complex. And the question is, what kinds of resources are 
available and/or necessary for both the Internal Revenue 
Service and the Treasury to deal with these issues?
    I think it is probably useful to begin this hearing by 
showing you the piece of video that I referred to just a moment 
ago. This is a piece of video that was broadcast on the 
internet by the accounting and consulting firm Ernst and Young 
in November of 2001. The broadcast was intended for Ernst and 
Young's clients and was posted on their website, available, of 
course, to everyone.
    Let us see that piece of video. It is about a minute and a 
    That is enough for the moment. In case you did not hear the 
remarks of the partner, she says, ``The improvement on earnings 
is powerful enough to say that maybe the patriotism issue 
should take a back seat.''
    I did ask Ernst and Young to come to this hearing to 
explain what they meant by that statement, but they declined to 
do so.
    PriceWaterhouseCoopers is another firm that has 
aggressively touted its expertise with corporate inversions on 
their website. Until recently, PriceWaterhouseCoopers was 
planning to invert to Bermuda as well. I also invited them to 
be present today, and they declined.
    I understand that no one enjoys paying taxes in this 
country. Company managers have a responsibility to their 
shareholders to make smart business decisions, including 
decisions on tax strategy.
    But I worry that in recent months, the line between 
intelligent business decisions and corporate self-interest has 
been crossed in a way that does not consider the broader public 
interest in this country.
    I think President Bush has the same concern. He recently 
said: ``I think we ought to look at the people who are trying 
to avoid U.S. taxes. I think American companies ought to pay 
taxes here, be a part, be good citizens.'' That is what the 
President said.
    The trend of corporate inversions is part and parcel of a 
wave of some irresponsibility, not among the majority or the 
rule of corporations, but among a select few. We have seen in 
recent months, in the last year and a half, the stories about 
Enron, Tyco, Worldcom, Qwest, and many others.
    Let me just talk for a moment about Tyco, because it has 
been in the news a great deal. In the clip we saw, the partner 
of Ernst and Young was talking about how successful the Tyco 
situation was. Tyco was a company based in New Hampshire. In 
1997, Tyco purchased ADT, a manufacturer of electronic systems 
that was based in Bermuda. The chairman of Tyco, Dennis 
Kozlowski, structured the deal as a reverse merger, moving 
Tyco's headquarters on paper to Bermuda, and because of its 
Bermuda base, Tyco no longer pays U.S. taxes on its growing 
overseas income, and through a variety of schemes, it also 
minimizes its taxes on U.S. income.
    For example, Tyco set up a Luxembourg-based subsidiary to 
finance most of its debt. In a process known as ``income 
stripping,'' the Luxembourg subsidiary makes loans to Tyco 
units in the U.S. and elsewhere which then deduct the interest 
payments from their taxable income.
    Tyco indicated that becoming a Bermuda company ``saved'' it 
about $400 million in 2001. One knows, of course, where those 
savings come from. It means that others in our country have to 
pay taxes to make up the difference.
    Bill Allison, a senior editor at the Washington-based 
Center for Public Integrity, described Kozlowski as ``a 
Benedict Arnold billionaire'' for moving offshore.
    I think most corporations in this country understand their 
responsibilities and do well to meet those responsibilities. 
But there are some that have decided it is ``Katie, bar the 
door,'' there are no limits, they are going to do whatever they 
feel like, and that includes deciding to renounce their U.S. 
citizenship in order to avoid paying U.S. taxes.
    These inversions call into question some people's 
commitment to this country and we will talk a lot about that 
    Also, I want us to try to evaluate what kinds of resources 
are necessary for the Internal Revenue Service and the Treasury 
Department to deal with this issue.
    An unrelated but similar question is raised by a September 
17 article in the Wall Street Journal which I will ask Ms. 
Olson about, ``IRS Seeks Quick Settlements in Pending Tax 
Shelter Probes.'' The implication of this article is that we 
have a lot of aggressive tax shelters, and what we want to do 
is just try to move these off the dock and get rid of them, 
with quick settlements.
    My feeling is that whether it is aggressive or abusive tax 
shelters or inversions, I want the Internal Revenue Service and 
the Treasury to have all the resources they need to combat this 
abuse in as aggressive a way as is possible.
    The American people pay their taxes. People who run 
businesses on Main Street pay their taxes. And frankly, it 
disgusts me to see corporations decide in their boardrooms that 
they would like to renounce their U.S. citizenship so they can 
avoid paying taxes. My feeling is that if they would like to be 
citizens of Bermuda, perhaps they should rely on the Bermuda 
navy to protect their assets of there is expropriation 
somewhere. And I believe the total Bermuda armed forces has 
somewhere around 27 people. So to Mr. Kozlowski and others who 
think they would like to become citizens of the country of 
Bermuda, the next time they are threatened somewhere, maybe 
they could call on the Bermuda army and navy and air force to 
protect them.
    I think a fair number of people are disgusted about all of 
this. I am, and I would like to have a discussion about it 
    We will begin with Ms. Olson, who is Assistant Secretary 
for Tax Policy at the Treasury Department.
    We will include all of the statements today in the 
permanent record. We will have people who are here supporting 
inversions, who think it is just good business--and I will 
question that, of course--but we will have people who think 
that it is a terrible abusive practice that calls into question 
the patriotism of those who make those decisions, and we will 
have others who give us likely dull and boring and highly 
detailed tax policy testimony--but I am not suggesting that you 
are in that category, Ms. Olson.

                          submitted statement

    Before you begin, the subcommittee has received a statement 
from Senator Campbell which he asked to be placed in the record
    [The statement follows:]

         Prepared Statement of Senator Ben Nighthorse Campbell

    Thank you Mr. Chairman for calling this hearing on an issue that 
needs very close and careful examination and I want to thank our 
witnesses for taking the time to come up and discuss this issue with 
    In recent months, several high-profile U.S. companies have 
announced plans to reincorporate outside of the United States. It is 
important to understand that it is well within the rights of these 
companies to operate how and where it is most beneficial to them, and 
in turn, to the American consumers as long as they remain within the 
bounds of the law. However, there have been recent attempts in Congress 
to prevent companies that have reincorporated in foreign countries from 
obtaining, completing, or even competing for Federal contracts. Some 
are even questioning their patriotism, despite the fact that these 
companies employ thousands of American workers.
    What we need to be focusing on is not how we keep these companies 
from incorporating overseas, but why these companies feel the need to 
reincorporate in a foreign country. Is it that incorporating a company 
in the U.S. is a disadvantage when competing against foreign interests? 
If this is the case, and if these Federal contracts are revoked or not 
renewed, could foreign workers be providing the same services and 
products and possibly leave the Federal Government at the mercy of 
foreign corporations and their employees? In a time when our economy 
has been suffering and our deficits are back in the red, can we truly 
say that we'd like more business to go offshore and stay there, 
possibly at the expense of U.S. jobs and economic gains? We need to 
look at the overall effects of the offshore reincorporation and 
determine exactly who will be hurt in the long run before making any 
rash decisions.
    I again want to thank the witnesses for coming.
    Senator Dorgan. Why don't we begin with you, however. You are the 
Assistant Secretary for Tax Policy. We appreciate very much you being 
here, and your statement will be made a part of the record. You may 
summarize, and we will go from there.

    Ms. Olson. Mr. Chairman, thank you. I appreciate the 
opportunity to be here today, and I will do my best to keep 
this short and keep you awake. My testimony probably will fall 
in the ``dull and boring'' category.
    I commend you for your interest in this important tax 
policy issue. Over the past year, several high-profile U.S. 
companies announced plans to reincorporate outside the U.S. The 
documents filed with the SEC cite substantial reductions in 
overall corporate taxes as a key reason for the transactions. 
While these so-called corporate inversion transactions are not 
new, there has been, as you have noted, a marked increase in 
the frequency, size, and profile of the transactions.
    Earlier this year, the Treasury Department announced that 
it was studying the issues arising in connection with corporate 
inversion transactions and the implications of these 
transactions for the U.S. tax system and the U.S. economy. This 
study culminated in the release of a Treasury Department report 
on the tax policy implications of corporate inversion 
transactions and a package of proposed legislative and 
regulatory actions.
    Inversion transactions implicate fundamental issues of tax 
policy. The U.S. tax system can operate to provide a cost 
advantage to foreign-based multinational companies over U.S.-
based multinational companies. The Treasury report identifies 
two distinct classes of tax reduction that are available to 
foreign-based companies and that can be achieved through an 
inversion transaction.
    First, an inversion transaction may be used by a U.S.-based 
company to achieve a reduction in the U.S. corporate-level tax 
on income from U.S. operations. In addition, through an 
inversion transaction, a U.S.-based multinational group can 
substantially reduce or eliminate the U.S. corporate-level tax 
on income from its foreign operations.
    An inversion is a transaction through which a new 
corporation, typically located in a low -or no-tax country, 
replaces the existing U.S. parent corporation as the parent of 
the corporate group. The transactional forms vary, but all 
involve little or not immediate operational change, and all are 
transactions in which either the shareholders of the company or 
the company itself are subject to tax.
    This reincorporation step may be accompanied by other 
restructuring steps designed to shift the ownership of the 
group's foreign operations outside the United States.
    The restructuring steps are complex and varied, but like 
the reincorporation itself, are transactions that are subject 
to tax. When the transactions are complete, the foreign 
operations of the company will be outside the U.S. taxing 
jurisdiction, and the corporate structure also may provide 
opportunities to reduce the U.S. tax on U.S. operations.
    Market conditions have been a factor in the recent increase 
in inversion activity because they have reduced the potential 
tax imposed on the transactions. But market conditions are not 
what motivates a company to undertake a transaction.
    U.S.-based companies and their shareholders are making the 
decision to reincorporate outside the U.S. largely because of 
the tax savings available. It is that underlying motivation 
that the Treasury Department proposals address.
    The ability to achieve a substantial reduction in taxes 
through a transaction that is complicated technically but 
virtually transparent operationally is a cause for concern as a 
policy matter. In formulating a response, however, we must bear 
in mind that an inversion is not the only route to 
accomplishing the same type of reduction in taxes. The policy 
response to the recent corporate inversion activity should be 
broad enough to address the underlying differences in the U.S. 
tax treatment of U.S.-based companies and foreign-based 
companies, regardless of how foreign-based status is achieved.
    Measures designed simply to halt inversion activity only 
address these transactions at the surface level and in the 
short run. Measures narrowly targeted would have the unintended 
effect of encouraging a shift to other forms of transactions 
and structures, to the detriment of the U.S. economy in the 
long run.
    Our policies should provide a level playing field. There is 
no merit in policies biased against domestic control and 
domestic management of U.S. operations.
    The Treasury Department has made specific proposals 
relating to legislative and regulatory changes that are needed 
to address these transactions and the opportunities to reduce 
taxes that are available through such transactions. Both the 
Senate Finance Committee and the House Ways and Means Committee 
have held hearings on this subject, and members of both 
committees have crafted legislation in response to these 
transactions. We are working closely with the committees to 
ensure the enactment of appropriate legislation.
    In addition to addressing strategies that inappropriately 
minimize U.S. income, we must address the tax disadvantages 
imposed by our international tax rules on U.S.-based companies 
with foreign operations. Relative to the tax systems of our 
major trading partners, the U.S. tax rules can impose 
significantly heavier burdens on the foreign operations of 
domestically-based companies. Our objective must be to ensure 
that the U.S. tax system maintains the competitiveness of U.S. 
businesses in the global marketplace.

                           PREPARED STATEMENT

    Our overarching goal is maintaining the U.S. position as 
the most desirable location in the world for incorporation, 
headquartering, foreign investment, business operations, and 
employment opportunities. In short, that means keeping and 
expanding job opportunities here in the U.S.
    Thank you for your attention. I would be pleased to answer 
your questions.
    [The statement follows:]

                   Prepared Statement of Pamela Olson

    Mr. Chairman, Senator Campbell, and distinguished Members of the 
Subcommittee, I appreciate the opportunity to appear today at this 
hearing relating to corporate inversion transactions.
    Over the past year, several high-profile U.S. companies announced 
plans to reincorporate outside the United States. The documents 
prepared for shareholder approval and filed with the Securities and 
Exchange Commission cite substantial reductions in overall corporate 
taxes as a key reason for the transactions. While these so-called 
corporate inversion transactions are not new, there has been a marked 
increase recently in the frequency, size, and profile of the 
    On February 28, 2002, the Treasury Department announced that it was 
studying the issues arising in connection with these corporate 
inversion transactions and the implications of these transactions for 
the U.S. tax system and the U.S. economy. On May 17, 2002, the Treasury 
Department released its report on the tax policy implications of 
corporate inversion transactions. (A copy of the Treasury report is 
attached.) The Treasury report describes the mechanics of the 
transactions, the current tax treatment of the transactions, the 
current tax treatment of the companies post-inversion, the features of 
our tax laws that facilitate the transactions or that may be exploited 
through such transactions, and the features of our tax laws that drive 
companies to consider these transactions.
    Inversion transactions implicate fundamental issues of tax policy. 
The U.S. tax system can operate to provide a cost advantage to foreign-
based multinational companies over U.S.-based multinational companies. 
The Treasury report identifies two distinct classes of tax reduction 
that are available to foreign-based companies and that can be achieved 
through an inversion transaction. First, an inversion transaction may 
be used by a U.S.-based company to achieve a reduction in the U.S. 
corporate-level tax on income from U.S. operations. In addition, 
through an inversion transaction, a U.S.-based multinational group can 
substantially reduce or eliminate the U.S. corporate-level tax on 
income from its foreign operations.
    An inversion is a transaction through which the corporate structure 
of a U.S.-based multinational group is altered so that a new foreign 
corporation, typically located in a low- or no-tax country, replaces 
the existing U.S. parent corporation as the parent of the corporate 
group. In order to provide context for consideration of the policy 
issues that arise, the Treasury report includes a technical description 
of the forms of the inversion transaction and the potential tax 
treatment of the various elements of the transaction under current law. 
The transactional forms through which the basic reincorporation outside 
the United States can be accomplished vary as a technical matter, but 
all involve little or no immediate operational change and all are 
transactions in which either the shareholders of the company or the 
company itself are subject to tax. This reincorporation step may be 
accompanied by other restructuring steps designed to shift the 
ownership of the group's foreign operations outside the United States. 
The restructuring steps involving movement of foreign subsidiaries are 
complex and varied, but, like the reincorporation itself, are 
transactions that are subject to tax. When all the transactions are 
complete, the foreign operations of the company will be outside of the 
U.S. taxing jurisdiction and the corporate structure also may provide 
opportunities to reduce the U.S. tax on U.S. operations.
    Market conditions have been a factor in the recent increase in 
inversion activity. Although the reincorporation step triggers 
potential tax at the shareholder level or the corporate level, 
depending on the transactional form, that tax liability may be less 
significant because of current economic and market factors. The 
company's shareholders may have little or no gain inherent in their 
stock and the company may have net operating losses that reduce any 
gain at the company level. While these market conditions may facilitate 
the transactions, they are not what motivates a company to undertake an 
inversion. U.S.-based companies and their shareholders are making the 
decision to reincorporate outside the United States largely because of 
the tax savings available. It is that underlying motivation that we 
must address.
    The ability to achieve a substantial reduction in taxes through a 
transaction that is complicated technically but virtually transparent 
operationally is a cause for concern as a policy matter. As we 
formulate a response, however, we must not lose sight of the fact that 
an inversion is not the only route to accomplishing the same type of 
reduction in taxes. A U.S.-based start-up venture that contemplates 
both U.S. and foreign operations may incorporate overseas at the 
outset. An existing U.S. group may be the subject of a takeover, either 
friendly or hostile, by a foreign-based company. In either case, the 
structure that results provides tax-savings opportunities similar to 
those provided by an inversion transaction. A narrow policy response to 
the inversion phenomenon may inadvertently result in a tax code 
favoring the acquisition of U.S. operations by foreign corporations and 
the expansion of foreign controlled operations in the United States at 
the expense of domestically managed corporations. In turn, other 
decisions affecting the location of new investment, choice of 
suppliers, and employment opportunities may be adversely affected. 
While the openness of the U.S. economy has always made--and will 
continue to make--the United States one of the most attractive and 
hospitable locations for foreign investment in the world, our policies 
should provide a level playing field. There is no merit in policies 
biased against domestic control and domestic management of U.S. 
    The policy response to the recent corporate inversion activity 
should be broad enough to address the underlying differences in the 
U.S. tax treatment of U.S.-based companies and foreign-based companies, 
without regard to how foreign-based status is achieved. Measures 
designed simply to halt inversion activity only address these 
transactions at the surface level and in the short run. Measures that 
are targeted too narrowly would have the unintended effect of 
encouraging a shift to other forms of transactions and structures to 
the detriment of the U.S. economy in the long run.
    An immediate response is needed to address the U.S. tax advantages 
that are available to foreign-based companies through the ability to 
reduce the U.S. corporate-level tax on income from U.S. operations. 
Inappropriate shifting of income from the U.S. companies in the 
corporate group to the foreign parent or its foreign subsidiaries 
represents an erosion of the U.S. corporate tax base. It provides a 
competitive advantage to companies that have undergone an inversion or 
otherwise operate in a foreign-based group. It creates a corresponding 
disadvantage for their U.S. competitors that operate in a U.S.-based 
group. Moreover, exploitation of inappropriate income-shifting 
opportunities erodes confidence in the fairness of the tax system.
    The Treasury Department has made specific proposals relating to 
legislative and regulatory changes that are needed to address these 
transactions and the opportunities available through such transactions. 
Both the Senate Finance Committee and the House Ways and Means 
Committee have held hearings on this subject and members of both 
committees have crafted legislation in response to these transactions. 
We are working closely with these committees to ensure the enactment of 
appropriate legislation.
    We also must address the U.S. tax disadvantages for U.S.-based 
companies that do business abroad relative to their counterparts in our 
major trading partners. The U.S. international tax rules can operate to 
impose a burden on U.S.-based companies with foreign operations that is 
disproportionate to the tax burden imposed by our trading partners on 
the foreign operations of their companies. The U.S. rules for the 
taxation of foreign-source income are unique in their breadth of reach 
and degree of complexity. Both the recent inversion activity and the 
increase in foreign acquisitions of U.S. multinationals are evidence 
that the competitive disadvantage caused by our international tax rules 
is a serious issue with significant consequences for U.S. businesses 
and the U.S. economy. A comprehensive reexamination of the U.S. 
international tax rules and the economic assumptions underlying them is 
needed. As we consider appropriate reformulation of these rules we 
should not underestimate the benefits to be gained from reducing the 
complexity of the current rules. Our system of international tax rules 
should not disadvantage U.S.-based companies competing in the global 
    As we consider these important issues, we must focus on the 
overarching goal of maintaining the attractiveness of the United States 
as the most desirable location in the world for incorporation, 
headquartering, foreign investment, business operations, and employment 
opportunities, to ensure an ever higher standard of living for all 

    Senator Dorgan. Thank you very much, Ms. Olson.
    I think the easy way for people to understand inversions it 
is that corporations effectively renounce their U.S. 
citizenship. They say, ``We do not want to be a U.S. 
corporation anymore. We want to be a Bermuda corporation,'' for 
    You indicate that there is an increase in that, and that is 
a ``cause for concern,'' you say. What kind of an increase--are 
you seeing and hearing much more of it--and what kind of cause 
for concern exists at the Treasury?
    Ms. Olson. The number that we have seen is about the same 
as the number that you mentioned, about 20 companies that have 
undertaken inversion transactions. At the same time, there have 
been some companies that have made decisions to commence 
operations outside the U.S. Although they are U.S.-based 
companies, they have made the decision to incorporate the 
parent company outside the U.S.
    We do not know what the revenue cost has been to the 
Treasury outside of what we have seen reported by the companies 
themselves as either their actual savings or their projected 
    Senator Dorgan. Give me your assessment of what you heard 
on that tape. I assume you are hearing a fair amount of that, 
and as a tax policy person at Treasury, you are wondering what 
is going on, what kind of tax advice is given by the major 
advisors. Here, you see a couple of months after 9/11 a partner 
at one of the major firms saying that patriotism probably ought 
to take a back seat to the tax issue for corporations. What do 
you think of that?
    Ms. Olson. Well, I think it is clear that Members of 
Congress, the public, and the administration think that this is 
a serious issue and one that has to be addressed. We clearly do 
not support the notion of companies deciding to leave the U.S. 
We think the right approach is to stay here in the U.S. and 
address whatever the problems are.
    Senator Dorgan. And you indicated that we have in our tax 
system some disadvantages relative to other countries and 
relative to what corporations face in other countries. Is that 
a uniformly-held view? Are you aware that the GAO and some 
others would take issue with that?
    Ms. Olson. I am not aware of GAO taking issue with it, no.
    Senator Dorgan. What kinds of disadvantages exist, and how 
would our tax system pose a disadvantage for U.S. corporations 
vis-a-vis other countries?
    Ms. Olson. Well, for example, we have a worldwide system of 
taxation. Some of our trading partners do as well, but some of 
them tax on a territorial basis rather than on a worldwide 
basis. The worldwide system is made similar to a territorial 
system through the grant of a foreign tax credit for taxes paid 
in other countries, but that is not a perfect match, and we 
have put a number of restrictions on the availability of 
foreign tax credits to companies here in the U.S., so that can 
put them at a disadvantage. That is one example.
    Senator Dorgan. The so-called territorial system can also 
be very complex, can it not?
    Ms. Olson. It can be complex, yes.
    Senator Dorgan. And the development of a system like that 
could accomplish what the corporations are intending to 
accomplish through inversion; is that correct?
    Ms. Olson. Well, the thing that we found in our meetings--
and as part of our study, we did meet with a number of the 
companies that had either inverted or were planning to invert, 
and we also met with a number of the advisors--what we found in 
our meetings with them and in our analysis of the materials 
that were available was that what really drove the transactions 
was the opportunity to reduce taxes on income earned here in 
the U.S. So it was the opportunity to, in the vernacular, 
``strip'' income from the U.S. that really made--it was really 
the juice in the transactions that drove them. So we think that 
that is the most significant issue that needs to be addressed 
in the immediate term.
    Senator Dorgan. When you say that this entire issue is 
``cause for concern,'' what is the concern--loss of revenue, or 
essentially the dismantling of a tax system dealing with the 
corporate tax?
    Ms. Olson. I think it is both. We obviously depend on the 
corporate tax for a significant amount of revenues for the 
government, and that system should be upheld.
    Senator Dorgan. How much money are we losing as a result of 
these corporate inversions?
    Ms. Olson. Other than the information that the companies 
themselves have provided, we do not have an estimate.
    Senator Dorgan. But if it is a cause for concern that we 
are losing money, I ask. Is it a lot; a little? I mean, do you 
have any sense of the order of magnitude?
    Ms. Olson. It has the potential to be in the billions of 
dollars, but no, we have not quantified it. What we can see 
based on the information we have is that there remain a number 
of opportunities for companies that might like to consider 
this. I think the attention that has been focused on the issue 
by the Congress and by the Treasury Department through its 
study has essentially brought the traffic in these transactions 
to a halt.
    Senator Dorgan. Tyco indicates that it was to save $400 
million, and that is one corporation. So when you say 
``billions,'' if one corporation is boasting about $400 million 
in savings, ``billions'' is an appropriate suggestion; right?
    Ms. Olson. That is the amount that is at stake, yes.
    Senator Dorgan. Let me ask you this. You develop tax policy 
at Treasury, and then, we collect taxes through the Internal 
Revenue Service. And as I indicated when we started, I do not 
think anybody really enjoys paying taxes. I think everyone 
would prefer to have all the benefits that now exist with 
respect to the way we govern ourselves and roads and defense 
and schools and so on, without having to pay taxes. But of 
course, we know that that is not the case; you have to pay the 
costs of these things that we do together in government.
    One of those costs, for example, is the military budget. At 
12 o'clock today, I believe, we will have a vote on the 
conference report on DOD, and I think it is roughly $360 
billion for this year. If we spend $360 billion for our defense 
in this country and, for example, Great Britain spends $34 
billion, one-tenth of that, France, $27 billion, Germany, $23 
billion, and policy analysts take a look at all this and say, 
``Well, gosh, U.S. corporations are at a disadvantage here with 
respect to the tax system,'' is it possible that U.S. 
corporations, like all other taxpayers, are having to pay part 
of this burden for our Defense Department that is 10 times 
larger than Japan, England, and France? Is that part of the 
reason for the burden? If one accepts--and I will get into that 
in a moment--but if one accepts the proposition that our tax 
system bears a heavier burden or requires a heavier burden on 
corporations than do some of our other trading partners in 
other countries, might it be that these corporations are paying 
part of this defense bill that is 10 times the other countries?
    Ms. Olson. That is certainly possible.
    Senator Dorgan. And if that is the case--and I expect it 
is--companies that renounce their citizenship, then, from a 
policy standpoint, while you take a look at it from the 
standpoint of tax policy, isn't it the case that they are then 
saying, ``We do not want to contribute to this country's 
defense expenditures''?
    Ms. Olson. I think what they are doing is taking advantage 
of what they see as opportunities in the Code to reduce their 
taxes, and we ought to look at those opportunities and do what 
we can to close them down.
    Senator Dorgan. What if they all have an opportunity to pay 
no taxes through whatever windows or cracks or crevices exist 
in the Tax Code? That would be a real serious problem, wouldn't 
    Ms. Olson. It would, and we absolutely need to address 
    Senator Dorgan. And when you indicate that a response is 
necessary to inversions, describe what you think the response 
ought to be. I get the feeling that you think the response 
ought to be that we should reduce taxes on the corporations who 
are wanting to renounce their citizenship.
    Ms. Olson. No. Actually, what the Treasury outlined was a 
four-prong approach to dealing with inversions. The first is a 
legislative change to reduce the opportunities for removing 
income from the U.S. tax base through related-party debt, 
interest deductions on related-party debt. And that is probably 
the most significant change that we need to make, because that 
appears to be the source of the greatest cost savings, tax 
    Senator Dorgan. Is that the income-stripping technique?
    Ms. Olson. Yes, that is the income-stripping.
    The second component of our proposal was the require----
    Senator Dorgan. Can we stay on that for just a moment?
    Ms. Olson. Certainly.
    Senator Dorgan. If corporations renounce their citizenship 
and decide ``I am now a proud citizen of Bermuda,'' and engage 
in ``income-stripping,'' as you call it, describe that for us.
    Ms. Olson. What they would do is encumber the U.S. now 
subsidiary, what used to be parent corporation, with debt to 
the Bermuda company or to a company located somewhere else in a 
low tax jurisdiction, and then, the interest paid on that debt 
would be deducted from U.S. income, and that would reduce U.S. 
    Senator Dorgan. And we need a legislative change to fix 
    Ms. Olson. We do indeed need a legislative change to fix 
that. There are specific rules in the Code that cover it, and 
they are very generous.
    Senator Dorgan. All right. And you mentioned three other 
    Ms. Olson. Yes. The second point is a regulatory point. We 
are looking at the 482 rules, which are the rules that govern 
transfer pricing, to make sure that those rules function 
appropriately. We have broad discretion under Section 482 to 
write changes in the regulations, so we are reviewing those 
regulations. We are also looking at the IRS' administrative 
practices. This is a joint effort between Treasury and the IRS 
to look at what they are doing in the transfer pricing area, to 
make sure that those rules are administered as well as possible 
and produce results that are appropriate so that through the 
transfer pricing rules, companies are not removing income from 
the U.S. tax base as well.
    Senator Dorgan. But how can you--let me ask about 482 for a 
moment--how can you, using that approach, convince yourself and 
the rest of the American taxpayers that you are able to enforce 
the law here? Are you tackling this through some sort of 
formulary approach, or is this the arm's-length method by which 
you are trying to attach the ends of two plates of spaghetti?
    Ms. Olson. I am not sure about attaching the ends of two 
plates of spaghetti, but we are looking at it using the arm's-
length standard bolstered by the ``commensurate with income'' 
language that was added.
    The IRS has a number of tools that were given it over the 
course of the last couple of decades to enforce the rules in 
this area, including contemporaneous documentation, extra 
penalties for mispricing goods and services that are sold 
between related parties. So there are lots of ways for the IRS 
to patrol and police this area to make sure that the rules are 
adhere to.
    Senator Dorgan. But corporations have convinced Treasury 
now for some while that they should continue trying to do 
something they cannot do, and I think it has been a spectacular 
failure. I think many in Treasury admit that enforcement of 
transfer pricing rules has been a failure can you really 
enforce rules so that you do not have transfer pricing abuses?
    There is a wonderful study that a couple of people have 
done a lot of work on called the Pack-Sadanowicz study down in 
Florida that gives you a pretty interesting road map of pricing 
transfers in which tractors are sold for $7, toothbrushes for 
$15, pianos for $50--and they are running the tax people around 
the track like that little rabbit does at dog tracks. And you 
have never caught them and never will using this 18th century 
    Ms. Olson. I think it is actually a 20th and 21st century 
method. Treasury did look at this same issue and came up with a 
    Senator Dorgan. Well, it is 20th century. I will admit it 
is a century back.
    Ms. Olson. Treasury looked at the same issue and concluded 
that the revenue lost through transfer pricing in 1999 was 
about $2.8 billion. So they came up with some fairly different 
conclusions about what was at stake. But what we are trying to 
do is make sure that--what can happen in an inversion 
transaction is not just a simple mispricing of something, which 
is something that the IRS ought to be able to catch. A movement 
of property outside of the U.S. borders--intangibles, for 
example, are something that can be very easily moved--and then, 
if royalties are charged to the U.S. company for use of the 
intangibles, you can see how you could strip income out of the 
United States. Those are hie kinds of things that we are 
particularly focusing on.
    Senator Dorgan. The reason I am asking these questions is 
because inversions, or the renouncing of corporate citizenship, 
enables schemes such as income-stripping and transfer pricing 
to just run circles around the tax administrators or the tax 
collectors, and therefore, substantially decrease their tax 
burden in this country, which is what the boards of directors 
apparently wanted when they decided ``We no longer want to be 
American corporations.''
    And you are saying that although there are some problems 
here, and there is some cause for concern, we have got a handle 
on transfer pricing, and we need some changes in some areas to 
try to deal with income-stripping. Is that what I am hearing?
    Ms. Olson. Yes, that is right. Now, as I said, we are 
studying this issue, and if we do conclude that there are 
additional statutory changes that would be beneficial in this 
area, we will be back to ask Congress for them.
    Senator Dorgan. I believe you indicated that you have 
recommended to the Finance Committee some things that I have 
seen in terms of policy changes. What kind of time do we have 
to try to deal with some of these issues? I think a number of 
the inversions are on hold. Some corporations have been 
embarrassed to death and have decided that their original urge 
to renounce their citizenship really needs to be rethought and 
have announced that they are now not going to do it.
    But I assume--and you probably know better than I--that 
there are people out there, like that partner from the 
accounting firm who, even today, are having a conference call 
with some company saying, ``You know, patriotism be damned. 
Here is a way for you to save on taxes and renounce your U.S. 
citizenship''--or do you think that that is not going on 
    Ms. Olson. The information I have, which is admittedly only 
anecdotal, is that, no, those kinds of marketing activities 
have essentially been put on ice. I think that companies 
recognize that there is so much PR cost to even considering a 
transaction that it has put a real crimp in any serious 
thinking about it.
    Senator Dorgan. So perhaps public embarrassment rather than 
a change in the law is having an impact here?
    Ms. Olson. I think the attention that has been focused on 
it has definitely had an impact, but I still think we need to 
change the law.
    Senator Dorgan. Let me ask about this issue, ``IRS Seeks 
Quick Settlements in Pending Tax Shelter Probes,'' because it 
relates to part of the reason I wanted to have this hearing. 
How much money do you need to effectively enforce the law so 
the folks who are living down on the corner and are working in 
the wage-earner jobs and have to pay a certain tax and do not 
have flexibility are not sitting there, wondering whether 
others who have a lot of flexibility are getting by with paying 
nothing, doing abusive and abusive tax shelters, and being able 
to settle later for a penny or 50 cents on the dollar?
    How much do you need in resources at the IRS in order to 
combat these issues and give people a sense of fairness? Tell 
me about this--``IRS Seeks Quick Settlements in Pending Tax 
Shelter Probes.'' It says: ``IRS officials said the agency has 
proposed settlement offers of 80 percent of the tax owed by 
major corporations that use''--it talks about a series of 
schemes here, but what does this mean?
    Ms. Olson. First of all, I think that that article is based 
on some misinformation, and the way it is written up suggests 
something that is not the case.
    Senator Dorgan. Okay.
    Ms. Olson. It leads one to believe that the IRS is 
conceding 80 percent. In fact, what the IRS had on the table 
for some time in that particular issue was an offer for a 
concession by the Government of 20 percent, and what was going 
on was that the Government was getting ready to withdraw that 
offer to settle on the basis of a 20 percent concession by the 
Government, 80 percent concession by the taxpayer.
    So the reporter just did not have complete information when 
he wrote that article. Since that article was written, the IRS 
has issued three settlement initiatives, and one of them is a 
withdrawal of the settlement initiative of the one that is 
discussed in there related to corporate-owned life insurance.
    Senator Dorgan. But later in the article, it says: ``Based 
on a partial review of the recent amnesty disclosures which 
involved other types of shelters, IRS officials estimated that 
in May, 600 or so taxpayers had taken at least $16 billion in 
improper deductions.'' That means they could have avoided 
roughly $5 billion in tax. They are talking there about the 
broader range of tax shelters, some very aggressive, perhaps 
some abusive. And the implication of the article--and I do not 
know whether it is accurate--but the implication of the article 
is that there is an interest, an aggressiveness on the part of 
the Service and also Treasury to settle these and move them out 
of the way. Is that not the case?
    Ms. Olson. We clearly need to move things through the 
system more quickly than we are moving them through. We are 
still dealing with--a lot of those issue go back for a decade 
and more. So we clearly need to find some ways to move them 
through the system more quickly than they are currently moving.
    The settlement initiatives that the IRS put out a couple of 
weeks ago do reflect the fact that there are differences among 
these transactions. Some of them have almost no merit, some of 
them actually have some credible arguments behind them, and 
reasonable people can differ about what the results might be, 
and the settlement offers that the IRS is entertaining reflect 
that. But there is a lot of work that needs to be done. The 
settlement initiatives that are out there only cover three of 
the 20 or so known shelter transactions that have been engaged 
in. Some of them have been engaged in by hundreds of taxpayers.
    When we are dealing with shelters in the corporate context, 
it is actually easier for us to deal with, because more 
corporations are examined on a routine basis by the IRS, so it 
is much more likely that the IRS is going to have an audit team 
there and already going to be aware of the transaction. But a 
lot of these transactions have been entered into by 
individuals, and that makes it a much more difficult thing for 
the IRS to handle.
    Senator Dorgan. In the last several years, there has been a 
fair amount of public discussion about tax shelters being more 
sophisticated and more abusive and concern that Treasury and 
the IRS need more resources, are not staffed or capable of 
really combatting the aggressiveness of these tax shelters.
    Is that still a concern? What are you seeing with respect 
to aggressive and abuse tax shelters?
    Ms. Olson. We are actually cautiously optimistic that we 
have turned the corner on the marketing of a lot of the 
transactions. We think that advisors are being more cautious; 
we think that taxpayers are being more cautious. Again, this is 
anecdotal information in large part, but taxpayers at least say 
that they are having far fewer promoters knocking on their 
doors, trying to sell them these kinds of transactions.
    So we think that a combination of the IRS getting more 
aggressive in enforcing in this area and beginning audits of 
the folks promoting tax shelter promotions is beginning to have 
an impact and that we will be able to turn the corner on this. 
There is still a lot of work to be done, because there are 
thousands of taxpayers who entered into these kinds of 
transactions during the nineties, and we have still got to 
clean all of that up.
    Senator Dorgan. But when you saw the video today, and you 
say that you think things are getting better, does it concern 
you--you are a tax policy person, an Assistant Secretary of the 
Treasury--does it concern you when you hear people at the top 
of some very good companies say, ``The improvement on earnings 
is powerful enough to say that maybe patriotism should take a 
back seat''? Does that anger you?
    Ms. Olson. It certainly concerns me, and I see it as my 
obligation to make recommendations that will end those kinds of 
    Senator Dorgan. Well, it angers me, and I think to myself 
what goes on every day in these kinds of discussions, 
conference calls, meetings, and the internet, by which some 
pretty high-profile advisors tell corporations, ``Here is a way 
to reduce your tax obligation, and it is your first 
responsibility; go find the line, if you will, or find the 
edge, and renounce your citizenship if necessary. Everything 
else takes a back seat.'' That worries me, and just in terms of 
what else they are recommending to clients. And I suspect that 
that is the root of these abusive shelters.
    When I read about some of the shelters that have been 
proposed over the last several years, it reminds me of the 
hearings that we have held about Enron. You open it up, and it 
just stinks. It smells; it is rotten inside. The board of 
directors of Enron did a study and said that what they found 
inside the corporation itself was ``appalling.''
    So I worry about these shelters, and I want you to have the 
resources necessary, and I want the Internal Revenue Service to 
have the resources necessary to make sure that the bigger 
economic interests are paying their fair share of taxes. That 
is the purpose of all of this, and I know that you share the 
same goal.
    Ms. Olson. Absolutely.
    Senator Dorgan. Ms. Olson, we will work with Treasury and 
with the Internal Revenue Service to make sure that we 
determine what kinds of resources are necessary for your 
combatting tax shelters, particularly abusive and aggressive 
tax shelters, and I hope you will continue your work, 
especially on the issue of inversions. I think that there are 
profound policy questions here, and even more than that, 
questions of business ethics that concern me a great deal. So I 
hope that Treasury and the Congress can work together to 
address some of these issues.
    I appreciate very much your being here, and we will include 
your entire statement as a part of the permanent record.
    Thank you very much.
    Ms. Olson. Thank you, Mr. Chairman.
    Senator Dorgan. Next, we have a panel that will be 
comprised of Richard Blumenthal, the Attorney General for the 
State of Connecticut; Reuven Avi-Yonah, professor of law and 
Director of the International Tax LLM Program at the University 
of Michigan Law School in Ann Arbor, MI; Martin Regalia, Vice 
President for Economic Policy and Chief Economist at the U.S. 
Chamber of Commerce; Robert McIntyre, Director, Citizens for 
Tax Justice; and William Gale, Senior Fellow and Deputy 
Director of Economic Studies at The Brookings Institution.
    Mr. Blumenthal, I understand that you are here today as the 
current Attorney General of Connecticut.
    Mr. Blumenthal. I am.
    Senator Dorgan. Welcome. Your entire statement will be made 
a part of the permanent record as well, and you may summarize.
    Please proceed.
    Mr. Blumenthal. Thank you very much, Senator, and like all 
the members of this panel, I am very grateful for this 
opportunity to talk to you about an issue that is very much on 
the minds of Connecticut's citizens and, I suspect, people 
around the country for exactly the reasons that you have 
articulated so powerfully at the outset of this hearing and 
that are supported by the kind of video that we saw before. I 
think many Americans, certainly I and many of my constituents, 
share the anger and outrage that any corporation should put 
patriotism in the back seat to profits.
    And I do not want to repeat here all of the public policy 
and moral implications of that stand--the loss of revenue to 
the United States, the absence of payment of fair share for 
services, and other benefits of protection to those 
corporations, and other public policy reasons. My reason for 
being here is really twofold--to emphasize the urgency and 
immediacy of this issue in light of Stanley Works' decision to 
do the right thing. For whatever reason, after very substantial 
criticism from myself and other public officials, and action by 
me in court, Stanley Works reversed its decision to 
reincorporate. Certainly, it did so under very heavy legal 
pressure as well as pressure from public opinion, but it now 
stands at a very distinct and perhaps disabling disadvantage in 
relation to two of its major competitors, Cooper and Ingersoll-
Rand, and it fails to have the benefit of a level playing field 
in relation to those competitors simply because they 
reincorporated before the spotlight of publicity shone on them, 
and now they have a very strong competitive advantage over 
Stanley Works simply because that corporation, a Connecticut 
corporation, did the right thing, and that has implications not 
only for the employees and shareholders of Stanley Works, but 
for all of corporate America.
    I urge that the Senate act as soon as possible to close 
this loophole, shut it down, adopt Senate bill 2119 or its 
equivalent, House bill 3884, that essentially adopt a common 
sense, reasonable, sensible test for closing this loophole. And 
obviously, the urgency and immediacy of this move relate to the 
rewards that now go to corporations that have already moved to 
Bermuda, and they are being in effect favored because they did 
the wrong thing.
    I want to urge also, Senator, an aspect of this 
reincorporation that is not much emphasized in these 
discussions, and that is its impact on shareholder rights. 
There are very severe and lasting ways that shareholders are 
deprived of substantial protection when a corporation moves 
offshore in this way. Their rights to bring derivative actions, 
to enforce judgments, to protect against insider trading or 
self-dealing, to simply know what the law of Bermuda is, 
because there is no official reporting system for Bermuda law, 
all are very, very substantially undermined, if not 
eviscerated, by these kinds of moves.
    As a law enforcement official, one responsible for fighting 
for the rights of my constituents and enforcing laws that 
protect them against misleading and deceptive statements, these 
moves to Bermuda are profoundly troubling. They disadvantage 
State law enforcement in protecting shareholder rights, as well 
as the investors themselves in protecting their rights.
    So there are corporate accountability issues here at a time 
when, as you very correctly observed, Enron has brought to the 
fore the enhanced need to protect shareholders against 
malfeasance, self-dealing, and other kinds of abuses that the 
Enron debacle so powerfully disclosed.

                           PREPARED STATEMENT

    For all of those reasons, I urge that this committee and 
the United States Congress move as quickly--and I emphasize 
``quickly''--as possible to close this loophole. I do not 
minimize the complexity and the far-reaching effects of changes 
in the Tax Code, but I would be very reluctant to see prolonged 
and unnecessary study that does continuing damage to the 
fairness and efficacy of our Tax Code.
    Thank you very much, Senator.
    Senator Dorgan. Thank you very much, Attorney General 
    [The statement follows:]

                Prepared Statement of Richard Blumenthal

    I appreciate the opportunity to speak on the issue of corporate 
inversions, a hyper-technical term for corporations exploiting tax law 
loopholes and corporate directors and management profiting and 
protecting themselves from proper accountability.
    Closing this egregious loophole is now more urgent and important 
than ever: corporations that do the right thing and resist the 
loophole's lure--Stanley Works is Exhibit A--should not be doubly 
penalized. A level playing field is a moral imperative as well as a 
public policy obligation.
    Hence, I urge your support for legislation such as S. 2119, 
Reversing the Expatriation of Profits Offshore Act, and HR 3884, the 
Corporate Patriot Enforcement Act, that would permanently close a 
loophole in our laws that permits corporations to abandon America and 
abrogate their moral responsibility to this country.
    I commend the Senate's recent action to prohibit the Pentagon from 
awarding contracts to corporate inversion companies. This first step is 
excellent, but only a first step. Congress must approve legislation 
that will permanently level the playing field between corporations that 
remain American corporations and those that choose to undergo a 
corporate inversion.
    Earlier this year, Stanley Works, a Connecticut based corporation, 
announced it was going to reincorporate in Bermuda. I will describe in 
greater detail later in my testimony this reincorporation attempt by 
Stanley Works, but the ultimate result was that the company reversed 
its decision. This reversal was the right decision. Now, Stanley Works 
must compete in the marketplace with two competitors who have taken 
advantage of the tax loopholes in corporate inversions: Cooper 
Industries and Ingersoll-Rand Company. To fail to adopt legislation 
such as S. 2119 or HR 3884, rewards companies that avoid their fair 
share of taxes and undermine their shareholders' incorporation rights. 
Congress must act now.
    Whatever my past sharp disagreements or criticism--directed at 
Stanley Works management--its employees and shareholders are severely 
at risk because competitors beat the path to Bermuda before the public 
spotlight revealed the inequity and unfairness of reincorporation.
    Henry Paulson, chairman of Goldman, Sachs, has expressed alarm that 
American business has never been held in lower repute. Now, even more 
clearly, we know that one major reason for such low repute is this type 
of tax avoidance loophole.
    Long-time American corporations with operations in other countries 
can dodge tens of millions of dollars in Federal taxes by the device of 
reincorporating in another country. How do they become a ``foreign 
company'' and avoid taxes on foreign operations? They simply file 
incorporation papers in a country with friendly tax laws, open a post-
office box and hold an annual meeting there. They need have no 
employees in that country or investments in that country--in short, no 
financial stake there at all. It is a sham, a virtual' foreign 
corporation--and our tax laws not only allow this ridiculous charade, 
they encourage it. This loophole is a special exception run amok. It is 
a tax loophole that must be slammed shut.
    Bermuda may seem close geographically and familiar in language and 
customs, but it might as well be the moon in terms of legal rights and 
protections for shareholders. In pitching reincorporation, management 
has repeatedly misled shareholders--failing to reveal the real long 
term costs, and concealing even the short term financial effects.
    Connecticut has learned this lesson the hard way from Stanley 
Works--the most recent and potentially most notorious corporation to 
attempt to avoid taxes through this corporate shell game. Stanley Works 
is a proud American company that is based in the industrial town of New 
Britain, Connecticut. For more than 150 years, it has manufactured some 
of the best-known American-made tools.
    Over the past 20 years, sadly, it has moved much of its 
manufacturing overseas where cheaper labor means more profits. In fact, 
it has moved so much of its operations that it was in danger of losing 
its ability to claim that its products were made in America, a major 
selling point. Several years ago, it supported an attempt to weaken the 
standards for claiming products are ``made in the U.S.A.''. This 
proposed rule would have allowed corporations to use the ``made in the 
U.S.A.'' label on products that were mostly made in other countries, 
with only the finishing touches applied here. It was nothing less than 
an attempt to create the veneer' of American craftsmanship. Along with 
others, I strongly opposed this weakened standard and it was eventually 
    This same company then sought to sell its American citizenship for 
$20-30 million pieces of silver. Reincorporating in Bermuda would 
render hundreds of millions of dollars in profits from foreign 
divisions tax-exempt in the United States. Stanley Works, of course, is 
not the only company to use this tax law loophole. Cooper Industries, 
Seagate Technologies, Ingersoll-Rand and PricewaterhouseCoopers 
Consulting, to name but a few, have also become pseudo-foreign 
corporations for the sole purpose of saving tax dollars.
    While profits may increase as a result of this foreign 
reincorporation gimmick, there are some significant disadvantages to 
shareholders that may not be readily apparent to them. Shareholders 
must exchange their stock in the corporation for new foreign 
corporation shares-generating capital gains tax liability. So while the 
corporation saves taxes, employees and retirees who hold shares are now 
unexpectedly facing significant capital gains tax bills. Some must sell 
many of the new shares in order to pay the capital gains tax--reducing 
the dividend income they were counting on for their retirements.
    At the same time, corporate executives and other holders of 
thousands of shares of the corporation will receive huge windfalls from 
stock options as the stock price rises because of increased profits. 
Stanley Works estimated that its stock would rise by 11.5 percent after 
re-incorporation in Bermuda. That increase would have produced a $17.5 
million gain in CEO John Trani's stock option value while shareholders 
would have faced $150 million in capital gains taxes. Smaller 
shareholders, of course, would not have huge stock option gains that 
they could have used to pay the capital gains tax.
    Incorporating in another country may also restrict shareholder 
rights and protections because foreign laws are far weaker than ours. 
This issue is not apparent to many shareholders because they may look 
at re-incorporation as a merely technical move with only corporate tax 
implications. The company's headquarters remains in the United States 
so shareholders may think that American laws will still apply. 
Management has hardly rushed to clarify the weakening, even 
evisceration of shareholder rights.
    Taking advantage of corporate tax loopholes, corporations like 
Stanley Works typically reincorporate in Bermuda. Bermuda law differs 
from the corporate law of most states in several very important 
    First, there is the simple problem of the opacity of Bermuda law. 
Even sophisticated shareholders may have extreme difficulty in 
obtaining information about Bermuda law and evaluating the impairment 
of their rights under Bermuda law. Bermuda does not even maintain an 
official reporter of its court decisions. We have learned from the 
Enron scandal the danger for shareholders, employees and regulators of 
shielding important corporate information from public scrutiny. The 
movement of corporations to a place where the legal rights of 
shareholders are severely constrained and confused--indeed at best 
unclear--is a matter of grave concern.
    Second, although corporations proposing to reincorporate to 
Bermuda, such as Stanley, often tell shareholders that there is no 
material difference in the law. There are several important aspects of 
Bermuda law that greatly diminish shareholder rights--and divining 
Bermuda law is no easy task.
    For example, Bermuda law lacks any meaningful limitations on 
insider transactions. Like most states, Connecticut imposes significant 
restrictions on corporate dealings with interested directors of the 
corporation--the kind of restrictions that appear to have been violated 
in the Enron debacle. Those protections appear to be absent under 
Bermuda law.
    Bermuda law also fails to provide shareholders with decision-making 
authority on fundamental changes in the corporation. Connecticut law, 
like statutes of most states, requires that shareholder approval be 
obtained before the corporation may sell or dispose of a substantial 
portion of the assets of the corporation. Bermuda law contains no such 
    Similarly, Bermuda law permits shareholder derivative lawsuits in 
only very limited circumstances. Derivative lawsuits are an essential 
protection for shareholders. In the United States, shareholders may 
bring actions on behalf of the corporation against officers and 
directors seeking to harm the corporation. The availability of 
derivative lawsuits is a profoundly important tool to protect 
shareholders from malfeasance and self-dealing by officers and 
directors. It is a central tenet of American corporate governance. This 
form of protection is apparently all but unavailable under Bermuda law.
    In addition, there are serious questions about the enforceability 
of U.S. judgments in Bermuda. There is presently no treaty with Bermuda 
that ensures the reciprocity of judgments. Thus, a person who has 
successfully prosecuted a Federal securities claim or products 
liability lawsuit in the United States against the corporation, for 
example, may be unable to enforce that judgment against the corporation 
in Bermuda. Bermuda courts have the right to decline to enforce an 
American judgment if they believe it is inconsistent with Bermuda law 
or policy. Bermuda may be not just a tax haven, but also a judgment 
    Finally, a Bermuda incorporation will greatly impede my office or 
any state Attorney General in protecting the public interest and 
safeguarding shareholder rights, including the state's financial 
interests--stopping a shareholder vote, for example, if shareholders 
are provided with misleading information.
    Earlier this year in Connecticut, Stanley Works issued conflicting 
statements to 401k shareholders. The first statement said that failure 
to vote would be counted as a ``no'' vote. The second one said that 
failure to vote would allow the 401k administrator to cast a ballot 
consistent with the 401k plan. My office, representing the state of 
Connecticut as a shareholder, filed an action in state court that 
halted the vote because of the tremendous confusion caused. Whether I 
could have taken a similar action had Stanley Works been incorporated 
in Bermuda is at best unclear.
    The misstatements made by Stanley Works management were so 
misleading and potentially deceptive that I requested a full 
investigation by the Securities and Exchange Commission (SEC) and an 
order delaying any revote until such an investigation was completed. I 
further requested that the SEC review the May 28, 2002 Stanley Works 
proxy statement to determine whether Stanley Works has accurately 
explained the impact of the Bermuda move on shareholder rights. The SEC 
expressed interest in reviewing the proxy statement.
    As a result of my complaint and SEC interest in this matter, 
Stanley Works issued a revised proxy statement on June 21, 2002. The 
revised statement contained--for the first time--a clear concession by 
Stanley Works that a Bermuda reincorporation would restrict 
shareholders' rights. The revised proxy statement states: ``Your Rights 
as a Shareholder May be Adversely Changed as a Result of the 
Reorganization Because of Differences between Bermuda Law and 
Connecticut Law and Differences in Stanley Bermuda's and Stanley 
Connecticut's Organizational Documents.''
    While the SEC was reviewing this matter, the Stanley Works Board of 
Directors, under great public and shareholder pressure, reversed its 
decision to reincorporate. Stanley Works is now at a disadvantage to 
other American companies--direct competitors--that chose to 
reincorporate in Bermuda and reduce their shareholders' rights.
    Shareholders should aggressively challenge the adequacy of similar 
proxy statements by other corporations proposing a reincorporation in 
Bermuda--compelling clearer and more truthful descriptions in proxy 
statements concerning the severe weakening of shareholder ability to 
hold management accountable under Bermuda law.
    Some corporation proxy statements may seek to assure shareholders 
that the new corporation bylaws will restore some of these lost 
shareholder rights. This substitute is simply inadequate. If corporate 
bylaws were sufficient to protect shareholder rights, we would not need 
Federal and State securities laws.
    In sum, reincorporation in another country like Bermuda undermines 
the interests and rights of American shareholders. Corporate CEOs, 
whose compensation is typically tied to short-term gains in stock price 
or cash flow, often reap millions in additional pay stemming directly 
from the tax savings obtained by these moves and are better able to 
engage in insider transactions. They are less exposed to shareholder 
derivative lawsuits and Federal securities action. They are shielded 
from shareholders seeking to hold them accountable for misjudgments or 
malfeasance. The incentive for corporate officers to make the move to 
Bermuda is obvious. But the interests of ordinary shareholders and the 
United States are gravely disserved.
    If American corporations seek a more level playing field--fairer 
tax burdens so they can better compete globally--they at least ought to 
stay on our side of the field. They ought to pay their fair share of 
the financial cost of American services and benefits that also aid 
them. And they should be required to show a specific need or 
disadvantage compared to some foreign competitor that threatens 
American jobs or economic interests.
    I urge the Committee to first approve legislation that will 
permanently close this loophole and then determine whether our tax laws 
need to be changed to address inequity concerns that have been raised. 
The Treasury Department's preliminary report listed several areas for 
review, including rules limiting deduction for interest paid on foreign 
related debt, rules on valuations on transfers of assets to foreign 
related parties and cross-border reorganizations. I do not endorse any 
specific proposal for tax law change, or even necessarily general 
change itself. What I endorse strongly and unequivocably is the need 
for closing this destructive loophole, as S. 2119 and HR 3884 would do. 
These measures should be permanent so as to assure credibility and 
certainty. The status quo is unacceptable.

    Senator Dorgan. Next, we will go to Professor Avi-Yonah, 
who is from the University of Michigan and is an expert in tax 
policy. We appreciate your being here.
    Please proceed.
            ARBOR, MI
    Mr. Avi-Yonah. Thank you very much, Mr. Chairman. Thank you 
for inviting me to testify at this hearing on corporate 
    I want to use my remarks to address a couple of the issues 
raised by Secretary Olson's testimony today. One is the 
supposed competitive disadvantage of American corporations and 
whether that is relevant to the inversion risk.
    The first thing I should say, as was pointed out in your 
questions, is that there really is no evidence that there is 
such a competitive disadvantage. The so-called territorial 
systems that we are competing against are not really 
territorial in the sense that they, just like us, tax passive 
income that multinationals earn overseas; they allow deferral 
for taxation of active income, and we do exactly the same 
thing. So there is no evidence that this is in fact a 
disadvantage or that takeovers are somehow motivated by it. We 
had large takeovers of American corporations by British 
corporations who were subject to a worldwide system, had other 
takeovers by German corporations who were subject to the so-
called territorial system, and there is no evidence that, 
either way, this was motivated by primarily tax considerations.
    Now, what is clear is that there is a competitive 
disadvantage, as Mr. Blumenthal noted, between inverted 
companies and American companies that stay in the United States 
and are in the same business. The reason for that is that 
inverted companies can avoid taxation on all of their overseas 
income as well as earning-strip out of the United States. So if 
you have a purely domestic American company that has purely 
domestic American income, they pay tax on that. If you have an 
inverted company, they do not pay tax on that American income 
because they can earn it straight by interest or royalties or 
transfer pricing. In addition, they have the huge advantage of 
being able to earn passive income overseas as much as they want 
without being subject to any of the American tax rules that are 
against it.
    Basically, I think that there are some companies that are 
too large to invert because of reputation concerns, because of 
corporate governance concerns, maybe because there is too much 
of a tax on the shelter base. I do not think that General 
Motors, for example, will invert any time soon. There are 
companies that are too small to invert because the transaction 
costs of inverting are significant; you have to pay Ernst and 
Young and all of these people to do it for you. And then, there 
are the middle companies, and among these middle companies, 
some companies as a matter of patriotism or for other reasons 
will not invert, and some will, and it is there that we need to 
level the corporate playing field.
    Secretary Olson also mentioned the possibility that in 
addition to inversions, there would be companies that would set 
up shop initially in Bermuda and places like that. In my mind, 
that is exactly the same as an inversion. I mean, there is no 
significant distinction here. We are talking about companies 
that have their management here, their operations here, their 
shareholders here, and so on. They set up shop, nominally. They 
have a paper company in Bermuda. There is no difference whether 
that is a new company or whether it used to be an American 
company and inverts, except for the fact that, of course, if it 
is a new company, there is no capital gains tax on the 
shareholders that would deter the inversion, and I think we 
should address those in exactly the same way as we do the 
    How are we going to address them? Well, it seems to me that 
the two bills that have been mentioned are a good start. They 
close the loophole immediately in the sense that they really 
fine inverting companies and new start-ups as long as the 
shareholder base is sufficiently American.
    My own view is that the focus on the shareholder base may 
be a little bit misguided in the sense that management cares 
more about what happens inside the company than whether the 
shareholders are American or foreigners. So I would focus more 
on whether the company is managed in the United States and 
whether its operations are in the United States, rather than 
the shareholder base. But that is kind of a technical point. I 
think that for the time being, you should certainly go ahead 
and enact those two bills that are the strongest bills that we 
have against inversions, where everybody agrees that basically, 
inversions are essentially a way of both stripping earnings out 
of the United States, avoiding tax on American source income 
that other companies have to pay tax on, and in addition, they 
are a way of avoiding the series of rules that we have 
developed over time to make sure that American multinationals 
do not avoid taxation on passive income that can be put 
anywhere in the world and earn income tax-free without being 
subject to any foreign tax.

                           PREPARED STATEMENT

    Thank you very much. I appreciate being invited to come 
    Senator Dorgan. Thank you very much, Professor.
    [The statement follows:]

             Prepared Statement of Reuven S. Avi-Yonah \1\

    Thank you very much for inviting me to participate in this hearing. 
In this testimony, I would like to discuss ``inversion'' transactions, 
in which a publicly traded U.S. corporation becomes a subsidiary of a 
newly established tax haven parent corporation. In the last 3 years, an 
increasing number of these transactions have been taking place, 
undeterred by the shareholder-level tax imposed by the IRS on them in 
1994. My testimony first discusses the reasons for the increasing 
popularity of the transactions and the tax goals they aim at achieving 
(primarily avoiding Subpart F and U.S. earnings stripping). My 
testimony then discusses the tax policy implications of these 
transactions. In the short run, I suggest that the proper response is a 
redefinition of the concept of corporate residency by adoption of a 
modified ``managed and controlled'' test for all corporations. In the 
longer run, inversions may lead to abandonment of residence based 
corporate taxation in favor of source-based taxation. If that is the 
case, it is imperative to preserve the corporate tax base by developing 
better methods of determining the source of income (e.g., formulary 
apportionment), and by putting some limits on tax competition.
    \1\ Irwin I. Cohn Professor of Law and Director, International Tax 
LLM Program, the University of Michigan.
              introduction: a brief history of inversions
    ``Inversion'' transactions are defined in the recent Treasury 
Report as ``a transaction through which the corporate structure of a 
U.S.-based multinational group is altered so that a new foreign 
corporation, typically located in a low-or no-tax country, replaces the 
existing U.S. parent corporation as the parent of the corporate 
group.'' \2\
    \2\ U.S. Treasury, Office of Tax Policy, Corporate Inversion 
Transactions: Tax Policy Implications, 2002 TNT 98-49 (May 21, 2002) 
(the ``Treasury Report''). For an excellent overview of inversions see 
also New York State Association Tax Section, Report on Outbound 
Inversion Transactions (May 24, 2002) (the ``NYSBA Report'').
    The first known inversion from the U.S. was McDermott 
International's relocation to Panama in 1983, which prompted the 
enactment of Code section 1248(i).\3\ The next inversion, over 10 years 
later, was Helen of Troy (1994), which prompted the IRS to issue Notice 
94-46, making inversions taxable to public shareholders.\4\ 
Nevertheless, inversions continued, with one transaction in each of 
1996, 1997 and 1998.\5\ But as the Treasury Report notes, ``there has 
been a marked increase recently in the frequency, size, and profile of 
the transactions.'' \6\ There were no less than six inversions in 
1999,\7\ followed by two more in 2000 \8\ and four in 2001.\9\ There 
was a temporary lull after September 11, but there are currently at 
least three new inversions that have been announced in 2002.\10\ In the 
post-September 11 climate, these transactions have raised public 
concerns, and there are currently seven bills pending in Congress to 
stop inversions.
    \3\ All ``Code'' references are to the Internal Revenue Code of 
1986, as amended.
    \4\ 1994-1 CB 356 (April 18, 1994), now reflected in the 
regulations under Code section 367.
    \5\ Triton Energy, Tyco, Playstar. For a description of all these 
transactions see the NYSBA Report.
    \6\ Treasury Report, 2.
    \7\ Fruit of the Loom, Gold Reserve, White Mountain Insurance, 
PXRE, Amerist Insurance, Xoma.
    \8\ Everest Re, Transocean.
    \9\ Cooper Industries, Foster Wheeler, Ingersoll Rand, Global 
Marine. In addition, Accenture, formerly Andersen Consulting, was 
established as a new Bermuda holding company for partnership assets.
    \10\ Stanley Works, Nabors, Weatherford International. In addition, 
Seagate Technology has been formed as a new Cayman parent for U.S. 
operations, and PwC Consulting has been formed in Bermuda to take over 
Pricewaterhouse Coopers consulting operations. Stanley and PWCC have 
since been abandoned under pressure.
                          why inversions now?
    The significant increase in the frequency of inversion transactions 
in the last 3 years raises the question of what accounts for this 
    As the Treasury Report notes, inversion transactions are primarily 
tax driven: ``U.S.-based companies and their shareholders are making 
the decision to reincorporate outside the U.S. largely because of the 
tax savings available.'' \11\ Moreover, these transactions ``involve 
little or no operational change'' in the company's business.\12\
    \11\ Treasury Report, 4.
    \12\ Treasury Report, 3.
    The tax advantages from inversion transactions are two-fold. First, 
since the new parent of the group is not a ``U.S. shareholder'', the 
group can establish new foreign operations without being subject to 
Subpart F. In some cases, the potential tax saving is significant 
enough so that even foreign operations currently held by the U.S. 
parent are transferred to the new foreign parent, even though these 
transfers are generally taxable at the corporate level.\13\
    \13\ Treasury Report, 19-21.
    Second, and no less significantly, the existence of a new foreign 
parent may enable the U.S. group to reduce taxes on U.S. source income 
by paying the parent deductible interest and/or royalties through a 
treaty jurisdiction such as Barbados or Luxembourg, and by manipulating 
transfer pricing.\14\ In addition, U.S. risks formerly insured in the 
U.S. may be reinsured overseas, with deductible premiums and no U.S.-
source income to the reinsurer.\15\ Existing provisions such as Code 
sections 163(j) and 482 appear to be inadequate to prevent this erosion 
of U.S. corporate tax on U.S. source income.
    \14\ Treasury Report, 38-39; see also NYSBA Report. Limitations on 
benefits rules, such as those in the Barbados and Luxembourg treaties, 
do not typically apply to publicly traded entities. This exception 
should be restricted to public trading in the residence country (i.e., 
Barbados or Luxembourg), but the current treaties do not restrict it.
    \15\ Treasury Report, 40.
    The combination of these post-inversion tax advantages can lead to 
significant reductions in effective overall tax rates for the group. 
For example, Cooper Industries and Stanley Works have stated that they 
expect their inversions to reduce their annual effective tax rate by 
12-17 percent (Cooper) and 7-9 percent (Stanley).\16\ Such reductions 
can translate into significant dollar amounts--Tyco International, for 
example, has been reported to save $400 million in 2001 by reason of 
its inversion,\17\ and Ingersoll Rand has stated that it expects to 
increase net earnings after its inversion by $40 million per year.\18\ 
Thus, the U.S. fisc's loss of revenues from inversions is likely to be 
significant, which explains why even the current Treasury (whose head 
does not believe in the corporate tax) is concerned.
    \16\ Cooper Industries Proxy Statement (July 27, 2001); Stanley 
Works Proxy Statement (April 2, 2002).
    \17\ David Cay Johnston, U.S. Corporations are Using Bermuda to 
Slash Tax Bills, NY Times, February 18, 2002.
    \18\ Ingersoll-Rand Proxy Statement (April 5, 2002).
    If inversions are so tax effective, why have they not taken off 
until 1999? The principal reason appears to be not tax-related, but 
rather involves the increased market acceptance of the transaction. 
Until Tyco inverted successfully in 1997, investment bankers generally 
assumed that a U.S. company would pay an unacceptable price in its 
share value if it reincorporated in Bermuda. This was the case even 
though U.S. securities law protections continue to apply to any stock 
traded on a U.S. exchange, and the companies are not delisted from, 
e.g., the S&P 500. The presumed drop in share value related to 
corporate governance concerns and to reputational issues. But after 
Tyco, it became clear that share prices do not drop as a result of 
reincorporation- on the contrary, recently inverting companies have 
seen their share prices rise in reaction to the expected tax savings. 
Thus, despite the recent troubles of Tyco and Global Crossing, there 
seems to be no market downside to inversions.
    In addition, as the Treasury Report notes, after the market 
declines in 2000-2001, when most taxable shareholders do not have big 
unrealized gains in their shares and many corporations have net 
operating losses, neither a shareholder-level tax nor even a corporate-
level tax is likely to deter inversion transactions.\19\ The present 
value of the expected recurrent tax savings overwhelms a one-time toll 
    \19\ Treasury Report, 51-52. In addition, many shareholders are tax 
exempt. The prevalence of inversions involving a corporate level tax 
shows that taxing inversions at the corporate level is not a sufficient 
                       the competitiveness excuse
    The Treasury Report highlights another purported reason for 
inversions-the supposed competitiveness concerns of U.S. 
multinationals. According to the Treasury, ``[t]he U.S. international 
tax rules can operate to impose a burden on U.S. based companies with 
foreign operations that is disproportionate to the tax burden imposed 
by our trading partners on the foreign operations of their companies. . 
. Both the recent inversion activity and the increase in foreign 
acquisitions of U.S. multinationals are evidence that the competitive 
disadvantage caused by our international tax rules is a serious issue 
with significant consequences for U.S. businesses and the U.S. 
economy.'' \20\ Thus, the Treasury recruits inversions as an argument 
in its quest for a territorial tax regime for the U.S., labeling them 
``self help territoriality,'' \21\ and calling for a consideration of 
``fundamental reform of the U.S. international tax rules, including the 
merits of the exemption-based tax systems of some of our major trading 
partners.'' \22\
    \20\ Treasury Report, 7, 96.
    \21\ Treasury Report, 97.
    \22\ Treasury Report, 98.
    There are well-known counterarguments to this line of thinking, 
including: Is there a direct relationship between the competitiveness 
of U.S. multinationals and the competitiveness of the U.S. economy? 
What is a ``U.S. multinational'', anyway (inversions seem to raise some 
questions on this point)? Is there any evidence for the supposed 
competitive disadvantage, or for the alleged harshness of our rules 
compared to those of our trading partners? \23\ If a subsidy to U.S. 
multinationals is needed, why limit it to foreign source income, since 
a subsidy directed at their domestic operations would be just as 
effective? And finally, what about the competitive disadvantage to U.S. 
companies with purely U.S. operations, if a subsidy is given only to 
U.S. multinationals by exempting their foreign source income? \24\
    \23\ In fact, the Europeans have recently been complaining about 
the harshness of their CFC rules-see discussion below.
    \24\ For these arguments see, e.g., Reuven S. Avi-Yonah, Tax 
Competition and Multinational Competitiveness: The New Balance of 
Subpart F, 18 Tax Notes Int'l 1575 (April 19, 1999).
    But it is not my intention here to rehash these old arguments. 
Instead, I would like to emphasize that in the inversion context the 
competitiveness issue is the reddest of red herrings--a completely 
irrelevant line of argument. To demonstrate this, try the following 
thought experiment: Suppose nothing was done to deter inversions, but 
the U.S. adopted an exemption for foreign source active income (e.g., 
by exempting dividends from such income from U.S. tax, as some have 
suggested).\25\ Would inversions stop?
    \25\ See, e.g., Harry Grubert and John Mutti, Taxing International 
Business Income: Dividend Exemption versus the Current System. 
Washington, DC: American Enterprise Institute, 2001.
    The answer is no, for three reasons. First, as the Treasury Report 
notes, a major reason for inversions is to reduce U.S. tax on U.S. 
source income, which would not be affected by the adoption of 
territoriality. Second, inversions enable U.S. multinationals to avoid 
all of Subpart F, including the taxation of passive income. None of the 
current proposals for territoriality go that far, since this would be 
an open invitation to U.S. multinationals to move their investment 
earnings overseas.\26\
    \26\ Even Rep. Thomas's bill continues to apply Subpart F to 
passive income.
    But the major reason why inversions are unrelated to 
competitiveness is the following: As even the Treasury Report 
acknowledges in a footnote,\27\ all of our major trading partners have 
regimes in place that tax passive income of their multinationals. Some 
of these regimes, in fact, are tougher than Subpart F--the French, for 
example, only require 10 percent ownership of a foreign corporation to 
apply CFC rules to it, and many countries include some low-tax active 
foreign income in their regime.\28\ Permitting inversions gives 
inverting U.S. multinationals a significant competitive advantage over 
foreign multinationals and non-inverting U.S. multinationals that have 
to pay tax currently on their foreign source passive income, at the 
expense of the U.S. fisc.
    \27\ Treasury Report, fn. 50.
    \28\ See Brian J. Arnold and Patrick Dibout, General Report, in 
Limits on the Use of Low Tax Regimes by Multinational Businesses: 
Current Measures and Emerging Trends, Cahiers de droit fiscal 
international LXXXVIb (San Francisco, 2001); see also Federation des 
Experts Comptables Europeens, FEE Position Paper of Controlled Foreign 
Company Legislations in the EU (2002) (complaining of harshness of 
European CFC rules). Even the base company rule has its analogues in 
the tax law of many of our trading partners. See Arnold and Dibout, 
    Thus, the whole competitiveness issue is misleading. It is not the 
reason for inversions, and inversions would continue even if the U.S. 
adopted territoriality. The competitiveness debate will doubtless go on 
(as it has for the last 40 years), but it should not affect what we do 
about inversions. No country should allow its tax base to be eroded by 
transactions that have no business content other than saving taxes.
         a short-term solution: redefining corporate residence
    What makes a corporation American? This question is at the heart of 
the inversion issue. It stems from a long-lasting debate about whether 
multinationals have a national identity.
    In the 1950s the distinction between a U.S. and a foreign 
multinational was clear. A U.S. multinational raised most of its 
capital (both debt and equity) in the U.S., was managed from the U.S., 
and had most of its operations and biggest market in the U.S. Although 
there were some operations and sales overseas, the bulk of the income 
came from the U.S.-and vice versa for a foreign multinational. In that 
context it was indeed plausible to state that ``what is good for GM is 
good for America.''
    Today, the distinction is far more cloudy. As Robert Reich has 
pointed out, no distinction can be made between U.S. and foreign 
multinationals on the basis of where their capital is raised (both 
trade shares and borrow at home and overseas), where their operations 
are (all over the world), and where their customers are (the most 
profitable markets for U.S. multinationals are frequently 
    \29\ Robert Reich, Who is Us? 68 Harv. Bus. Rev. 53 (1990); Robert 
Reich, The Work of Nations (1993). A similar point is made from a 
different political perspective in Edward M. Graham and Paul R. 
Krugman, Foreign Direct Investment in the United States (3rd ed. 1995), 
ch. 3.
    Reich would thus argue that there is no meaningful distinction any 
more between U.S. and foreign multinationals. In the tax area, this 
would suggest abandoning residence-based taxation in favor of a purely 
source-based (i.e., territorial) regime.\30\
    \30\ See Gary Hufbauer, Blueprint for International Tax Reform 
(1991); Reuven S. Avi-Yonah, the Structure of International Taxation: A 
Proposal for Simplification, 74 Texas L Rev 1301 (1996).
    However, most Americans still believe that there is a meaningful 
distinction between, say, GM and Toyota, even though there is little 
significant difference in their capital structure, operations or 
markets. The difference, as Laura d'Andrea Tyson pointed out in 
response to Reich, is that GM is run from Detroit, Toyota from 
Tokyo.\31\ There even is a difference between GM and DaimlerChrysler, 
because the latter (as Chrysler management belatedly found out) is run 
from Stuttgart.
    \31\ Laura d'Andrea Tyson, They Are Not Us, The American Prospect 
(Winter 1991).
    This would suggest that the immediate answer to inversions is to 
change the way corporate residence is defined for tax purposes. Instead 
of defining a U.S. corporation as one incorporated in the U.S. and a 
foreign corporation as one incorporated overseas, we should adopt the 
definition used by many of our trading partners-where the corporation 
is ``managed and controlled'' from.\32\
    \32\ A corporation incorporated in the U.S. should be presumed to 
be managed and controlled from the U.S.
    The ``managed and controlled'' test has a long history, some of 
which is not very distinguished. In particular, many former U.K. 
colonies have interpreted it in a mechanical way to focus on where the 
Board meets, which makes the test not less manipulable than the U.S. 
test. Boards do not mind meeting twice a year in Bermuda. Even the 
U.K., from which ``managed and controlled'' originated, has recently 
supplemented it with a place of incorporation test.
    And yet, if properly defined and interpreted, the managed and 
controlled test offers the most promising current definition of 
corporate residency--the one most congruent with business realities and 
therefore least open to abuse.\33\ That is because even in this age of 
teleconferencing, there is a distinct business advantage in locating 
the principal officers of a corporation in one location where they can 
meet and run the corporation on a daily basis. Thus, if one defines 
``managed and controlled'' as the place where the principal officers of 
a corporation (the CEO and those reporting to her) manage the 
corporation's business on a daily basis, one gets close to what 
actually distinguishes GM from Toyota.
    \33\ Note that there have been few inversions from Europe--not 
because of territoriality (Europeans tax passive income too), but 
because the managed and controlled test makes it harder to invert.
    The major advantage of this test is that it is difficult to avoid 
without significant business cost. The principal officers will not 
relocate to Bermuda for tax reasons, because the personal and business 
costs of actually living in a tax haven are too high. And it is still 
very hard to run a corporation at long distance.\34\
    \34\ In addition, changes in the location of management and control 
should be a taxable event at the corporate level. That would deter tax-
motivated expatriations under the new test.
    Several objections can be raised against this proposal.\35\ First, 
the test represents a significant departure from a long-held U.S. 
tradition.\36\ But it is congruent with the test used by many of our 
trading partners and in tax treaties, and therefore will readily win 
international acceptance--an important consideration when changing 
international tax rules unilaterally. Second, the proposed change will 
affect more than inversion transactions--for example, it would catch 
corporations newly incorporated overseas, such as Accenture, PwCC and 
Seagate. But that is actually an advantage, since it is hard to 
distinguish as a policy matter between these transactions and ``pure'' 
inversions. Accenture, PwCC and Seagate, like Tyco and Stanley Works, 
continue to be managed from the U.S. Third, the test will not catch 
foreign takeovers of U.S. multinationals (like Daimler/Chrysler or BP/
Amoco). But these transactions are motivated by business reasons and 
should not be deterred.\37\
    \35\ See the NYSBA Report, which considers and rejects it for the 
reasons discussed below.
    \36\ For example, it may make many CFCs incorporated in tax havens 
into domestic corporations. That is an advantage, since it indicates 
they do not have a real business presence overseas and thus should not 
enjoy deferral.
    \37\ It was not tax considerations that led to Daimler/Chrysler 
being a German corporation--it was the German government's 
determination to protect Daimler and co-determination.
    Finally, the proposed test is less clear-cut than the current, more 
formal one, and therefore involves some added measure of uncertainty. 
But it is clear enough, and far more congruent with business realities 
(and thus less manipulable) than place of incorporation. U.S. taxpayers 
have been living with less well-defined terms, such as ``effectively 
connected'' and ``U.S. trade or business''. They can learn to live with 
``managed and controlled'' as well.
          a long-term solution: a modified source-based regime
    In the longer term, however, Reich may be right and residence-based 
corporate taxation may be doomed. With advances in technology, it may 
one day be possible to efficiently run a multinational enterprise from 
multiple locations via an intranet, without the need to meet face to 
face. In that case, the headquarters-based definition of corporate 
residency offered above would become obsolete. This is not likely to 
happen, however, in the next couple of decades, even if a ``managed and 
controlled'' test is adopted (and there is therefore a tax incentive to 
disperse top management).
    If residence-based corporate taxation becomes impossible (much to 
the chagrin of economists, who tend to prefer it), the only way to 
continue to tax multinationals is on the basis of source.\38\ In 
principle, this would not be a terrible outcome, because the current 
international tax regime assigns the primary right to tax active 
business income to the source jurisdiction, for good reasons.\39\
    \38\ Note, however, that the U.S. Treasury's E-commerce White Paper 
(1996) predicted the demise of source-based taxation because of e-
commerce, and recommended re-evaluation of corporate residency.
    \39\ For these reasons see Avi-Yonah, Structure, supra.
    However, a pure source-based regime is problematic, for two 
reasons. First, it fosters tax competition among source jurisdictions, 
not just for passive but also for active income, leading to distortions 
in the location of business activity and erosion of the corporate tax 
base. Second, the current source rules (and their cousin transfer 
pricing) are notoriously manipulable and, if left unchanged in a purely 
source-based world, would lead to massive shifting of income to low-tax 
    \40\ Subpart F was after all enacted in part as a backstop to Code 
section 482. Note that the tax expenditure budget's relatively modest 
estimate of the potential gain from abolishing deferral ($8 billion) is 
not the same as the potential loss from adopting a pure territorial 
system (much more).
    The first problem can be addressed by limiting tax competition, as 
the OECD is currently trying to do. However, the ability to do this 
would itself be compromised by a demise of residence-based taxation. 
Currently, OECD members are the residence jurisdictions for 85 percent 
of the world's multinationals. Therefore, a major focus of the OECD 
effort has been to expand CFC regimes in its member countries, thus 
eliminating the incentives of source countries to engage in tax 
competition. But if residence jurisdiction succumbs, then the OECD can 
only restrict competition by its members and (perhaps) by pressuring 
the weaker tax havens. It can do little about tax competition by non-
members that are not tax havens, but have preferential regimes to 
attract foreign investors.
    If the OECD cannot be relied on to limit tax competition, what can 
be done? One possibility is to use the WTO, since some preferential 
regimes (involving export of goods) are export subsidies under WTO 
rules. But the WTO subsidies code does not currently cover services, 
and therefore does not address the tax haven problem and financial 
services (the current focus of the OECD effort). In addition, as the 
FSC litigation shows, combating export subsidies via the WTO is a long 
and cumbersome process.
    A potential solution to both issues (tax competition and sourcing) 
involves a general shift to formulary apportionment in a way that 
restricts the ability of multinationals to shift income to 
jurisdictions in which they have no substantial economic activity 
(measured, e.g., by payroll, tangible assets or arm's length sales). 
But even that would leave ``production tax havens'' (preferential 
regimes for real activities) in place, unless some kind of throw-back 
rule that reassigned low-tax income to other jurisdictions was agreed 
upon.\41\ In any case, the adoption of such an agreed upon formula 
seems at present unlikely, although the recent EU proposals in this 
direction are a promising start.\42\
    \41\ Admittedly, whether production tax havens pose a problem is 
debatable. For an argument that they are, see Reuven S. Avi-Yonah, 
Globalization, Tax Competition and the Fiscal Crisis of the Welfare 
State, 113 Harv L Rev 1573 (2000).
    \42\ See EU Commission, Company Taxation in the Internal Market 
(2002), 501-504 (``Despite complications, in practice [formulary 
apportionment] works'').
    The most plausible long-term solution to the problems of source 
based taxation involves a coordinated effort by the large market 
jurisdictions (most of whom are OECD members) to tax multinationals on 
sales into their markets. The key consideration is that market 
jurisdictions do not typically engage in tax competition to attract 
imports. Thus, one could impose a withholding tax on sales to consumers 
in a given market (such as the EU tax on e-commerce sales to 
consumers). Such a tax can be modeled on a destination-based VAT, but 
designed to replicate the corporate income tax base. Moreover, a credit 
or refund can be given for taxes imposed by other source jurisdictions, 
thus providing an incentive to them to refrain from tax 
    \43\ For a fuller elaboration of the details of this proposal see 
Reuven S. Avi-Yonah, International Taxation of Electronic Commerce, 52 
Tax L Rev 507 (1997); Avi-Yonah, Globalization, supra.
    The current international tax regime is based on two principles: 
The single tax principle and the benefits principle.\44\ The single tax 
principle states that cross-border transactions should be subject to a 
single level of tax-no more but also no less.\45\ The benefits 
principle sets the tax rate by allocating passive income primarily to 
the residence jurisdiction and active income primarily to the source 
    \44\ See Avi-Yonah, Electronic Commerce, supra.
    \45\ Interestingly, the Treasury Report acknowledges this when it 
states that the purpose of tax treaties is to ``reduce or eliminate 
double taxation of income, not eliminate all taxation of income.'' 
Treasury Report, at 78. This seems incongruent with the Treasury's 
support of a territorial tax regime that exempts foreign source income 
regardless of whether it was taxed overseas. Note that the adoption of 
a territorial regime for the U.S. without changing the source rules 
(e.g., the title passage rule) would leave us vulnerable to WTO action, 
since it would be an export subsidy.
    The inversion issue illustrates the potential tension between the 
two principles: If active income is taxed purely on a source basis 
(under the benefits principle), there will be zero taxation if income 
can be sourced to no-tax jurisdictions (a violation of the single tax 
principle). Residence-based taxation of corporations was designed by 
T.S. Adams (the inventor of the foreign tax credit) to prevent zero 
taxation by having the residence country pick up the tax when there is 
no source-based taxation. That was the reason Adams rejected 
    \46\ See Michael J. Graetz and Michael O'Hear, The Original Intent 
of U.S. International Taxation, 46 Duke L J 1021 (1997).
    If residence-based corporate taxation becomes impossible because 
technological developments have reduced corporate residence to 
meaninglessness, some other solution needs to be found to preserve the 
corporate tax base.\47\ A source-based tax on sales into market 
jurisdictions is the most plausible solution. But I am not convinced 
that as of 2002, corporate residence has lost its meaning as a business 
concept, if it is redefined as where the corporation is actually run 
from. That is the immediate solution to the inversions problem.
    \47\ Of course, this assumes that the corporate tax should be 
preserved, an issue I hope to address elsewhere.

    Senator Dorgan. Next, we will hear from Mr. Robert 
McIntyre, Director of Citizens for Tax Justice.
    Mr. McIntyre. Thank you, Senator. I am glad you are having 
this hearing today. We should have more like it, because our 
tax system is really facing a crisis these days.
    Offshore tax-sheltering by our big companies is reaching 
epidemic proportions, with the Bermuda loophole just being one 
example of what has been going on.
    I used to think that almost everybody could agree that we 
need taxes to run this country and that we cannot run the tax 
system where people can choose to just opt out if they happen 
to have enough money and enough power.
    But I am not sure that we can all agree on that anymore. 
There has been a complete moral breakdown at the big accounting 
firms. We singled out Arthur Andersen, but Arthur Andersen is 
probably the best of them. You saw Ernst and Young earlier 
today. You saw PriceWaterhouseCooper's consulting almost move 
to Bermuda before they got scared away. The whole crowd of them 
just seem to have lost their moral compass, and they have been 
advising their corporate clients to do anything and everything 
to avoid paying for their share of supporting this country, and 
the main route has been to shift profits offshore--call it tax 
shelters, call it inversions, call it what you will--it is all 
the same game they think of it as, and it is not a very pretty 
game, and that is to generate deductions in the United States, 
to generate income that magically ends up in Liechtenstein or 
Luxembourg or the Cayman Islands or the Bahamas or Bermuda or 
some other place that does not tax them.
    It is reprehensible behavior, and the Bermuda example is so 
clear, so ugly, so awful, just renouncing your U.S. 
citizenship, that you would not think anybody would defend it. 
Who could? The Treasury Department did last spring, but Pam 
Olson came in here today and backed away from that. That is 
good. Of course, that was Ernst and Young working at the 
Treasury at the time--before, after, and during, apparently.
    But there are some who are defending it--the kneejerk anti-
tax groups, the Grover Norquists and the Cato Institutes and 
the Heritage Foundation. They have written letters to you 
endorsing inversions. The Chamber of Commerce calls it--what do 
they call it here--``prudent decisionmaking'' to not pay any 
taxes on U.S. profits. Yikes. So there are some people who are 
in the sort of American mainstream here, which is sad.
    My testimony goes into some of the arguments that are made 
in favor of the Bermuda loophole and why they do not make any 
sense. I was glad to see the Treasury Department endorse that, 
because their report last spring went in the other direction.
    The funny argument for why we should keep the Bermuda 
loophole is coming from Accenture and a few of the other 
companies, who say that they did not go there for tax reasons. 
Well, in that case, I guess they will not mind if we close the 
tax loophole, will they?
    But most of the lobbyists admit it. They say, ``Yes, we 
went there to avoid paying taxes, but we did it so we would not 
have to pay taxes and could compete with our foreign 
competitors who do not have to pay taxes, either.'' Well, that 
is just false. They are trying to avoid paying taxes on their 
American profits and, as Professor Avi-Yonah notes, their 
passive income, and that is all there is to it.
    We do not attempt in any way in this country to tax 
companies on truly foreign profits. We do attempt to make 
companies, whether they are foreign-or American-owned, to pay 
taxes on what they make in the United States. And the companies 
try to restyle their profits as foreign in order to avoid 
paying taxes here. That is what the fight is about, but it has 
gotten a lot worse lately.
    So my testimony--and I am almost done here--has a lot of 
suggestions on what we ought to do in terms of improving our 
Tax Code in this area. I urge you to be worried about what they 
are thinking about doing in the House of Representatives, which 
is to open up many of these loopholes far wider--that is the 
Chairman of the Ways and Means Committee, Bill Thomas', plan. 
And I urge, as you talked about earlier today, that if you can 
get a Treasury Department of good will and an IRS of good will, 
giving them the resources to work on this will help quite a 
    Prepared statement
    So, yes, this is one of the ugliest issues anybody has seen 
in a while, but remember--it is just the tip of a large 
mountain of ugliness that is going on in the American business 
community and the accounting profession today.
    Thank you.
    Senator Dorgan. Mr. McIntyre, thank you very much.
    [The statement follows:]

                Prepared Statement of Robert S. McIntyre

    Today's hearing involves what is rapidly becoming a crisis in the 
American tax system: the growing use of offshore tax shelters by many 
of America's largest and most profitable corporations to avoid paying 
huge amounts of taxes that ought to be due on their U.S. profits. This 
issue has received considerable public attention this year due to the 
publicity over well-known companies reincorporating themselves in 
Bermuda or other tax haven countries.
    I assume we can all agree that taxes are essential to the well-
being of our nation and that a tax system that punishes honest, 
straightforward taxpayers while rewarding sharp dealers and tax 
scofflaws is unacceptable, unfair, immoral and unsustainable.
    Unfortunately, in recent years we have seen a sharp rise in tax 
dodging by large American corporations. In the just completed fiscal 
year, corporate tax payments fell to only 1.2 percent of the gross 
domestic product, their lowest level as a share of the economy since 
the early 1980s and their second lowest level since the 1930s.\1\ Of 
course, part of this decline is due to the lagging economy and part is 
due to the huge corporate tax cut enacted last January. But a 
significant factor in the drop in corporate tax payments is the 
proliferation of aggressive corporate offshore tax shelters. The 
Bermuda reincorporation scheme is an easy to understand example of this 
disturbing trend, but it is only the tip of the tax-shelter iceberg.
    \1\ According to the Congressional Budget Office, in fiscal 2002, 
corporate income tax receipts fell to only $125 billion excluding an 
artificial shift of $23 billion from fiscal 2001 to fiscal 2002 last 
fall. Congressional Budget Office, Monthly Budget Review,, Oct. 9, 
2002. That represented only 1.2 percent of the GDP, slightly higher 
than in fiscal 1983 (1.1 percent), but below every fiscal year from a 
least 1940 on.


    This past March, the IRS reported that companies had responded to a 
mandate to disclose certain kinds of tax-sheltering activities, mostly 
offshore, by reporting 322 deals involving $16.1 billion in tax 
savings. And these disclosures apparently represent only a small part 
of the action, since only ``about 100 companies filed the required 
information, compared to the thousands of disclosures that were 
expected.'' \2\
    \2\ ``Tax Shelter Disclosure Fall Short, IRS Says Agency Seeking to 
Halt Corporate Abuses,'' The Washington Post, March 1, 2002, p. E01:
    Corporations are refusing to cooperate with a high-profile effort 
by the Internal Revenue Service to prod U.S. companies to disclose tax 
avoidance schemes, government official said.
    Two years are the tax-shelter crackdown was announced, about 100 
companies have filed the required information on approximately 325 
transactions, compared to the thousands of disclosures that were 
expected, said David Harris, manager of the IRS's office of tax shelter 
analysis. A limited amnesty from penalties for abusive tax shelters, 
launched two months ago and in effect until April 23, has resulted in 
52 more disclosures.
    ``We believe that many companies should have disclosed that did not 
disclose,'' Harris said. In one case, he said, the agency had obtained 
from the accounting firm that created one tax shelter a list of 17 
companies that used it and found that only five of those companies had 
revealed their participation to the IRS. . . .
    Still, even the limited disclosures obtained by the IRS suggest 
that tax ramifications from shelters may be large. Harris said the 272 
transactions disclosed by 99 companies in 2001 resulted in total tax 
savings of $14.9 billion, while the 52 additional disclosures under the 
amnesty resulted in more than $1.2 billion in claimed losses or 
    In fact, for corporate America, tax sheltering is all the rage 
these days. Big accounting firms like PricewaterhouseCoopers, 
investment banks like Merrill Lynch, and a legion of unscrupulous tax 
advisers are aggressively marketing their services to otherwise 
``respectable'' companies by promising to help them abuse the tax laws 
with little likelihood of being detected by the IRS. A reasonable 
estimate is that corporate tax sheltering activity is now costing 
ordinary taxpayers upwards of $50 billion a year.
    In 1998, PricewaterhouseCoopers bragged to Forbes magazine that it 
was promoting some 30 ``mass-market'' corporate tax shelters, plus 
speciality items for big firms willing to pay extra. It also said that 
it had hired 40 new salespeople to push its corporate shelters.
    We began to learn a little about how some of these shelter deals 
purport to work because a few of the tax abusers, such as UPS, Colgate-
Palmolive, Compaq and AlliedSignal, have actually been caught. The 
courts threw out their tax shelters as ``sham'' transactions, entered 
into for no purpose other than to escape taxes. But these cases, 
although very recently decided, all date back to shelters from the 
early nineties or earlier. Since then the problem has gotten much worse 
and the shelters much more brazen.
    For example, in early 2000, a flier for ``The Eleventh Annual 
Cross-Border Leasing Conference'' came through my fax machine. For 
$1,445, it informed me, members of the Structured Finance Institute and 
their corporate clients could learn new ways to set up international 
leasing tax shelters, under the guidance of big accounting firms such 
as PricewaterhouseCoopers, Deloitte & Touche, and Ernst & Young.
    ``Let [us] help you meet the challenge in providing timely and 
authoritative information on doing business overseas,'' said the 
promotional material on the referenced website. ``This information 
translates to tax savings for your business.'' At the conference, 
participants could ``Discover what opportunities are available for 
doing a cross-border synthetic lease'' and ``Find out the latest issues 
in structuring double dip . . . transactions.'' They could ``Learn how 
to avoid abusive tax shelter issues . . . and how to deal with IRS 
audit activity in the leasing area'' aka: how not to get caught at tax 
cheating. Based on a previous ``Cross-Border Leasing Workshop,'' the 
conference probably featured plenty of controversy about the relative 
advantages of ``Service Contracts'' versus ``QTEs,'' or ``FSCs'' or 
``Pickles.'' But beyond the mumbo jumbo, the big accounting firms 
clearly think they have the IRS on the run in the multinational tax-
shelter leasing area so much so that they are willing to brag about it 
in public.
    Shelters may not explain all of the big shortfall in corporate tax 
payments in recent years, but by the late nineties, the Treasury 
reported that ``there is no doubt that there has been a striking growth 
in abusive tax shelters.'' Treasury's concerns were shared by the 
congressional Joint Committee on Taxation, which said ``the problem is 
becoming widespread and significant,'' and by the American Bar 
Association, which expressed ``growing alarm [at] the aggressive use by 
large corporate taxpayers of tax products' that have little or no 
purpose other than the reduction of Federal income taxes.''
    Although corporate tax-shelter arrangements are typically made 
intentionally complex to try to avoid detection, the gist of most of 
the deals is pretty simple. A company enters into a paper transaction, 
often with a foreign subsidiary or a hired non-taxable third party. The 
idea is to generate deductions against the company's otherwise taxable 
U.S. profits, while shifting the resulting income either offshore or 
into some other tax-exempt form. The deals have no economic purpose 
other than tax avoidance.
    So why can't the IRS crack down on this abusive activity? As the 
experts describe the problem, it often comes down to this. Companies 
are finding that they can get big rewards from illicit tax behavior 
with very low risk.
    Because the deals are so well hidden, they are rarely detected by 
the IRS. And even when the IRS does discover an abusive shelter, the 
penalty rules are so lax that usually the worst result a company faces 
is having to give back the money it stole. (A recent exception to this 
no-penalty rule of thumb involved Compaq, which didn't even bother to 
get a bogus ``opinion of counsel'' condoning its tax shelter, and then 
shredded the key documents to boot.)


    This year, the press has been full of stories about how sleazy 
American companies have reincorporated themselves in Bermuda and other 
tax-haven countries to avoid paying taxes on their U.S. profits. 
Insurance companies led the way a few years ago, and when Congress 
failed to take action, other patriotically challenged corporations 
followed suit.
    The ploy entails little more than some creative paperwork. In late 
2000, for example, Silicon Valley computer-hard-drive maker Seagate 
Technology turned itself into a Cayman Islands ``shell company'' called 
``New SAC,'' whose operations, Seagate notes in its 2000 annual report, 
``are substantially identical to the operations of Seagate Technology 
before the transactions.''
    In fact, these freshly minted offshore companies don't do anything 
at all in their new ``home'' countries. The chief financial officer for 
New Jersey-based Ingersoll-Rand, which expects to cut its U.S. taxes by 
$40 million a year by pretending to move to Bermuda, cheerfully 
admitted to the New York Times that Ingersoll won't even set up an 
office in Bermuda. ``We just pay a service operation'' to accept mail, 
he said.
    Stanley Works, the well-known Connecticut toolmaker, hoped to cut 
its taxes from $110 million a year to $80 million by reincorporating in 
Bermuda although it has since backed out of the deal under public 
pressure. The notorious New Hampshire-based Tyco International says it 
saved more than $400 million last year by moving to Bermuda. Others 
with existing or planned mail drops in Bermuda include: the infamous 
Global Crossing; New Jersey manufacturer Foster Wheeler; the Texas oil-
well-services giant Nabors Industries; and Cooper Industries of Texas, 
which anticipates cutting its taxes by 40 percent.\3\
    \3\ Companies that have reincorporated in Bermuda or other tax 
havens include: Accenture (formerly Andersen Consulting), APW, Cooper 
Industries, Everest Reinsurance Group, Foster-Wheeler, Global Crossing, 
Global Santa Fe, Gold Reserve, Helen of Troy (Helena Rubenstein), 
Ingersoll-Rand, Leucadia National (pending), McDermott International 
(Panama-based), Nabors Industries, New SAC (Seagate), Noble, PXRE, 
Transocean Offshore, Tyco International, Veritas DGC, Weatherford 
International, White Mountains Insurance Group and Xoma Corp. Companies 
that announced planned Bermuda moves, but changed their mind include: 
Monday Ltd (PricewaterhouseCoopers Consulting) and Stanley Works.
    Our country's biggest accounting firms are aggressively promoting 
the Bermuda tax- avoidance scheme, and in some cases, engaging in it 
themselves. Accenture, formerly Andersen Consulting, is now a Bermuda 
holding company. PricewaterhouseCoopers Consulting almost became a 
Bermuda corporation this summer, but changed its mind at the last 
minute. In a message to its clients not long after the Sept. 11, 2001 
terrorist attacks, an Ernst & Young partner conceded that moving 
offshore might look unpatriotic, but urged that ``the improvement on 
earnings is powerful enough that maybe the patriotism issue needs to 
take a back seat.''
    Why would setting up a mail drop on a sunny island allow an 
American company to avoid taxes? United States corporate income tax 
laws do have restrictions against companies using tax havens like 
Bermuda to avoid taxes on their U.S. profits. But our anti-tax-haven 
rules generally apply only to companies incorporated in America. As 
newly-born ``foreign corporations,'' companies claim to be suddenly 
exempt from the anti-tax-haven rules. They argue they must pay taxes 
only on whatever profits they deign to characterize as American. Not 
surprisingly, that's a lot less than what they really earn here.
    One might think that it would be hard to find anyone willing to 
defend the Bermuda tax avoidance scheme. Unfortunately, that thought 
would be far too optimistic. Proving that some people will do anything 
for money, Capitol Hill is now besieged with lobbyists, representing an 
array of ethically and patriotically challenged companies, accounting 
firms and trade associations, who are arguing for retention of the 
    The Chamber of Commerce of the United States, for example, wrote to 
all the members of the Senate on August 30 of this year apparently 
endorsing ``corporate flight from U.S. tax domicile'' and stating: ``We 
believe that corporations should be free to incorporate where they 
choose, without the Federal Government imposing economic penalties upon 
their free exercise of prudent decision-making.'' \4\
    \4\ August 30, 2002 Letter to Members of the United States Senate 
from R Bruce Josten, Executive Vice President, Government Affairs, 
Chamber of Commerce of the United States of America.
    Simultaneously, knee-jerk anti-tax groups such as the Heritage 
Foundation, the Cato Institute, Citizens against Government Waste, 
Citizens for a Sound Economy, the National Taxpayers Union, Paul 
Weyrich's Coalitions for America and Americans for Tax Reform also 
wrote in support of the Bermuda tax dodge. Preposterously, they claim 
that even briefly creating ``barriers against companies that wish to 
re-charter'' is ``misguided'' and would ``undermine economic growth.'' 
    \5\ August 29, 2002 Letter to House Ways and Means Committee 
Chairman Bill Thomas, signed by Andrew E Quinlan, President, Center for 
Freedom and Prosperity; Daniel Mitchell, Senior Fellow, The Heritage 
Foundation; Veronique de Rugy, Fiscal Policy Analyst, The Cato 
Institute; Paul Beckner, President, Citizens for a Sound Economy; 
Robert B. Carleson, Chairman, American Civil Rights Union; Stephen J. 
Entin, President, Institute for Research on the Economics of Taxation; 
Tom Giovanetti, President, Institute for Policy Innovation; John C. 
Goodman, President, National Center for Policy Analysis; John Hood, 
President, John Locke Foundation; Lawrence Hunter, Chief Economist, 
Empower America; Charles W Jarvis, Chairman, United Seniors 
Association; Gordon S. Jones, President, Association of Concerned 
Taxpayers; David A. Keene, Chairman, American Conservative Union; Karen 
Kerrigan, Chairman, Small Business Survival Committee; James L. Martin, 
President, 60 Plus Association; Ed H. Moore, President, The James 
Madison Institute; Steve Moore, President, The Club for Growth; Grover 
Glenn Norquist, President, Americans for Tax Reform; Duane Parde, 
Executive Director, American Legislative Exchange Council; John 
Pugsley, Chairman, The Sovereign Society; Richard Rahn, Senior Fellow, 
Discovery Institute; Gary and Aldona Robbins, President and Vice 
President, Fiscal Associates; Terrence Scanlon, President, Capital 
Research Center; Tom Schatz, President, Council for Citizens Against 
Government Waste; Eric V Schlecht, Director of Congressional Relations, 
National Taxpayers Union; Solveig Singleton, Senior Analyst, 
Competitive Enterprise Institute; Lewis K. Uhler, President, National 
Tax Limitation Committee; Paul M. Weyrich, National Chairman, 
Coalitions for America; Christopher Whalen, President, The Whalen 
Consulting Group; Neal C. White, President, National Retail Sales Tax 
Alliance, Inc.
    Perhaps these groups should consider changing their names. How 
about the Coalition Against America? Or Citizens for an Insane Economy? 
Or Bermudians for Tax Reform? Or the Cayman Islands Chamber of 


    Beyond the blather, what do the proponents of offshore tax 
shelters, in particular the Bermuda loophole, specifically have to say 
in defense of the indefensible? Well, the lobbyists offer two 
contradictory arguments, neither even slightly plausible. Their 
silliest claim is that tax avoidance wasn't why the companies moved 
offshore merely ``a minor factor,'' as lobbyist and former-
Representative Bob Livingston puts it on behalf of Accenture (the 
former Andersen Consulting, now incorporated in Bermuda). Actually, 
Livingston asserts, Accenture's European partners suddenly decided they 
couldn't stand being headquartered in the U.S., while the American 
partners were adamant that they wouldn't accept European control. ``So 
they picked a nice island, Bermuda,'' Livingston told the Washington 
    Well, gee, if avoiding taxes isn't a big deal, then why are the 
companies so upset about proposals to close their tax loophole? And if 
Accenture really was only seeking ``neutral turf,'' then why does its 
SEC filing note that ``Accenture Ltd is a Bermuda holding company with 
no material assets other than . . . shares in . . . Accenture SCA, a 
Luxembourg partnership?'' Last time I checked, Luxembourg was in 
    The lobbyists' second claim concedes the obvious: avoiding taxes is 
indeed the only reason their clients moved offshore. Sadly, we're told, 
they were forced to do so, because otherwise U.S. tax law would 
unfairly tax them on their foreign earnings under our allegedly 
``worldwide'' corporate tax system. This claim is also a ridiculous 
    In calling our tax system ``worldwide,'' the lobbyists conveniently 
fail to mention two rather large exceptions to that supposed rule. 
First of all, U.S. taxes on foreign profits are deferred indefinitely. 
And second, in the rare cases in which companies decide to waive 
deferral, U.S. taxes are almost always completely offset by a credit 
for taxes paid to foreign governments.
    Rather than taxing corporations on their foreign profits, we try, 
with insufficient success, to tax companies, both American and foreign, 
solely on what they earn in the U.S. For their part, the multinational 
companies try, with considerable success, to recharacterize their U.S. 
profits as ``foreign'' in order to avoid paying taxes on their U.S. 
earnings. That's precisely the goal of the Bermuda shelter, as it is 
for a wide array of other abusive offshore tax machinations.


    Despite the poverty of their arguments, the multinational tax 
dodgers and their accounting firm allies continue to clamor for even 
more ways to avoid paying taxes on their U.S. profits. Legislation 
introduced in August by Ways and Means Chairman Bill Thomas, for 
example, includes an array of new offshore tax-sheltering loopholes 
that the companies have long sought.
    To be sure, politics forced Thomas to pretend to attack the Bermuda 
loophole, but his bill does as little as possible. For starters, he 
sharply watered down proposals to disallow sham Bermuda 
reincorporations and then insisted that even that limited reform must 
expire after 3 years! Although the change might at least temporarily 
stop some companies' Bermuda plans, it explicitly grandfathers 
companies like Tyco that set up their mail drops early.
    Another of the Thomas's Bermuda-related measures would limit 
schemes to shift profits offshore through interest write-offs a good 
idea but it would not curb similar deductions for the use of patents, 
trade names and so forth. That seems to have been carefully designed to 
protect the Bermuda tax sheltering activities of companies like 
Accenture, which remonikered itself from Andersen Consulting to get 
around a law forbidding expatriate companies from charging their 
American operations hefty deductible fees for the use of pre-existing 
trade names.
    In total, these and a few other reforms in Thomas's bill are 
estimated to curb tax-shelter abuses by about $15 billion over the next 
decade. In sharp contrast, Thomas wants to spend $83 billion on what 
they outlandishly calls ``simplification'' measures. As Wayne State law 
professor and leading international tax expert Michael J. McIntyre 
notes in a written analysis of the Thomas bill, these eighteen new 
``loophole provisions . . . would reduce the fairness and efficiency of 
the tax system and reduce the competitiveness of the U.S. economy . . . 
Their unifying aspect is that they have been on various goody lists 
prepared by the big accounting firms over the past several years.''
    For example, while Thomas's Bermuda-related reform curbing improper 
interest write-offs would raise $5.5 billion over 10 years, another 
provision in the bill would increase unjustified interest deductions 
for multinationals, at a cost of $23.4 billion. Another Thomas proposal 
would lose $37.4 billion by scrapping a long-standing rule that's made 
it harder for companies to artificially shift profits into tax havens 
by manipulating intracompany ``transfer pricing.'' Other provisions 
would undo essential prior reforms, expand existing tax-shelter 
loopholes or create brand new ones.
  what we should do to curb abusive corporate offshore tax sheltering
    Rather than expanding offshore corporate tax shelters, we should be 
taking major steps to curb them. In brief outline, here are some of the 
changes that could put a real crimp in corporate tax sheltering.
  --For starters, we don't have to let a mail drop in Bermuda turn an 
        American corporation into a foreign corporation. Instead, 
        Congress should simply follow the lead of countries such as 
        Germany, Japan and the United Kingdom, and treat any ostensibly 
        ``foreign'' corporation whose shares are mostly owned by 
        Americans as, well, American.
  --Next, we should substantially strengthen our general anti-abuse 
        laws to disallow U.S. tax deductions for interest, royalties, 
        etc. ostensibly paid to offshore affiliates. (A limited example 
        of this kind of change is one of the few salutary provisions of 
        the Thomas bill.)
  --We should consider scrapping our impossibly complex ``transfer-
        pricing'' rules in favor of a simpler and more effective 
        formula approach. Formulary apportionment is not a panacea, but 
        it could have major benefits if we can persuade our trading 
        partners to participate.
  --We could establish an ``economic substance'' test for tax shelters, 
        so that deals entered into mainly for tax avoidance would be 
        disallowed. Such a rule is often invoked by the courts, but 
        statutory authorization might be helpful, so long as the rule 
        remains flexible enough to deter crafty lawyers and 
  --More fundamentally, we ought to scrap the antiquated rule that lets 
        American companies indefinitely ``defer'' reporting their 
        foreign profits on their U.S. tax returns. As noted earlier, 
        it's not that we really want to tax actual foreign earnings we 
        give companies a full tax credit for the taxes they pay to 
        foreign governments if they ever report the foreign income. But 
        deferral opens up the door to other scams companies use to 
        shift their American profits on paper to tax-haven countries, 
        and our current anti-abuse rules are far too weak. Eliminating 
        deferral would stem abuses and hugely simplify the corporate 
        tax laws to boot. That's exactly what the Kennedy 
        administration unsuccessfully proposed back in the early 
        sixties, and what both the House and Senate passed in the mid-
        seventies unfortunately not at the same time.
  --Finally, the IRS needs considerably more resources to fight against 
        abusive corporate tax sheltering. The payoff from such an 
        investment, both in revenues and in renewed public respect for 
        the tax system, would be enormous.


    Most Americans probably believe that multinational corporations, 
whether U.S. or foreign owned, ought to pay taxes on their American 
profits just like purely domestic companies. Unfortunately, we learn 
more every day about how severely that goal has been undermined by 
aggressive tax sheltering on the part of unscrupulous corporate bosses 
and their accountants often with at least implicit congressional 
    Despite foot-dragging on corporate reform by the Bush 
administration and the House leadership, the well-publicized accounting 
and tax scandals of the past few years present a rare opportunity for 
real reform. We encourage the members of the Subcommittee to push hard 
to take advantage of this opportunity.

    Senator Dorgan. Next, we will hear from Mr. Martin Regalia, 
Vice President for Economic Policy and Chief Economist for the 
U.S. Chamber of Commerce.
    Mr. Regalia?
    Mr. Regalia. Thank you.
    Mr. Chairman, we have heard a number of witnesses testify 
as to the differences in the Tax Code, the territorial nature 
of foreign tax codes and the worldwide nature of ours, and how 
that places U.S. multinationals at a disadvantage and has led 
some of those companies to invert and domicile overseas for tax 
    Opponents of the inversions have criticized this behavior 
on the grounds that it reduces the U.S. tax base, that it 
demonstrates a lack of patriotism, and that it enables 
corporations to escape their obligations and pay their fair 
share of taxes.
    Congress has responded to these inversions by suggesting a 
number of restrictions or penalties that otherwise discourage 
corporate inversions. They include treating inverted 
corporations as if they were still domestic, imposing 
moratoriums on corporate inversions, treating inverted 
companies' property as being sold for fair market value on the 
date before the move takes place, denying use of International 
Tax Treaty benefits, and barring Federal contracts from certain 
inverted companies.
    We oppose the attempts by Congress for a number of reasons. 
Not only is it permissible for a corporation to plan to 
minimize its taxes, but it really is a matter of fiduciary 
responsibility for a corporation's managers to do so in order 
to maximize corporate competitiveness and value for its 
shareholders. It is important to keep in mind that corporate 
inversions result in permissible tax avoidance under the 
Internal Revenue Code, not tax evasion. It is a perfectly legal 
and valid strategy.
    A corporate inversion does not excuse the U.S. corporation 
from paying taxes on its domestic operations; in fact, it 
remains legally obligated to do so. At the State level, 
property and sales tax, income taxes, continue to be levied on 
plants, facilities, and domestic business operations.
    What an inversion does is place a U.S. corporation on an 
equal footing with its foreign competitors. The U.S. Chamber 
urges Congress to reject these counterproductive legislative 
measures previously discussed. We believe that corporations 
should be free to incorporate where they choose, without the 
Federal Government imposing economic penalties on their free 
exercise of prudent business decisionmaking, and assert that 
Congress certainly should not favor foreign firms over their 
U.S. competitors.
    These measures are a poor substitute for needed systemic 
reform of the U.S. Tax Code's archaic international provisions 
which currently put our corporations at a competitive 
disadvantage and provide great incentive for them to leave the 
    In addition, our tax structure also has the deleterious 
consequence of encouraging takeovers of our corporations by 
foreign interests or providing new businesses with the 
motivation to initially incorporate in countries other than the 
United States.
    Congress' varied plans to stem the tide of corporate 
inversions have a common single, glaring, critical flaw. In 
each case, enactment of the legislative proposals would 
perpetuate the inequality between the U.S. worldwide tax system 
and its foreign territorial counterparts, leaving U.S. 
multinational corporations disadvantaged vis-a-vis their 
foreign multinational competitors.
    While this disparity remains in effect, we can expect to 
see a continued increase in mergers and acquisitions that place 
foreign interests in functional control of U.S. businesses.
    We believe that the proper response should be the 
undertaking of serious and overdue tax reform through the 
restructuring of the international provisions of the U.S. Tax 
Code, such as conversion of the U.S. Code to a system that is 
based on territoriality. This would help achieve a much-needed 
parity between U.S. and foreign corporations and simplify our 
tax structure.
    Undertaking the task of formulating a more appropriate 
international tax structure would have significant beneficial 
effects on the U.S. economy through its ability to attract and 
retain corporate parents of multinational groups.
    In sum, our overriding goal should be to fashion a tax 
system that will attract businesses to the United States rather 
than drive them away.
    Thank you very much.
    Senator Dorgan. Mr. Regalia, thank you very much.
    And let me also say, Mr. Regalia, as I indicated in my 
opening statement, that we did invite a number of other people 
who would have had the same opinion as you--I wanted to have a 
balanced panel--but you were the only one willing to come and 
take that position publicly. We certainly tried and invited a 
number of others, and I will expand on that if necessary.
    Prepared statement
    I wanted to have a balanced panel here, but it was hard to 
find someone who would come and provide the testimony that you 
have provided. I appreciate you being here, and I will ask some 
questions, of course.
    [The statement follows:]

             Prepared Statement of Martin A. Regalia, Ph.D.

    The U.S. Chamber of Commerce is the world's largest business 
federation, representing more than three million businesses and 
organizations of every size, sector, and region.
    More than 96 percent of the Chamber's members are small businesses 
with 100 or fewer employees, 71 percent of which have 10 or fewer 
employees. Yet, virtually all of the nation's largest companies are 
also active members. We are particularly cognizant of the problems of 
smaller businesses, as well as issues facing the business community at 
    Besides representing a cross-section of the American business 
community in terms of number of employees, the Chamber represents a 
wide management spectrum by type of business and location. Each major 
classification of American business--manufacturing, retailing, 
services, construction, wholesaling, and finance--numbers more than 
10,000 members. Also, the Chamber has substantial membership in all 50 
    The Chamber's international reach is substantial as well. We 
believe that global interdependence provides an opportunity, not a 
threat. In addition to the U.S. Chamber of Commerce's 94 American 
Chambers of Commerce abroad, an increasing number of members are 
engaged in the export and import of both goods and services and have 
ongoing investment activities. The Chamber favors strengthened 
international competitiveness and opposes artificial U.S. and foreign 
barriers to international business.
    Positions on national issues are developed by a cross-section of 
Chamber members serving on committees, subcommittees, and task forces. 
Currently, some 1,800 business people participate in this process.
    My name is Dr. Martin A. Regalia, and I am Vice President and Chief 
Economist of the U.S. Chamber of Commerce. The U.S. Chamber is the 
world's largest business federation, representing more than three 
million businesses and organizations of every size, sector and region. 
This breadth of membership places the Chamber in a unique position to 
speak for the business community. Mr. Chairman, Senator Campbell and 
Members of this Subcommittee, we appreciate this opportunity to express 
our views on the issue of corporate inversions, and we commend you for 
holding these hearings.


    The United States subjects its corporations to taxation on their 
worldwide income, while ``territorial'' systems utilized by many of our 
trading partners and other foreign countries only tax their resident 
corporations on income earned within their borders. A U.S. corporation, 
therefore, has income from its foreign operations taxed both here and 
in the foreign country in which such income was earned. Double taxation 
may be avoided to some extent via foreign tax credits allowed, within 
limitations, against the U.S. tax, and by provisions of tax treaties. 
Typically, this credit for taxes paid to a foreign jurisdiction does 
not fully offset the U.S. taxes on that foreign income.
    Consider a situation in which a U.S.-based multinational group 
produces goods and/or services in the U.S. and abroad, and a foreign-
based multinational group produces exactly the same things, in the same 
amounts, for the same prices, in the same places as the U.S.-based 
group. Typically, the foreign-based group incurs a lower overall tax 
bill than the U.S-based group. This disparity occurs because of tax 
rate differentials and the fact that both the United States and the 
foreign jurisdiction subject the foreign-earned income of the U.S.-
based multinational group to taxation. To the extent that the U.S. tax 
credit against taxes paid to foreign countries fails to fully alleviate 
this double taxation, the U.S.-based group is placed at a distinct 
disadvantage, as compared with the foreign-based group.
    These tax disadvantages have caused some U.S.-based multinational 
corporations to reincorporate and relocate their domiciles abroad. 
These reincorporations are achieved through transactions known as 
corporate inversions.
    Corporate inversions replace the U.S. parent of a multinational 
corporate group with a foreign parent, with the U.S. corporation 
thereby becoming its subsidiary. This has the effect of removing 
foreign operations income from the more onerous U.S. taxing 
jurisdiction, since the parent is no longer U.S.-based. The resulting 
tax savings help ``level the playing field'' for the corporate group, 
allowing the multinational operations to attain tax rates enjoyed by 
its foreign competitors.

                         CONGRESSIONAL RESPONSE

    Congress has responded to these inversions by concocting a number 
of schemes to penalize or otherwise discourage corporate inversions. 
They include tax bills that would, among other things:
  --treat inverted corporations as if they were still domestic (i.e., 
        as if the inversion transactions had not taken place);
  --impose ``moratoriums'' on corporate inversions--in other words, 
        disregard the tax inversion for a predetermined period of time;
  --treat inverted corporations' property as being sold for fair market 
        value on the date before the ``move''; and
  --deny the use of international tax treaty benefits.
    Furthermore, a recent trend is for Congress to include language in 
non-tax legislation that would bar federal contracts to certain 
inverted U.S. companies (the resulting U.S. subsidiaries). Examples are 
the Treasury-Postal and Defense appropriations bills, and legislation 
to establish the Department of Homeland Security. However, some 
legislators from both sides of the aisle have had second thoughts about 
the wisdom of this tact, and stripped this provision out of the Defense 
appropriations bill in conference, on the rationale that some 
corporations are forced offshore by a U.S. tax code that puts them at a 
disadvantage with foreign corporations.


    Proponents of the foregoing assert a number of rationales in 
support of their proposals. They assert that corporate inversions must 
be thwarted, because they:
  --reduce the U.S. tax base;
  --demonstrate a lack of ``patriotism'' for the corporation's U.S. 
        home; and
  --enable escape from the corporation's obligation to pay its ``fair 
        share'' of taxes for the protections, rights, and benefits of 
        infrastructure that are accorded it in doing business within 
        the U.S.'s borders.


    The often-quoted and esteemed Judge Learned Hand had something to 
say about the propriety of planning to minimize one's tax burden. Hand 
wrote, ``Over and over again courts have said that there is nothing 
sinister in so arranging one's affairs as to keep taxes as low as 
possible. Everybody does so, rich or poor; and all do right, for nobody 
owes any public duty to pay more than the law demand: taxes are 
enforced exactions, not voluntary contributions. To demand more in the 
name of morals is mere cant.'' Commissioner v. Newman, 159 F.2d 848 (2d 
Cir., 1947, dissenting opinion).
    Not only is it permissible for a corporation to plan to minimize 
its taxes--and thereby reduce the U.S. tax base--but it is a matter of 
fiduciary obligation for a corporation's managers to do so, in order to 
maximize corporate competitiveness and value for its shareholders. It 
is important to keep in mind that corporate inversions result in 
permissible tax avoidance under the Internal Revenue Code--not tax 
evasion. It is a perfectly legal and valid strategy.
    Nor do corporate inversions demonstrate a lack of ``patriotism'' 
for the United States. Tax planning is merely a function of business 
decision-making. Taxes are levied by the tax code and are measured by 
its provisions, not by the depth of sentiment for our country.
    Indeed, imposing and retaining punitive levels of taxation that 
place U.S. corporations at a competitive disadvantage when compared to 
their foreign rivals is unpatriotic. Denying government contracting 
opportunities to U.S. corporations that take steps to achieve tax 
parity with their foreign competitors is unpatriotic. Either way, the 
corporation is harmed. This double-edged sword of loss of tax dollars 
versus loss of business revenue penalizes the U.S. corporation by 
depriving it of vital sources of revenue, with the attendant loss of 
jobs and restriction on ability to fund growth and attract future 
business opportunities--while penalizing the investor through the 
resulting drag on the value of the corporation's stock and the U.S. 
economy. True patriotism would be demonstrated by steps our government 
could--and should--take to enable our corporations to thrive 
internationally in the global economy.
    It is important to keep in mind that a corporate inversion does not 
excuse the U.S. corporation from paying taxes on its domestic 
operations. In fact, it remains legally obligated to do so. Payment of 
these taxes continues to support the functions and operations of our 
government, and compensate it for the protections, rights, and benefits 
of infrastructure that are bestowed upon corporations operating here--
whether the corporation is a product of an inversion, a company 
acquired by a foreign corporation, or merely a domestic corporation 
that has no foreign operations. At the state level, property, sales, 
and income taxes continue to be levied on plants and facilities, and on 
domestic business operations.


    The U.S. Chamber urges Congress to reject the short-term and 
counterproductive legislative measures previously discussed. We believe 
that corporations should be free to incorporate where they choose, 
without the federal government imposing economic penalties upon their 
free exercise of prudent business decision-making, and assert that the 
U.S. Congress certainly should not favor foreign firms over U.S. firms 
in the tax code. These measures are a poor substitute for needed 
systemic reform of the U.S. tax code's archaic international provisions 
which currently put our corporations at a competitive disadvantage 
internationally and provide great incentive for them to leave this 
country. In addition, our tax structure also has the deleterious 
consequences of:
  --encouraging takeovers of our corporations by foreign interests; or
  --providing new businesses with the motivation to initially 


    Congress's varied plans to stem the tide of corporate inversions 
have in common one glaring, critical flaw. In each case, enactment of 
the previously discussed legislative proposals would perpetuate the 
inequality between the U.S. worldwide tax system and its foreign 
territorial counterparts, leaving U.S. multinational corporations 
disadvantaged vis-a-vis their foreign multinational competitors. While 
this disparity remains in effect, we can expect to see a continuing 
increase in mergers and acquisitions that place foreign interests in 
functional control of our U.S. businesses.
    We believe that the proper response should be the undertaking of 
serious and overdue tax reform through restructuring the international 
provisions of the U.S. tax code, such as conversion of the U.S. tax 
system to one based on territoriality. This would help achieve much-
needed parity between U.S. and foreign corporations and simplify our 
tax structure. It is only fair that foreign operations of a U.S.-based 
company not be subject to a burden not borne by its competitors.


    Undertaking the task of formulating a more appropriate 
international tax structure would have significant beneficial effects 
on the U.S. economy, through its ability to attract and retain 
corporate parents of multinational groups. When the resulting decisions 
affecting the future location of new investment, operations and 
facilities, and employment opportunities are made by U.S.-based 
companies, U.S. interests will be promoted. In sum, our overriding goal 
should be to fashion a tax system that will attract businesses to the 
United States, rather than drive them away.

    Senator Dorgan. Finally, we welcome William Gale, Senior 
Fellow and Deputy Director for Economic Studies at The 
Brookings Institution.
    Thank you for being here, Mr. Gale, and please proceed.
    Mr. Gale. Thank you very much for inviting me to testify at 
this hearing.
    International taxation is complicated, even for experts, 
and because of that, I will try to focus on a few broad 
intuitive themes and try to focus on the forest rather than the 
trees here.
    The single bright line in international tax policy has to 
be that features of the Tax Code that affect the taxation of 
offshore income should not be allowed to erode the taxation of 
domestic income. That is, we should avoid at all cost features 
of the tax system that let U.S. firms strip their earnings out 
of the U.S. and into foreign tax havens.
    How we tax foreign-source income is a separate issue that 
is also important, but if we leave the domestic tax base up for 
attack by allowing firms to move revenues offshore, we are in 
for a very long and difficult set of problems in the tax 
    I think--and I emphasize ``think''--that everyone on the 
panel agrees with this, but I would like to know in particular 
whether Marty Regalia does or not.
    The second point is that corporate inversions are legal. 
They may be repugnant. Flag-burning may be repugnant, but it is 
legal. And in a strict, narrow, financial sense, it often makes 
sense from a firm's perspective.
    Regardless of the legality of the transactions, they are 
troubling from a policy viewpoint. That is, it is one thing to 
say that they are legal; it is another thing to say that they 
are a desirable thing to have happen. I think it is very clear 
that they are an undesirable thing to have happen, because 
inversions allow firms not only to reduce or eliminate taxes on 
their foreign income, but also to eliminate and reduce taxes on 
their domestic income.
    I thought that Assistant Secretary Olson's emphasis on the 
domestic earnings-stripping this morning was both notable and 
    Another thing to add is that inversions create these 
incentives without creating any change in real economic 
activity. We have energy incentives because we want firms to 
invest in certain types of energy. We have other incentives. We 
subsidize health care because we want firms to provide health 
insurance. Inversions give firms tax benefits while engaging in 
no socially redeemable, socially valuable behavior.
    So it is a pure tax avoidance mechanism, and as such, it is 
very bad public policy to allow these things to occur.
    Let me emphasize the incentives for inversion. The cause of 
U.S. earnings-stripping is not the overall competitiveness of 
the U.S. tax system. Our tax system is about on average in its 
competitiveness in terms of how it taxes foreign income 
relative to our major trading partners. Some tax it more 
heavily, some tax it less heavily.
    The competitiveness is a complete red herring as far as 
incentives for inversions are concerned. The incentive to strip 
earnings is based only on the statutory tax rate, and that is 
not on the effective tax rate. The way to think about this is 
that a firm makes an investment, it gets some deductions, and 
then it gets the income, and the income is taxed. The incentive 
to strip the earnings out depends only on the statutory tax 
rate that applies to that income. The deductions have already 
been taken in earlier years.
    So even if we made the system ``more competitive,'' quote-
unquote, by increasing deductions, increasing depreciation, the 
incentive to strip earnings out would still be there because 
that incentive depends only on the statutory tax rate, not on 
the effective tax rate.
    What should we do about this? Treasury suggests that we 
restrict earnings-stripping via interest payments, but they 
make no mention of earnings-stripping via royalty payments. 
Instead, they suggest that we move to a territorial system 
instead of the worldwide system.
    I want to emphasize that a territorial system does not 
solve the inversion problem. Under domestic systems, firms 
still pay domestic taxes on their foreign passive income; under 
inversion, they would not. And of course, inversions are also, 
as has been discussed, put in place to reduce taxes on domestic 
income, which a territorial system does not address.
    Basically, going to a territorial system as a response to 
corporate inversions is like choosing to reduce the crime rate 
by legalizing certain crimes. It is not a solution in any 
substantive sense.
    We can talk for a while about other solutions. The one I 
would like to suggest be put on the table is to consider a 
change in the definition of corporate residency. Currently, it 
is based on where a firm files its incorporation papers. There 
is another possibility, which is where the day-to-day 
management and control of the firm occurs. If residency were 
defined on this basis, the inverting firms would still be 
considered U.S. firms, Accenture would still be considered a 
U.S. firm. This is a much harder criterion to avoid than simply 
filing papers in a different jurisdiction. It is consistent 
with what our trading partners do, which is important for any 
unilateral change in international tax rules. And this would 
catch new establishments like Accenture as well as existing 
establishments that have already inverted.

                           PREPARED STATEMENT

    So there are other proposals, but I would like to put that 
one on the table for consideration.
    Thank you.
    [The statement follows:]

                 Prepared Statement of William G. Gale

    Mr. Chairman and Members of the Committee: Thank you for inviting 
me to testify at this hearing. Corporate inversions have increased in 
recent years and raise a number of difficult and sometimes confusing 
issues. My testimony aims to provide background on both the 
institutional and economic aspects of inversions.
    Inversions.--Corporate inversions occur when firms move their legal 
headquarters out of the U.S. solely for tax purposes. Although they are 
not illegal and often make sense from the firm's perspective, 
inversions are particularly troubling from a policy viewpoint. 
Specifically, inversions allow firms not only to reduce or eliminate 
taxes on their foreign source income, but also to reduce or eliminate 
taxes on their domestic income. And they create these incentives 
without requiring any sort of change in ``real'' economic activity. The 
economic incentive for inversions is not due to the overall taxation of 
corporate income, it is due only to the statutory tax rate.
    Policy response.--New laws should strive to eliminate the tax 
savings from inversions. Several legal options are available, but the 
most often-discussed options--reducing the effective tax rate on 
capital, moving to a territorial tax system or implementing fundamental 
tax reform--would not resolve the basic incentives for, or problems 
with, inversions.
    Territorial tax system.--It is natural to consider more broad-based 
reforms to the tax system as a response, but moving to a territorial 
system is not a helpful way to deal with corporate inversions. 
Territorial systems generally make it more difficult to defend the 
domestic tax base from attack, since moving offshore results in a 
bigger tax savings under a territorial system than a world-wide system. 
That is, territorial systems enhance and legitimize methods of tax 
avoidance and evasion that should be curtailed under any sensible 
policy rule toward inversions. Going to a territorial system as a 
response to corporate inversions is like choosing to reduce the crime 
rate by legalizing certain crimes. Thus, although there are reasons to 
consider territorial tax systems, stopping inversions are not among 
    Fundamental tax reform.--Replacing the corporate income tax with a 
value-added tax raises many important issues, including the impact on 
economic growth, the distribution of tax burdens, tax complexity and so 
on. A VAT, however, would not relieve the demand for corporate 
inversions by very much, if at all. Some businesses would see their 
statutory tax rate on income fall, which would reduce demand for 
inversions, but others would see their tax liabilities skyrocket under 
a VAT and thus would have increased incentives to shift profits out of 
the U.S.

                              ANALYSIS \1\

International features of the U.S. tax system
    The United States taxes the world-wide income of its individual and 
corporate residents. Although this may sound simple in theory, in 
practice it raises a number of difficult issues.
    \1\ Due to time constraints in the development of this testimony, I 
do not provide references to particular publications used throughout 
the text. Rather, the sources listed at the end of the text include the 
publications that I referenced in developing these comments.
    To avoid having the foreign source income of its residents taxed 
twice, the U.S. provides a foreign tax credit for income taxes paid to 
foreign governments. To ensure that the credit does not reduce tax on 
domestic income, the credit cannot exceed the tax liability that would 
have been due had the income been generated domestically. Firms with 
credits above that amount in a given year have ``excess'' foreign tax 
credits, which can be applied against their foreign source income for 
the previous 2 years or the subsequent 5 years. To limit the ability of 
firms to use foreign tax credits for one type of foreign source income 
to reduce taxes on a different type of foreign income, the foreign tax 
credit limitation is calculated separately for nine different 
``baskets'' of income.
    Foreign branches of U.S. corporations are considered U.S. residents 
and therefore are subject to immediate taxation on foreign source 
income and eligible for the foreign tax credit. In contrast, controlled 
foreign corporations (CFCs, which are American-owned, separately 
incorporated foreign subsidiaries of U.S. corporations) are not 
considered U.S. residents. Their profits, therefore, are not taxable as 
long as the earnings are retained and reinvested locally in active 
lines of business. That is, U.S. income tax (and foreign tax credits) 
on such income is deferred until the income is repatriated to the U.S. 
    Deferral of taxes and credits on retained earnings is intended to 
allow foreign subsidiaries to compete on a more even basis with local 
firms. To ensure that the benefits of deferral are used only to achieve 
that goal, the law provides complex and extensive limits on the ability 
to defer income. These rules (subpart F) make deferral available only 
on active business income that is reinvested locally. Certain forms of 
income are ``deemed distributed'' and thus denied deferral. These 
include passive income broadly defined, and including portfolio 
interest and dividends.
    Because the tax treatment of domestic and foreign income differ 
under the U.S. system, firms have incentives to shift income to low-tax 
jurisdictions and deductions to high-tax jurisdictions. Income can be 
shifted via the transfer prices at which internal firm transactions are 
recorded. As a result, the U.S. imposes an extensive set of rules, that 
essentially require that transfer prices correspond to the prices that 
would have occurred in an arms-length transaction. These rules, 
however, are notoriously difficult to enforce and, in some cases, to 
interpret. The U.S. also imposes rules regarding the allocation of 
deductible expenses--such as research and development costs and 
interest payments--across jurisdictions. U.S. corporations may allocate 
only a portion of their expenses to domestic operations, with the rest 
being allocated against foreign income.
    The U.S. generally treats exports as taxable income and imports as 
deductible expenses. But, relative to the rules above, the U.S. 
subsidizes exports in two ways. First, the sales source rule allows 
taxpayers that manufacture in the U.S. and sell outside the U.S. to 
report 50 percent of the income from the sale as foreign income. For 
firms with sufficient excess foreign tax credits, this provision 
eliminates U.S. income tax on half of export sales. The U.S. also 
provides a subsidy for extra-territorial income. Taxpayers are allowed 
to exclude a portion of their income that is attributable to ``foreign 
trading gross receipts'' (FTGR) or net income from FTGR. A firm cannot 
generally benefit from both the ETI regime and the sales sourcing 
rules. Firms with excess foreign tax credits will generally save more 
through the sales sourcing rules. The ETI rules thus mainly benefit 
taxpayers that do not have excess foreign tax credits--that is, those 
who either operate in low-tax foreign countries or do not have foreign 
    The U.S. taxes foreigners on income from their active business 
operations in the U.S. The U.S. imposes 30 percent withholding taxes on 
interest (but not portfolio interest, which is untaxed), royalties, and 
dividends that flow to foreigners, but frequently reduces or eliminates 
the withholding tax rate through bilateral tax treaties.
Background on inversions
    ``Inversions'' refer to a complicated set of procedures that allow 
firms not only to reduce their taxes on foreign source income, but to 
reduce taxes on domestic income as well. Here is how a typical 
inversion works. First, a domestic corporation creates a foreign parent 
in a country like Bermuda--which has no income tax and no tax treaty 
with the United States. This allows it to eliminate U.S. taxes on 
foreign source income. Second, the domestic corporation sets up a 
foreign subsidiary of the foreign parent in a third country--often 
Barbados or Luxembourg--that has a treaty with the United States and 
has lax residency requirements. To qualify as a resident of Barbados, 
for example, the company just has to meet there once a year. The reason 
the third country and its U.S. tax treaty are important for this scheme 
is that the tax treaty eliminates withholding taxes on flows of 
royalties or interest payments from the U.S. to the third country. 
Thus, once the funds are transferred to Bermuda, which does not have a 
treaty, there is no access to the funds by U.S. government.
    With the new foreign parent in place and the existing foreign 
subsidiaries turned over to the foreign parent, the inversion works in 
two steps. First, the American company ``sends profits'' to the foreign 
subsidiary in the third country. Sending profits means the American 
company makes payments to the subsidiary that are deductible under U.S. 
tax law. Note that this reduces the American company's American taxes 
on domestic operations. These payments could include interest payments, 
royalties for use of the company logo, and so on. No taxes are withheld 
on these transactions because of tax treaties with the U.S. and the 
third country. Second, the foreign subsidiary then sends the funds to 
the foreign parent in Bermuda, which has no income tax. As a result, 
taxable American profits have been shifted to Bermuda and escape U.S. 

Inversions: Notes on economic analysis
    This section discusses several economic aspects of inversions. 
First, inversions have nothing to do with a lack of competitiveness of 
our tax system. Competitiveness, if it means anything, should refer to 
the effective rate of taxation on businesses. The effective rate of 
taxation depends on the statutory tax rate, depreciation rules, whether 
the corporate and personal taxes are integrated. The ETR does not 
affect the incentive for inversions. Rather, inversions depend on the 
statutory tax rate. That is, U.S. firms have incentives to shift 
profits out of the U.S. because of the 35 percent statutory corporate 
tax rate. This would be true even if investments were expensed, which 
would reduce the effective tax rate on capital income to below zero, 
since some investment is debt-financed.
    Second, there is a natural break on the tendency of firms to 
invert. Firms that invert create forced stock sales by their 
shareholders, who have to pay capital gains taxes on those sales. Thus, 
the presence of substantial capital gains and/or a high rate of tax on 
capital gains would inhibit inversions. Given the large declines in the 
stock market recently, the number of companies whose shareholders have 
large capital gains would have diminished over the last few years. 
Thus, the decline in the asset prices could encourage inversions by 
reducing or eliminating the capital gains taxes that shareholders would 
have to pay. Equally important, a low capital gains tax rate makes it 
easier for firms to invert, since it creates a smaller tax liability 
upon forced realization. Other things equal, a higher capital gains tax 
rate would reduce the incentive for firms to invert.
Territorial versus world-wide taxation
    As noted above, the U.S. operates its tax system on what is 
essentially a world-wide basis. No country, though, operates a pure 
territorial or world wide system. About half of OECD countries operate 
systems that are essentially territorial, while the other half operate 
systems that are basically world-wide in nature. In theory, the 
differences between a pure world-wide system and a pure territorial 
system are large. A world-wide system taxes all income of residents 
regardless of where it is earned, gives credits for foreign income 
taxes paid, and defers taxation of foreign subsidiaries until the funds 
are repatriated. As noted above, these rules lead to complex provisions 
regarding foreign tax credit limitations, anti-deferral rules, and 
income and expense allocation. In contrast, a territorial system only 
taxes income earned within the country's borders and only allows 
deductions for expenses incurred within the borders. While a 
territorial system sounds simpler in theory, in practice it often turns 
out not to be. First, territorial systems have to define the income 
that is exempt. In practice, territorial systems tend to apply only to 
active business income. Even within that category, the territorial 
system may only exempt active business income (a) if it faces taxes 
above a certain threshold level in the host country, (b) from a certain 
type of business (e.g., e-commerce), and/or (c) from certain countries. 
Second, the treatment of non-exempt income must be specified. Third, 
the allocation of income and expenses across jurisdictions takes on 
heightened importance in a territorial system. For all of these 
reasons, territorial systems end up with complex rules regarding 
foreign tax credits, anti-deferral mechanisms, and allocation of income 
and expenses.
    Although the two systems are not as different in practice as in 
theory, they do have different tendencies that are worth noting. First, 
in a world of sophisticated and mobile transactions and firms, neither 
system is easy to operate. A territorial system is based on being able 
to define the geographic area where income is earned and expenses are 
incurred. A world-wide system is based on being able to define the 
geographic area where a corporation is resident. Both concepts are 
becoming increasingly difficult to assign and monitor and increasingly 
easy for firms to manipulate.
    Changing to a territorial system would be a curious and flawed 
response to corporate inversions (and corporate shelters more 
generally). Territorial systems make it harder to protect the domestic 
tax base. In a world-wide system, if firms go abroad, their income is 
still taxable. In a territorial system, it is not. Thus, going to a 
territorial system as a response to inversions would not make the 
underlying problem go away, it would simply ignore it by legitimizing 
and enhancing opportunities for behavior that should instead be 
prohibited or curtailed. It would be like legalizing a criminal 
activity as a way of reducing the reported crime rate.
    Finally, it should also be noted that territorial systems are not 
generally much simpler than world-wide systems, for reasons noted 
above. In addition, moving to a territorial system may generate 
difficult transition issues with respect to deferred income, deferred 
losses and accumulated tax credits in the old system. It may also 
require the renegotiation of numerous tax treaties. For all of these 
reasons, although there may be many reasons to consider a territorial 
tax system, switching to one does not seem to be a useful way to 
address the problems raised by export subsidies or inversions.
Fundamental tax reform
    In recent years, increased attention has been given to fundamental 
tax reform. Usually, this refers to the idea of eliminating the 
individual income tax, corporate income tax, and estate tax (and 
sometimes payroll and excise taxes, too) and replacing them with broad-
based, low-rate taxes on consumption.
    Four main alternatives have emerged in recent years. A national 
retail sales tax (NRST) would tax all sales between businesses and 
households. A value added tax (VAT) would tax each firm on the 
difference between the sales of goods and its purchases of goods from 
other businesses. (Alternatively, firms pay VAT on their sales of goods 
and receive tax credits for the VAT that they paid on their input 
    The NRST and VAT are similar in economic substance. First, the 
retail price of a good represents the entire value added of that good. 
Thus, the NRST collects all tax on the value added at the final sale to 
the consumer. The VAT, in contrast, collects the same amount of tax (if 
VAT and NRST rates are the same), but collects it at each stage of 
production. Second, both are consumption taxes.
    The similarity in structure between the VAT and the NRST indicate 
why it is appropriate for European countries to rebate VAT on exports. 
No one would expect a country to charge a retail sales tax on its 
exports. Thus, by rebating the VAT payments made up to the point of 
exports, European countries are giving firms the same treatment under a 
VAT as they would get under a retail sales tax.
    A third approach to fundamental tax reform--the flat tax--is 
probably the most well known and the best conceived. Essentially, the 
flat tax is a VAT that is divided into two parts. The flat tax would 
tax non-wage valued added at the firm level and wages at the household 
level. There are some other differences (the VAT taxes pension 
contributions when made, the flat tax taxes pension contributions when 
they are consumed; the VAT is destination-based whereas the flat tax is 
origin-based), but essentially the flat tax is a two-part VAT. This 
means that the flat tax is also a consumption tax, though it may not 
appear that way to consumers or businesses.
    A fourth approach is the so-called U.S.A. (unlimited saving 
allowance) tax, which combines a personal consumption tax and a VAT on 
businesses. Since both of these taxes are consumption taxes, the 
overall system would be a consumption.
    In considering replacements for the corporate income tax, however, 
there are only two fundamental reform options: the NRST and the VAT. 
The flat tax and U.S.A. tax would not be implemented without repeal of 
the individual income tax, too. For purposes of this testimony, 
therefore, I focus on the NRST and VAT. Moreover, since all European 
countries that experimented with national retail sales taxes eventually 
switched to a VAT, I focus exclusively on switching the corporate tax 
to a VAT in this testimony.
    Replacing the corporate tax with a VAT raises numerous issues. The 
main result, however, should be clear. The VAT would not be a panacea 
and although it offers the potential for improvement, it provides no 
guarantees of that, and indeed it creates several other identifiable 
    Although VATs can be described simply (see above), in practice VATs 
are extremely complex. Thus, one should compare existing corporate 
taxes to VATs as they would likely be created, not as they exist on 
    Basically, the broader the tax base (i.e., the fewer the number of 
zero-rated or exempt goods), the lower the tax rate can be and (with a 
few exceptions) the simpler the tax system can be. But if the VAT is 
the only tax affecting corporations, one can expect to see pressure to 
allow corporations to deduct health insurance payments, payroll taxes 
and State and local taxes as they currently do. If these deductions 
were allowed, the required rate would jump significantly. This in turn 
would create pressure to exempt certain goods--e.g., food, health 
insurance, housing--which would raise rates further. In addition, items 
like energy subsidies and other forms of ``corporate welfare'' could be 
implemented through the VAT. Unless some mechanism were developed to 
keep such subsidies out, the VAT base would be eroded like the 
corporate base currently is and rates would be quite high.
    Even if the VAT base is kept broad (and it is not in most European 
countries), there would be a fundamental conflict in the U.S. system 
with having an individual income tax but a VAT at the corporate level. 
Essentially, income could be sheltered indefinitely via retained 
earnings in corporations. This problem does not arise in Europe because 
European countries have a corporate income tax as well as a VAT.
    Also, under a VAT, firms have incentives to report any cash inflow 
as an interest receipt and any cash outflow as a deductible expense. 
This would give firms incentives, in their transactions with 
government, non-profits, and foreigners, to relabel cash flows. Zodrow 
and McLure in a 1996 paper declared that this feature of the flat tax 
(it is also a feature of the VAT) offered unacceptable opportunities 
for abuse. Again, these issues do not arise with VATs in Europe because 
those countries have corporate income taxes (that tax interest income).
    Switching from the corporate income tax to a VAT would likely be 
regressive. The ultimate incidence of the corporate income tax is 
unclear, but most estimates suggest it is borne by capital owners. The 
VAT, in turn, would be borne by consumers. In addition, the appearance 
of changes in distributional effects might prove very important: it 
would be hard to make the political case, for example, for a tax that 
raised the cost of food and health care for low-income families in 
order to reduce the costs for a multinational corporation to invest in 
a foreign country.
    The impact on growth of a switch would likely be positive, if the 
VAT were implemented in a simple broad-based way. But if a U.S. VAT 
ends up looking like a European VAT, the net effects on growth may be 
substantially smaller. Many papers suggest that replacing the entire 
U.S. tax system with a clean, broad-based, low-rate consumption tax 
would raise the size of the economy by about 1-2 percent over the next 
10-15 years. Certainly, replacing only one small portion of that 
system--the corporate tax--with a complex VAT would have significantly 
smaller effects.
    Unlike the current corporate or individual business taxes, the VAT 
does not attempt to tax profits as commonly understood. Changing the 
entire logic and structure of business taxation will create several 
situations that will be perceived as problems by taxpayers and firms, 
even if they make perfect sense within the overall logic of the VAT. 
First, some businesses will see massive changes in their tax 
liabilities. For example, the developers of the flat tax, Hall and 
Rabushka, note that General Motors' tax liability would have risen from 
$110 million in 1993 under the current system to $2.7 billion under a 
19 percent flat tax--and the flat tax offers deductions for wages, 
which a VAT would not.
    Some businesses with large profits will pay no taxes. This will 
occur because calculations of profit (before Federal taxes) include 
revenue from all sources and subtract expenses for a variety of items, 
including fringe benefits, interest payments, payroll taxes, and State 
and local income and property taxes. In the VAT, only revenues from 
sales of goods and services is included (financial income is omitted) 
and expenses on fringe benefits, interest payments and other taxes are 
not deductible. Thus, firms may be in the enviable position of 
reporting huge profits to shareholders, while paying no Federal tax. 
This sort of situation makes perfect sense within the context of the 
VAT. However, in the past, precisely this situation led to the 
strengthening of the corporate and individual alternative minimum 
taxes, which are universally regarded as one of the most complex areas 
of the tax code. It is hard to see why those same pressures would not 
arise in the VAT.
    Conversely, some firms with low or negative profits may be forced 
to make very large tax payments. Again, this makes sense within the 
context of the VAT, but will not be viewed as fair by firm owners who 
wonder why they have to pay taxes in years when they lose money and who 
will push for reforms.
    Finally, converting the corporate income tax to a VAT would raise 
difficult transition with respect to unused depreciation allowances, 
interest payments on previously incurred debt, net operating loss 
carryovers, excess foreign tax credits and so on.
    Turning to international issues, the generally lower tax rate on a 
VAT would cause firms to set transfer prices to shift some income into 
the U.S. But even with a lower-rate VAT, there would be big incentives 
for corporate inversions, especially for firms whose tax burdens rise 
under a VAT relative to the current system.
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    Senator Dorgan. Mr. Gale, thank you very much.
    Well, your testimony has offered a lot of opportunity for 
questions. Let me begin by asking Professor Avi-Yonah: Why now? 
Why are we hearing about inversions now? Were there inversions 
5 years ago, 10 years ago, by large corporations?
    Mr. Avi-Yonah. No, there were not. I mean, there were 
inversions as far back as the eighties, but really, what 
changed things was Tyco, because when Tyco inverted in 1997, 
people realized--before that, people thought there would be a 
relocation cost of coming to Bermuda in terms of corporate 
governance and the other issues that Attorney General 
Blumenthal mentioned. Tyco inverted, and suddenly, their stock 
price went through the roof, and as was also mentioned, that 
has an influence on management stock options and various things 
like that. There has now been an empirical study done about the 
impact of inversion on stock price decisions, and generally, 
the impact is favorable.
    The other thing that happened, as the Secretary also 
mentioned, was that the reduction in the value of shares in the 
stock market recently has meant that the fact that the IRS in 
1994 put a capital gains tax on the shareholders on inversion 
has not been a sufficient deterrent, because a lot of people 
even before that were tax-exempt, but now a lot of people do 
not have a lot of gain in their shares, and therefore, putting 
a tax at the shareholder level makes no difference. I also 
think that in general, management cares more about a reduction 
in the corporate tax than they care about what happens to 
    Senator Dorgan. I used the term ``renouncing their U.S. 
citizenship''; is that a fair term?
    Mr. Avi-Yonah. I think that is a fair term. I mean, 
basically, what is happening is that the parent corporation 
becomes a Bermuda corporation, and the American corporation 
remains a subsidiary, with no change in the operations, but in 
terms of formal citizenship, and certainly--taxation without 
representation--citizenship goes with paying taxes, and the 
effect of this is to reduce the tax.
    Senator Dorgan. And we invented corporations in this 
country as artificial persons who could contract and be 
contracted with. And so, Mr. Gale, you are not an artificial 
person; what happens if you renounce your citizenship? Are 
there consequences to that for you?
    Mr. Gale. I would presume so, and very severe consequences 
in terms of being able to vote, being able to benefit from 
certain Government programs.
    Senator Dorgan. So an artificial person that we have 
created here--and I support its creation--can contract, be 
contracted with, can sue and be sued. We have created this 
structure called an artificial person. It has citizenship 
rights and responsibilities as well. A real person, such as an 
Attorney General of Connecticut, if the real person renounces 
his or her citizenship, I assume there are consequences to 
    It sounds to me as if the only consequence to the 
renouncement of citizenship by an artificial person--that is, a 
corporation--is that they are able to pay lower U.S. taxes.
    Is that the case, Mr. Attorney General?
    Mr. Blumenthal. Well, they pay lower U.S. taxes, Senator, 
but they also have the self-interest or self-benefits of being 
above and beyond certain laws that otherwise would affect them.
    Senator Dorgan. The point you made in your testimony was 
very interesting, and I think a lot of people do not understand 
that point. Shareholders lose--the corporate entity gains by 
being able to avoid certain U.S. tax obligations, but 
shareholders lose certain rights. Can you amplify on that?
    Mr. Blumenthal. They lose certain rights that are critical 
to holding management accountable. Whenever management engages 
in self-dealing or malfeasance, right now, a shareholder can 
bring a derivative action, can sue the management and enforce 
those rights under our Federal and State securities laws. That 
effort becomes much more difficult, if not impossible, if a 
corporation inverts to Bermuda.
    Just to give you one very specific and concrete example, my 
office went to court on behalf of our pension funds, 
essentially, because Stanley Works issued misleading and 
potentially deceptive statements. We would not have been able 
to do so probably as effectively, and perhaps not at all, if 
Stanley Works had been at that time already reincorporated in 
    So the enforcement of legal rights becomes much more 
problematic, and that is why the status quo really is 
    Senator Dorgan. Were you taking legal action on behalf of 
shareholders, and did that result from shareholders gathering 
together and asking you to take legal action?
    Mr. Blumenthal. We took legal action on behalf of the 
pension funds of the State of Connecticut, as well as the 
State, and on behalf of shareholders, and employees and 
shareholders of Stanley were mislead about certain critical 
factors. One of them was the payment of capital gains, another 
was the loss of shareholder rights, and still a third was what 
exactly a non-vote meant in that context.
    But I think the central point that you are making, Senator, 
is that there are tremendously profound and far-reaching 
changes that occur legally once a corporation renounces its 
United States citizenship, and it is not only in the area of 
tax policy; it goes to basically holding citizens accountable, 
as we do in this country, more directly and immediately through 
our courts and our legal system.
    Senator Dorgan. But my point is that it is not to the 
disadvantage of the corporation itself, the structure of the 
corporation. That disadvantage would be to the shareholder.
    Let me put up a couple of charts if I might, because I want 
to address the question that Mr. Regalia has raised, and I 
think it is a question that others raise on behalf of those who 
    The first chart shows the share of the Federal tax burden, 
corporation versus payroll taxes. You will see that what is 
happening over a period of 50 years is that the share of 
corporate taxes a percentage of what we are collecting in this 
country is going down, down, way down; payroll tax is up, up, 
way up.
    So the fact is that corporations are by and large bearing a 
smaller percentage of the requirement to raise the income 
necessary for our Government.
    But the next chart shows that corporate income tax revenue 
as a percentage of gross domestic product--and this shows a 
whole range of countries--you cannot see it very well--but the 
yellow line is the United States, and we are somewhere closer 
to the bottom, certainly, than the midpoint or the top. Our 
corporate income tax revenue as a percentage of our GDP 
relative to other OECD member countries is relatively small.
    In light of that, let me ask you, Mr. Regalia--you and 
others, and Ms. Olson also, made the point that our tax system 
renders our corporations at a disadvantage when competing 
against other countries. How does that square with, for 
example, this chart which shows that, related to other OECD 
countries, we are relatively low, coming in with corporate 
income tax revenue? How does that square with the notion that 
we are somehow anticompetitive in our tax system?
    Mr. Regalia. Senator, in the spirit of balance, I will 
assume that I can take four times the amount of time to answer 
so I can address each and every criticism up here.
    First of all, with respect to your chart, it would be very 
interesting if you were to plot the relative GDP growth rates 
of those same countries, too, to see what it is about corporate 
tax rates and GDP that would correlate as well.
    With regard to what is happening in terms of that chart, it 
does not really show the relative tax vis-a-vis an individual 
corporation and its competitor in those countries as well.
    What is alluded to by Ms. Olson and myself is that if you 
take two companies in exactly the same situation, with 
operations here and operations abroad, it is unequivocal that 
the company that is domiciled abroad in that situation, whose 
headquarters is domiciled abroad, has a tax advantage over the 
one that is domiciled here. Otherwise, there would not be this 
issue, and there would not be this hearing, because there would 
not be any inversions if that were not the case.
    You have all admitted that in fact, the reason why 
companies inverted was to save money on taxes. I do not see how 
we can contend, then, that there is not an advantage to that.
    I think the question really is what should we do about it; 
what is the issue? Is the issue inversions? Is the issue 
earnings-stripping? And I think that a specific response to 
that problem would show that if we adjust our tax system, if we 
reform it in a way that removes the tax decision from where a 
company domiciles, we would not have this issue. And I think 
that that is at the heart of the matter, is why do companies 
invert. They invert because there is a disadvantage. It is not 
a question of patriotism.
    I think that the whole citizen question is an interesting 
spin on it, except that when I took civics, I learned that 
citizens get a chance to vote. Corporations do not vote. They 
provide income and jobs to individuals who do, but the 
corporation itself does not vote, and I think that that is a 
big difference when you talk about corporate citizenship versus 
determinations of business decisions as to where to domicile.
    Senator Dorgan. Mr. Regalia, I actually have plenty of 
time, so you will have plenty of time. But you actually 
answered a question I did not ask and then answered a question 
you posed, so let me see if I can straighten it out, because 
you covered that and then a lot of additional ground.
    You indicated that because someone can invert, a 
corporation can renounce its citizenship and go somewhere to 
save taxes, that means by definition that our tax system is 
unfair and places our corporations at a disadvantage to 
corporations domiciled in other countries. The fact point that 
a corporation can find a country someplace where it might save 
on taxation is one thing. I admit that that is the case. But 
that by itself does not suggest that we have a tax system that 
is fundamentally anticompetitive vis-a-vis other countries.
    The last time I asked the GAO to examine the tax burden of 
large U.S.-based companies, they found that 30 percent of the 
large U.S.-controlled companies--that is, with assets of $250 
million or more--doing business in the U.S. paid no U.S. income 
taxes. Now, I assume they are not at a competitive disadvantage 
to anyone. Would you agree with that? If you have companies 
with $250 million in assets, 30 percent of them paying no U.S. 
income taxes, they are hardly at a competitive disadvantage.
    Mr. Regalia. Companies that pay no tax because they have 
had loan losses that they carried forward, or depreciation 
allowances that are still in existence when the economy turns 
down and their profits go down and do not pay any taxes--that 
has nothing to do, really, with whether, over the course of 
time and the course of the economic cycle, a particular tax 
code is advantageous or disadvantageous to companies locating 
in one locale or another. So I think it is a different 
question, Senator.
    Senator Dorgan. In the last 10 years, if you were owning a 
company, running a company, would you sooner have been doing it 
in the United States or in Japan?
    Mr. Regalia. It really depends on what product I was 
producing, Senator.
    Senator Dorgan. Well, just generally.
    Mr. Regalia. I think that in general, given where I am and 
where I live, I would rather be producing in the United States. 
And in fact, many of the companies that have inverted, and many 
of the companies that compete internationally, do produce 
significant products in the United States.
    My own preference, being that I do not speak a foreign 
language, is that I would prefer to live in the United States. 
But once again, we are not really discussing, I do not think, 
where we want to live or where we want to domicile companies. I 
thought we were discussing the specific question of inversions 
in the Tax Code and whether the Tax Code is in need of reform 
in order to provide a level playing field for companies 
domiciled in the United States versus companies that produce 
the same products, compete in the same markets, but are 
domiciled elsewhere. That is the issue that I am prepared to 
discuss today.
    Senator Dorgan. Fair enough. I was asking the question 
because all of us understand that corporations largely have 
done better in the United States than in Japan in the last 10 
years given the two economies, including the tax codes of both 
    But aside from that, let me just ask quickly--and then I 
will ask a number of other questions of the other witnesses, 
too--do you get any tinge of concern or angst about seeing the 
kinds of things you saw on the video screen, where people say 
that patriotism probably ought to take a back seat here, that 
this is all about money and tax burden, and maybe patriotism 
has to take a back seat. Does that give you any tinge of 
concern or angst as a citizen?
    Mr. Regalia. Well, as I saw what was on the screen--and I 
do not mean to be mincing words, but words are important--they 
did not say that companies should renounce their U.S. domicile 
and move abroad, that they should ignore any patriotic 
implications. They said that in fact the overwhelming 
advantages in some cases have led some companies to make the 
    So I do not think that anyone on the screen was advocating 
that companies not be patriotic. In fact, I think companies, 
even those that are domiciled abroad, that maintain jobs and 
create income in the United States are doing something very 
    Senator Dorgan. Let me read the statement, though, because 
you have misrepresented the statement. This is the statement by 
the partner, Kate Barton, at Ernst and Young, and she says: 
``The improvements on earnings are powerful enough to say that 
maybe the patriotism issue should take a back seat.'' Do you 
have a problem with that?
    Mr. Regalia. Has led some companies to say that maybe the 
patriotism issue should--they were not saying----
    Senator Dorgan. No. That video was to clients, talking 
about whether they ought to invert or not, and she said ``maybe 
the patriotism issue should take a back seat.''
    Does that cause you any pangs at all?
    Mr. Regalia. Well, I am sorry, Senator, but as I saw it, I 
did not see the person say that.
    Senator Dorgan. I am reading it to you. We can play it 
    Mr. Regalia. Well, we can play it again, sir, but I am 
sorry--what I heard was somebody saying that the interpretation 
was that there were significant earnings differences, after-tax 
earnings differences, that have led some companies to make that 
decision to invert.
    I did not see anything where it said patriotism should take 
a back seat. I do not think it makes a difference, because----
    Senator Dorgan. I do not have the foggiest idea how you and 
I can have a discussion if we do not hear the same thing. The 
excerpt I played was clear.
    ``Maybe patriotism should take a back seat,'' the advisor 
says, and I am just asking the question, the value question, 
here about whether you have some pangs about that.
    Let me ask one additional question----
    Mr. Regalia. I do not believe patriotism should take a back 
seat, and I do not believe American companies believe that 
patriotism should take a back seat, nor do I believe even that 
inverted companies would say that patriotism should take a back 
seat, because I do not think that creating jobs and providing 
income for U.S. citizens is an unpatriotic act. And I do not 
believe that providing the best rate of return possible within 
the law for U.S. investors is an unpatriotic act.
    So yes, we do have a difference of opinion on what was said 
on that screen. We can play it again, but I believe that 
companies in the U.S. and companies that do business in the 
U.S. and create jobs in the U.S. are behaving in a patriotic 
    Senator Dorgan. Well, let me ask Mr. McIntyre, is it the 
case that a company that decides to change its mailbox and 
become a citizen of Bermuda is creating new jobs?
    Mr. McIntyre. No. They do not create any jobs at all except 
perhaps for Ernst and Young and maybe a part-time job for 
somebody to check the mail in Bermuda. What they do is stop 
paying taxes on their U.S. profits, and that is what we are 
talking about here today. The question is whether companies, 
like people, should have to pay something to support this 
    Now, I guess, if you think that we have to make our 
corporate system identical to the tax system of, let us say, 
Barbados, that we take the revenues, from what is already their 
second-lowest in the last six decades, down to zero, let us 
say, that we could then replace the revenue with--well, doggone 
if I know; that has not been brought up--but let us say we are 
talking about, once the economy comes back, $150 billion a year 
in revenue we need to replace. According to the Chamber of 
Commerce, we should take it to zero because that would be the 
competitive position. Well, yipes--that would mean raising 
income taxes on ordinary people by quite a bit, or it would 
mean eliminating half the Department of Defense. Take your 
    Senator Dorgan. Mr. Avi-Yonah, you and Mr. Regalia of the 
Chamber of Commerce have a disagreement in your testimony, I 
think, about whether or not our tax system is out of sync or 
out of balance or unfair, and therefore, it is our fault that 
these inversions are occurring.
    Describe the difference, and how do we resolve the 
difference in your testimony with Mr. Regalia?
    Mr. Avi-Yonah. Well, I think this chart is quite telling. 
These inversions are not to Germany and they are not to France. 
They are to Bermuda. Nobody is seriously suggesting that we 
adopt the taxes of Bermuda, except maybe Secretary O'Neill, who 
thinks we should not have a corporate income tax--but I do not 
think that is on the table.
    What is on the table is adopting, quote, 
``territoriality.'' Now, let me make an offer to Mr. Regalia. 
Why don't we actually adopt the system of France? The French 
tax overseas earnings of noncontrolled but 10 percent held 
subsidiaries of their corporation on all income with a tax rate 
that is below, say, 75 percent of the French tax rate, with an 
exception for companies that have real business activity and 
market growth in the country where they are.
    I think I would be quite supportive of our adopting that. 
That would mean that all the insurance companies and all the 
finance companies and all of those nice companies that are 
sitting in the Cayman Islands and in Barbados would pay 
American tax, and it would be much more restrictive than 
anything that we have today under Subpart F.
    It is the same with the Germans and the same with all of 
those so-called territorial systems. If you look at the 
details, and if you talk with people actually in Europe who 
complain bitterly about the competitive disadvantage of their 
companies vis-a-vis our companies because of their tax system, 
you hear that in fact there is a range. We are somewhere at the 
lower end of that range, exactly like on this chart, in terms 
of how tough our rules are--even some rules where we are 
notoriously tough, it turns out if you look at it that other 
countries have rules that are just as tough or tougher.
    It is just not accurate to say that we are at a competitive 
disadvantage with other countries.
    Senator Dorgan. Mr. Gale--I am going to ask Mr. Regalia to 
feel free to respond to that--but Mr. Gale, again from the 
standpoint of international competitiveness, is there an issue 
    Mr. Gale. The issue is that competitiveness is not the 
issue. If we, for example, allowed firms to expense all their 
investment in the first year it was taken, then, the effective 
tax rate on new investment would be negative. It would be zero 
if it were just expensed and financed out of equity, but 
because you can finance it by borrowing and deduct the 
interest, you would have a negative effective tax rate on new 
investments. That is the standard, cost of capital, Dale 
Jurgenson type of economic result that I think we can all agree 
    Doing that would reduce the cost of new investment in the 
United States below that of any of our major trading partners 
by far. It would have virtually no effect on the incentive for 
firms to invert. It would still be the case that our statutory 
rate would be higher than the statutory rate in Barbados or 
Bermuda, and there would still be huge incentive for firms to 
invert and to strip earnings out, either by interest payments 
or royalty payments, to strip earnings out of the United States 
and into a second or third country.
    So the competitiveness issue relates only to the effective 
tax rate on new investment. The incentive to invert depends on 
something entirely different, which is the statutory tax rate. 
Therefore, competitiveness is not the cause of inversions, or 
at least, it is not the cause of inversions that are designed 
to strip U.S. earnings out of the U.S. tax system.
    Senator Dorgan. Mr. Regalia, you may respond to those 
comments, but I would also ask you to respond to the idea that 
Mr. Gale advanced some while ago of changing the residency 
determination of corporations, which I think is an idea that 
has been kicked around some, and an interesting idea. Mr. Gale 
is saying that a corporation's residence is where they are 
doing their business, where their offices are, where their 
executives are, where they park their cars, where they get 
their mail in the morning. What is wrong with that?
    Mr. Regalia. I will respond to the questions in order. 
First, with regard to the chart and the comments by Mr. Avi-
Yonah, that chart shows the corporate income tax revenue as a 
percentage of GDP in those countries. So it is the corporate 
taxes paid to those countries by the companies working in those 
    This issue is about a U.S. company that operates 
multinationally versus a foreign company that operates 
multinationally and the tax each has to pay, not to everybody 
else but to the U.S. And in the U.S., the company that is 
domiciled in the U.S. has to pay taxes on its worldwide income 
and taxes on its U.S. income; whereas the foreign----
    Senator Dorgan. Mr. Regalia, wait. Let us stop at that 
point just to clear it up. We do have a worldwide system with 
tax credits for all foreign taxes paid.
    Mr. Regalia. No, not for all foreign taxes paid. We have a 
limited tax credit system that in almost no case compensates 
100 percent. So it does not bring the two back to ground zero. 
And that does not address the issue, of course, of earnings 
stripping or the ability to shift earnings to low-tax areas.
    But what I am trying to address is why that particular 
chart does not apply to this question----
    Senator Dorgan. Could we stay on that point for just a 
moment? Can we just clear up that point? Our foreign tax credit 
you are saying does not really cover the issue because U.S. 
corporations doing business abroad are paying a tax on some 
residual foreign income that the foreign tax credit does not 
    Can you describe for me how much income that is and what 
kind of a problem it is?
    Mr. Regalia. No, I cannot, because I cannot describe it for 
each company without knowing each company's internal books. 
    Senator Dorgan. I am talking about the aggregate. Are there 
aggregate numbers that you have?
    Mr. Regalia. No, I do not have aggregate numbers.
    Senator Dorgan. Then, what is the basis for saying that?
    Mr. Regalia. The basis for saying it is that it is in 
everybody's testimony. It was in Ms. Olson's testimony earlier, 
it was in the testimonies delivered to the House of 
Representatives when they had a hearing on this issue, where 
the limitations on the foreign tax credits are such that the 
foreign tax credit does not fully offset the worldwide nature 
of our tax system. And I do not have figures on it, but it is 
    Mr. Gale. Could I intervene for a second? There are two 
ways in which the foreign tax credit does not cover everything. 
One is if the--you can only offset foreign taxes in the current 
year to the extent that they equal what your U.S. taxes would 
have been. So if you pay 100 in foreign taxes, but your U.S. 
liability would have been only 80, you can take the 80 this 
year, and you take the 20 carrying forward.
    Senator Dorgan. That is right. You can carry it forward or 
    Mr. Gale. That is right. So that is one way in which it is 
limited in this particular year.
    The other way is that I don't think foreign non-income 
taxes are applicable to the foreign tax credit. I think it 
applies only to foreign income tax.
    Mr. Regalia. I think there are certain limits on passive 
losses as well.
    Mr. Gale. I understand that, but that is a Subpart F issue, 
not a----
    Senator Dorgan. I want to understand this issue. My 
understanding has always been that although we talk about a 
worldwide system, we are not trying to import a tax burden that 
belongs to some other country. We are saying to a corporation: 
If you pay taxes over here, we are going to give you a tax 
credit for the taxes you paid for income you earned in another 
    And I know it is highly complicated--the foreign tax 
credits are not a very straightforward part of the law--they 
are very complicated, but I do not think it is fair to say that 
we are importing all kinds of income from around the world.
    In fact, the studies that I have had done--I have had 
several of them done--suggest that there is a great deal more 
``nowhere'' income around the world than anything else. The 
biggest problem is no tax on income in significant parts of the 
    Mr. Regalia. The issue--again, the chart vis-a-vis 
everything else--that chart is what corporations pay foreign 
governments. It is not an issue as to how much they pay--how 
one company vis-a-vis a multinational company domiciled in 
another area, what their tax burden would be. And that is 
different, and if it were not different, we would not be here. 
There would be no reason to invert.
    Senator Dorgan. I agree with that point, but the point has 
been made that if that is the circumstance under which you make 
judgments, then, everybody should go to Bermuda, where they 
have a 27-person armed forces.
    Mr. Regalia. If in fact tax were the only reason, the 
answer would be yes; but the fact is the taxes are not the only 
reason, but they are a reason.
    Senator Dorgan. But your whole testimony today is to say 
that the tax system is the juice by which these people are 
moving. And if that is the case----
    Mr. Regalia. Well, Senator, yes, it is. At the margin for 
those companies that have moved, it has been a big issue. That 
is an undeniable fact.
    Senator Dorgan. But if that is the case, and there are no 
other issues with respect to--everything else is amoral or no 
ethics issues--then, why doesn't everybody go to Bermuda? And 
you would not object to that, I assume.
    Mr. Regalia. Everybody does not go to Bermuda because 
everybody is not in the same situation. Everybody does not have 
the same marginal impact of the Tax Code. But for those 
companies that have moved to Bermuda or other offshore 
domiciles, it has been, and the question is why.
    Now, you can try the ``lock the door'' method, and that is 
what has been suggested--let us lock the door; let us lock the 
door by changing the residency issue from one of tax to one of 
residency, or let us just lock the door, or let us exclude them 
from getting government contracts. But what the ``lock the 
door'' method does not address is the fact that there is a 
discrepancy and that that discrepancy is not addressed.
    In other words, it addresses the idea that you do not like 
a company moving, but it does not address why that company is 
moving. And I think what the testimony at least tried to 
suggest was that rather than addressing this with symptomatic 
salve and a bandaid, let us go at the disease or let us go at 
the issue itself and say why do they move.
    Senator Dorgan. But Mr. Regalia--and I am going to come to 
some other questions as well--but I guess I have two points on 
that. One, if I am a corporation, and I decide I want to invert 
or renounce my citizenship and go to Bermuda to save on taxes, 
one of the obvious reasons for that is that living in the 
United States, they have part of the obligation to bear the 
burden of a Defense Department that is going to pay out $360 
billion this year for U.S. security. And when they go to 
Bermuda, they have an opportunity to support a defense 
department that has 27 soldiers.
    Mr. Regalia. And to the extent that they work and create 
jobs and sell product and have operations in the United States, 
they pay U.S. taxes.
    Senator Dorgan. No----
    Mr. Regalia. Now, if what you are saying is will they shift 
the taxes, then, let us address the tax shift and not the 
inversion issue. Locking the door does not address the tax 
shift. The biggest part of the tax shift in this country is, 
then, what foreign companies pay and what they do not pay vis-
a-vis what U.S. companies pay and what they do not pay. The Tax 
Code ought to be fair. It ought to treat these different 
companies that operate in the U.S. equally.
    Senator Dorgan. Except that the purpose of inversion is to 
shift, as you know. But let me ask you this----
    Mr. Regalia. Well, I do not believe it is the only purpose. 
It certainly is one of the----
    Senator Dorgan. I have letters from companies--I assume 
they are members of the Chamber of Commerce; they are pretty 
sizeable companies--that I will ultimately put in the record.
    Mr. Regalia. Well, they may or they may not be, sir. I 
would have to take a look at them.
    Senator Dorgan. But are you speaking for all----
    Mr. Regalia. I am speaking for the members of the U.S. 
Chamber of Commerce, and they represent about 3 million 
    Senator Dorgan. Will those 3 million members support what 
you are saying today?
    Mr. Regalia. I think the 3 million members believe that the 
U.S. Tax Code should be adjusted to address this question so 
that they all pay a fair amount of tax, and that the companies 
in the same economic situation pay the same tax.
    Senator Dorgan. I was in Fargo yesterday. I will bet there 
are some Chamber members in Fargo that think it is disgraceful 
and unpatriotic to go through inversion and renounce your 
citizenship. What do you think of that? Do you think there are 
some who feel that way?
    Mr. Regalia. I think there are individuals and individual 
companies that are on all sides of this issue--there always are 
in a free country with freedom of thought; everybody has a 
different opinion--but I think that the majority of members 
believe that the taxes that are levied on corporations ought to 
be levied in a consistent fashion, and I think that that is 
what we are asking for.
    Senator Dorgan. Mr. Blumenthal, you have heard this 
discussion. You come at this from a slightly different 
perspective, because you are a chief law enforcement officer of 
the State of Connecticut. I was interested in your testimony 
because you talked about shareholders' rights, which is 
something that almost no one has focused on. Most of the 
articles that we see written talk about patriotism and talk 
about post-9/11 corporate issues and so on.
    I started this--and I want to say this for Mr. Regalia's 
purposes as well--I think there are some great companies in 
this country, some really great companies. I was on an airplane 
a while back, and a fellow two rows ahead of me whom I had 
never met before sent his business card back to me, and he had 
written on the back of it: ``I am the president of a 
corporation. I am honest, I work very hard and try to do the 
best job I can, and most corporate executives do the same.''
    And I sent him a note back and thanked him for it. And I 
understood why he sent me that card, because there is so much 
discussion about the corporations that have cheated and played 
fast and loose. My expectation is that inside the Chamber, for 
example, you must chafe and get angry about what has been 
disclosed by the board of directors of Enron itself, saying 
what happened there was appalling----
    Mr. Regalia. Absolutely.
    Senator Dorgan [continuing]. And shame on those people who 
did it.
    So we do not want to tarnish everyone here. There are a lot 
of great businesspeople out there who do create jobs, run good 
businesses, and I admire them. Especially in the last several 
years and in recent months, these disclosures of enablers--yes, 
Arthur Andersen enabling certain things to be done inside Enron 
that they should not have enabled, and law firms, and 
executives and so on--have, I think, created a climate in which 
the inversion question in terms of public policy is debated in 
a far different way than it would have been 2, 5, or 10 years 
ago. And that is fine with me, because I think these are basic 
questions about who we are and what we are doing and what kind 
of obligation we have as people, what kind of obligation 
corporations have as citizens of this country.
    So you come at this in a slightly different way. You, 
seeing a corporation in Connecticut talking publicly about 
inversion, go to court on behalf of shareholders. I guess what 
I would like to ask you is do you think this is a case, as Mr. 
Regalia suggests, of trying to slam the door shut in terms of 
what we are talking about in public policy here, trying to 
prevent inversions, instead of fixing other issues such as the 
Tax Code, or is it a circumstance, do you think, of 
corporations trying to take advantage of loopholes and trying 
to find a way to slide through the crevice and just avoid 
    Mr. Blumenthal. I think that it is an effort to take 
advantage of a loophole that exists in the law and that should 
be shut. The loophole creates the opportunity for tax 
avoidance, and Mr. Regalia may be right that there is a 
fiduciary duty on behalf of corporate management to maximize 
profits for shareholders. That is one way to view the duty of 
management, but it is not necessarily the top priority of all 
    And I agree with you that there is a significant body of 
corporate managers who may not want to put profits above 
patriotism, especially in the wake of 9/11 and many of the 
moving and inspiring statements that have been made by the 
President and other public officials, Members of the Senate, 
and State officials.
    But most important, I feel that we cannot postpone fixing 
this problem in the Tax Code until we do a complete overhaul 
and reform of the entire Tax Code. Mr. Regalia and I can agree 
that there ought to be a more equal footing for American 
companies vis-a-vis foreign competitors, and that perhaps there 
are other ways that the Tax Code should be improved to make 
that footing more equal. But I think this loophole has to be 
fixed now for the sake of companies like Stanley Works, just to 
put it in very specific and concrete terms, that is at a 
competitive disadvantage vis-a-vis its competing companies that 
produce the same products--Cooper Industries and Ingersoll-
Rand--and I suspect that that kind of comparison can be made in 
a variety of other contexts.
    So I would opt for fixing the broken leg now, even though, 
ultimately, the patient may need a hip repair or something more 
fundamental, and make sure that at least the patient can walk 
evenly and fairly.
    Senator Dorgan. Mr. Avi-Yonah--we have a vote starting in 
just a matter of moments, so I will not be able to continue 
this much longer--but the issue of competitiveness with respect 
to tax structures is a real issue. I do not know the real 
answer, but I know that it is a question that is worthy of 
asking. But tell me how important is the issue of the 
competitiveness of the tax structure in a global economy 
relative to the competitiveness of wages, environmental 
regulations, worker safety issues.
    One can make the case that, gee, we are just 
anticompetitive as heck, because we can find people who will 
make shoes for 16 cents an hour in some parts of the world with 
respect to minimum wages.
    Mr. Avi-Yonah. I completely agree with that.
    Senator Dorgan. So, where do taxes fit into all this 
competitive discussion?
    Mr. Avi-Yonah. Taxes is one element of a company's cost 
structure, and the ability of companies to make a profit is one 
element of a Nation's overall competitiveness. But what we 
really care about is the overall competitiveness of the United 
States' economy, which includes, for example, the ability of 
foreign corporations to come here and make products and other 
    There is no clear reason why subsidizing U.S. 
multinationals is the best way of improving the competitiveness 
of the U.S. economy, as opposed to investing in our workers, 
investing in our infrastructure, luring companies to put their 
research and development here, and many, many other ways in 
which we can use the Tax Code to encourage activities that have 
a proven beneficial--what the economists call ``positive 
externalities''--a proven beneficial effect on other people.
    If we encourage companies to come here and train people, 
then, these people can walk away from that company that trained 
them and take those skills and go somewhere else and use that 
to the benefit of the overall economy. If we give a company a 
tax break, maybe they will use that money to advantage the U.S. 
society; maybe they will distribute it as a dividend to their 
shareholders. Most American companies now have a lot of foreign 
shareholders. It is not at all clear that this would be 
something that would give a competitive advantage to U.S. 
society as a whole.
    Senator Dorgan. Mr. McIntyre, in your testimony, you talked 
about the growth of abusive tax shelters and your great concern 
about that, inversion being only one of them. Can you expand on 
    Mr. McIntyre. Well, it looks like between inversions and 
various other activities that companies are engaging in, some 
of them legal, some of them illegal, some of them right on the 
edge, it is probably about a $50 billion a year loss to the 
government these days from offshore shelters.
    They got a big boost in the late 1990's with a mistaken 
Treasury regulation that basically opened the door to doing 
almost anything you wanted and getting around all of our 
Subpart F anti-abuse rules by routing it through a real 
    We have now run shelters that go through Germany on their 
way to Liechtenstein due to a mistake by the Clinton Treasury 
that, when they tried to correct it, the House Ways and Means 
Committee said: Oh, no. You can open loopholes up by mistake, 
but you sure as hell cannot close them.
    That one was huge. Nobody knows--the articles at the time 
when that was discovered called it ``the end of the corporate 
income tax.'' It has not gotten there yet, but it is on its 
    So it is a huge problem, and it needs to be addressed, and 
it can be addressed very straightforwardly. Right now, we just 
have so many holes in our Swiss cheese of anti-abuse rules that 
we need to step back a couple steps and say, wait a minute--we 
have anti-deferral for this, but no anti-deferral for that, so 
companies call this that, and they win.
    How about if we just get rid of deferral and tax companies 
on what they make, worldwide, as it is said, but with a full 
credit for foreign taxes paid so that--the rounding error on 
how much American companies pay on their foreign income, with 
the rounding error, the amount paid is zero. I am not sure--it 
might be slightly negative, possibly $100 million a year, but I 
think probably closer to minus-something.
    So that, yes, we tax companies on their foreign profits, or 
what they would like to call their foreign profits, and we say 
they are not foreign because they are not, but we do not tax 
them on real foreign profits. They know that, and they are just 
trying to recharacterize their income.
    Anyway, back to what you started with--I am rambling here--
but the foreign offshore tax shelter issue is threatening to 
swallow the whole corporate income tax. Bermuda fortunately has 
focused the public's attention on it. We need to strike while 
the iron is at least slightly warm, or we will be looking for 
ways to pay for our government and will not be able to find 
them in the future.
    Senator Dorgan. Mr. Regalia, finally, why are we unable to 
find anyone other than you to come to a hearing, and assume 
that side of the debate?
    Mr. Regalia. Sir, that is a question I cannot possibly 
answer. I do not even know who you invited. I know that we at 
the U.S. Chamber feel strongly about this issue. We were very 
happy to be able to come here and represent the business 
community, and we thank you very much for the opportunity to do 
    Senator Dorgan. I appreciate you being here. In fact, I 
should just say that everyone we invited turned us down except 
for you, so I do appreciate you coming.
    One last question. Do you think that all of these newspaper 
stories, and the tone of this hearing and the question of 
patriotism are all unfair to business?
    Mr. Regalia. Well, I think that business plays such a 
central role in the economy that issues like this are always 
going to be of great concern, both to individuals, to people in 
political positions, and to the people who have jobs at those 
businesses and whose incomes depend on those businesses being 
    So I think it is important to look at issues like this, and 
it is important to try to formulate solutions that meet 
everyone's concern, that leave our businesses paying taxes to 
support the public goods that the government provides and also 
to leave businesses competitive to create jobs for our citizens 
and create income so that they can pay taxes, too.
    So I certainly believe that it is an issue and a concept 
that deserves to be explored.
    Senator Dorgan. And is it fair, do you think, to make the 
point that if we pay 10 times more for defense than England or 
France, somebody has to pay that, and American business feels 
that it has a responsibility to bear a part of that burden 
because it also benefits from our country having the capability 
to make sure that their assets are not appropriated overseas 
and elsewhere--do you agree----
    Mr. Regalia. Absolutely, and I agree that foreign companies 
that do business in the United States and share the benefits of 
our great work force, our very productive economy, our 
tremendous rule of law, and our national defense should be on 
the same competitive basis with their U.S. counterparts.
    Senator Dorgan. And there is perhaps a reason why we have a 
higher tax burden on corporations in the United States than in 
Bermuda; would you agree with that?
    Mr. Regalia. Oh, certainly. I think that the issue of what 
our corporate tax rate is vis-a-vis what others' corporate tax 
rate is is not really the issue at debate here today. The issue 
at debate here today is the issue of inversions and the issue 
of one multinational's relative tax relative to another 
multinational's, based solely on their country of domicile.
    Senator Dorgan. Mr. Gale, I have long admired your work at 
The Brookings Institution, and you are a Senior Fellow and 
Deputy Director of Economic Studies. That sort of takes this 
several steps up in terms of loftiness, I guess--maybe I am 
wrong about that.
    Mr. Gale. ``Deputy Director'' is a long title with not many 
    Senator Dorgan. I see. Give me your summary of where we are 
now on this matter, which I think is an important issue. We 
have legislation, we have a debate about whether inversions are 
a problem. The Assistant Secretary today said that inversions 
are cause for concern which, was, I think, a change in response 
from Treasury, and I appreciate that change in response.
    I think Treasury, like others, is beginning to be concerned 
about the ramifications of all this. They understand that we 
face some pretty daunting challenges. We have a reduced income 
stream at the Federal level, and surpluses have turned to 
deficits, so we have got to be concerned about tax shelters, 
inversions, our revenue base at the Federal level. And the 
Treasury Department today, on the issue of inversions, said 
that they are concerned about them and the potential revenue 
    Mr. Gale. I think you summarized very nicely. I will just 
add a couple of things. One is that not only did the Treasury 
indicate that it is a problem, but they indicated that the loss 
of domestic tax revenue on domestic operations is a big 
problem. To me, that is very important, because that crosses a 
huge line about inversions and what is motivating them and what 
the proper policy response is.
    I think it is important to keep in mind that 
competitiveness is not the issue in stripping earnings out of 
American subsidiaries into foreign parents. It is a statutory 
tax rate issue.
    I think most of the proposed solutions miss the mark. In 
particular, I think Treasury's comes up short in not dealing 
with royalties and in advocating a territorial system.
    I will just mention one other thing that has not come up, 
but I think it is important. When a firm does invert, the 
shareholders of the American subsidiary have forced 
realizations. They have to pay capital gains taxes on the 
realization. That capital gains tax acts as a natural break, as 
a disincentive for firms to invert. That means that lower 
capital gains tax rates encourage inversions.
    So we hear the routine bowing in the favor of lower capital 
gains taxes. People like me have said for years that they have 
unintended consequences. One of the unintended consequences is 
that they have encouraged firms not to pay out dividends, which 
has led to Enron-type things. Another of the unintended 
consequences is that they encourage firms to invert.
    So, as we think about tax policy more generally, we need to 
think about all the pieces of the puzzle.
    Senator Dorgan. You are just trying to start another one-
hour debate with Mr. Regalia.
    Mr. Regalia. It would take much longer than that, sir.
    Mr. Gale. We have had that debate; that is right.


    Senator Dorgan. Let me thank all the witnesses for 
appearing today. Your full statements will be a part of the 
permanent record.
    We have statements from others and, by consent, I will keep 
the record open.
    Accenture, while they did not want to appear, have 
submitted a written statement.
    The AFL-CIO has submitted a written statement.
    We will keep the record open until the close of business 
today for the inclusion of other statements that are sent to 
    [The statements follow:]

                   Prepared Statement of the AFL-CIO

    The AFL-CIO is pleased to have the opportunity to express our 
concerns about American companies reincorporating to tax havens such as 
Bermuda. We commend the Subcommittee for holding this important 
hearing. While there are a variety of issues raised by corporate flight 
from the United States, our testimony will focus on the corporate 
governance implications of these arrangements. Though some argue these 
corporate inversions are in the interests of corporations and their 
investors, we believe they shelter corporate management from 
accountability to investors and that is why they are opposed by leading 
institutional investors and have become increasingly difficult to 
effectuate in the face of growing shareholder opposition.
    The 13 million members of the AFL-CIO's member unions participate 
in benefit funds with over $5 trillion in assets. Our members' funds 
have lost tens of billions of dollars as a result of the collapse of 
corporations where there appears to have been significant wrongdoing. 
In this context, our funds and our members' corporate governance rights 
in the companies we invest in are critical both to preventing 
wrongdoing and to recovering lost assets if wrongdoing does occur.
    A growing number of companies are seeking to ``reincorporate'' from 
the U.S. to tax haven countries to avoid paying taxes on non-U.S. 
income. In general, the disadvantages of these reincorporations 
outweigh the advantages for shareholders because these reincorporations 
reduce the legal protections given to shareholders and also reduce 
shareholders' ability to hold companies, their officers and directors 
accountable in the event of wrongdoing.
    In light of highly publicized recent events at other publicly 
traded companies such as Enron, WorldCom, Tyco International, and 
Global Crossing, worker pension funds have become more sensitive to 
issues of corporate accountability. We want to be sure we are able to 
seek appropriate legal remedies on behalf of our worker beneficiaries 
in the event of any corporate wrongdoing--when companies elect to 
incorporate in Bermuda our ability to do so is limited.
    We believe this trend represents a significant threat to 
shareholders and the pension funds of working people. These 
reincorporations can diminish shareholders' rights, and set in motion a 
race to the bottom that generally lowers the standards of corporate 
    For these reasons, the AFL-CIO and its member unions have in the 
last 6 months led efforts by shareholders at two companies, Nabors 
Industries and Stanley Works, to oppose efforts at reincorporation in 
    On June 14, 2002, only 65 percent of the shares at Nabors 
Industries approved the company's proposal to reincorporate to Bermuda, 
a very low vote total for a management proposal. A coalition of 
institutional investors--the Amalgamated Bank, the AFL-CIO, the Central 
Laborers' Pension Fund and the Laborers' International Union of North 
America--opposed the move based on concerns about its adverse impact on 
shareholder rights and doubts over the economic benefits of the 
reincorporation. The principle reason Nabors gave for reincorporating 
is lower tax bills, although Nabors did not quantify the savings.
    In our effort to preserve shareholder rights and corporate 
accountability at Nabors, we gained the support of several influential 
public pension funds. These public funds included the New York State 
Common Fund, New York City funds (all five), Connecticut Retirement 
Plans and Trust Funds, State of Wisconsin Investment Board and 
California Public Employees Retirement System. Also due in part to our 
efforts, the investment management community is becoming increasingly 
concerned about the effects of these reincorporations on shareholder 
    We believe the disclosure about the impact on shareholder rights 
and the tax effects did not comply with Federal securities law or with 
Nabors fiduciary duties of disclosure under Delaware law. The AFL-CIO 
has joined a lawsuit brought by individual investors of Nabors in 
Federal District Court in Houston, and that lawsuit is proceeding.
    Following the Nabors efforts, the AFL-CIO joined together with our 
affiliated union the International Association of Machinists and 
Aerospace Workers, which represents Stanley Works employee 
shareholders, and the Connecticut Retirement Plans and Trust Funds to 
oppose the reincorporation of Stanley Works. The company agreed to a 
revote after the Attorney General of Connecticut raised concerns that 
the company misrepresented facts regarding the vote to its employees. 
The first vote approved the reincorporation by less than one percent. 
But then following a large demonstration by Stanley Works employee 
owners against reincorporation on July 29, 2002, the company abandoned 
its efforts to reincorporate in Bermuda. We believe they did so because 
they could not win the shareholder vote.
    Delaware is the State of incorporation for 60 percent of Fortune 
500 companies, according to the Delaware Division of Corporations. We 
believe that so many companies choose to incorporate in Delaware 
because it has an advanced and flexible corporate law, expert 
specialized courts dealing with corporate-law issues, a responsive 
State legislature and a highly developed body of case law that allows 
corporations and shareholders to understand the consequences of their 
actions and plan accordingly. Bermuda, by contrast, does not even have 
published reports of legal cases, making it difficult to determine how 
the courts have ruled on corporate law issues. It is also difficult to 
obtain access to books on Bermuda law, since public law library 
resources are almost non-existent. We believe the stability, 
transparency and predictability of Delaware's corporate-law is superior 
to Bermuda's and provide advantages to shareholders.
    While many investors have concerns about aspects of corporate law 
statutes and the interpretation of those statutes in Delaware, and 
shareholder activists have long worried that incorporation in Delaware 
represented a race to the bottom, Delaware law is clearly superior to 
Bermuda law from a shareholder perspective.
    Reincorporation in Bermuda substantively reduces shareholder rights 
and corporate accountability. In those areas of the law under which 
shareholders continue to enjoy the same rights--for example Federal 
securities law--shareholder's substantive rights may not be affected by 
the reincorporation, but their procedural ability to enforce those 
rights is weakened.
    By incorporating in Bermuda companies may make it more difficult 
for shareholders to hold companies, officers and directors legally 
accountable in the event of wrongdoing. It is crucial that shareholders 
have ability to pursue legal remedies to deter wrongdoing. If a company 
reincorporates to Bermuda, it may be more time consuming and expensive 
to hold that company or its officers and directors accountable in U.S. 
courts for several reasons. A judgment for money damages based on civil 
liability rendered by a U.S. court is not automatically enforceable in 
Bermuda. The U.S. and Bermuda do not have a treaty providing for 
reciprocal enforcement of judgments in civil matters. A Bermuda court 
may not recognize a judgment of a U.S. court if it is deemed contrary 
to Bermuda public policy, and Bermuda public policy may differ 
significantly from U.S. public policy.
    Unlike Delaware, Bermuda does not generally permit shareholders to 
sue corporate officers and directors derivatively--on behalf of the 
corporation--to redress actions by those persons that harm the 
corporation. Shareholder derivative suits recognize that a corporation 
is unlikely to pursue claims against the same officers and directors 
who control it and provide, we believe, a critical mechanism for 
remedying breaches of fiduciary duty, especially breaches of the duty 
of loyalty.
    A derivative lawsuit under the laws of the jurisdiction of 
incorporation is the primary remedy available to shareholders if an 
officer or director of their company is stealing from the business. 
Federal securities laws do not provide a direct remedy for this most 
basic form of wrongdoing. Bermuda law limits derivative lawsuits to a 
narrow set of specific circumstances primarily involving acts that are 
beyond the authority of the officers and directors to take as a 
statutory matter. As a result, we believe, though we cannot be sure in 
light of the secretive nature of Bermuda's legal system, that no 
derivative actions have been filed by shareholders against the officers 
and directors of either Tyco or Global Crossing.
    In addition, in Delaware and many other States the shareholder 
lawsuit has evolved to give investors remedies in a variety of 
situations, such as in circumstances where company management may be 
interfering with shareholders' exercising their proxy voting rights, or 
where management may be misleading shareholders in an effort to obtain 
their consent to a corporate action. It is unclear at best whether 
shareholders have these important rights of action under Bermuda law. 
Thus the steps that were taken both by shareholders and by the State of 
Connecticut to protect shareholders' rights after the first tainted 
Stanley Works reincorporation vote would probably not have been 
possible had Stanley Works actually been a Bermuda corporation.
    Bermuda law also differs from Delaware law in ways that may limit 
shareholders' ability to ensure accountability and participate in 
corporate governance. Bermuda law requires unanimous written consent of 
shareholders to act without a shareholders' meeting. Delaware law 
contains no such prohibition, although it allows companies' charters to 
limit the right. In the event a Delaware company does elect to include 
such a provision in its charter, shareholders can request that the 
board initiate a charter amendment to remove it.
    Unlike Delaware law, Bermuda law does not require shareholder 
approval for a corporation to sell, lease or exchange all or 
substantially all of the corporation's assets. Thus, a Bermuda company 
can significantly change its business without seeking shareholder 
    At Bermuda companies like Tyco and Global Crossing, shareholders 
appear to have been unable to assert the kinds of legal claims for 
breach of fiduciary duty one would expect to see given what has 
occurred at those companies.
    In addition, when worker funds have attempted to exercise basic 
shareholder rights under Federal securities laws, Tyco has taken the 
position that those laws did not apply to Tyco in the same way they 
applied to U.S. incorporated companies.
    It concerns us that many of these transactions have been structured 
in a way that executives receive large payments in connection with the 
reincorporations. The combination of these structures and reduced 
accountability suggest that management may have other reasons to 
reincorporate besides tax benefits.
    We understand there is bi-partisan support for a legislative 
response to this problem, and we encourage Congress to take swift 
action. The AFL-CIO is in full support of S. 2119, Reversing the 
Expatriation of Profits Offshore Act, and H.R. 3884, the Corporate 
Patriot Enforcement Act.
    Beyond our shareholder concerns, we believe that it is unpatriotic 
for corporations to place a larger burden on other taxpayers while 
still benefiting from the stability and privileges this country 
provides. America's working families pay their taxes, and expect that 
American corporations will do the same. Simply put, reincorporation is 
a poor decision and should be reevaluated by all who promote good 
corporate citizenship and governance.
    The AFL-CIO urges this Subcommittee and this Congress to support 
legislation that puts a stop to these corporate inversions. The AFL-CIO 
looks forward to working with you in the coming days on this important 

                  Prepared Statement of Accenture Ltd.

    Accenture recognizes the legitimate concerns being raised regarding 
corporate inversions. Since we have been mischaracterized as a 
corporate inversion, we respectfully submit written comments to the 
Subcommittee on Accenture's incorporation and previous structure as 
well as our views on legislative proposals designed to address the 
corporate inversion issue.
Accenture Did Not Engage in a Corporate Inversion Transaction
    Accenture is one of the world's largest management and technology 
consulting organizations with more than 75,000 employees worldwide, 
including 26,000 in the U.S. Accenture is, and always has been, a 
global organization. Accenture has never been a U.S.-based or operated 
organization and has never operated under a U.S. parent corporation. 
The majority of Accenture's partners, employees and revenues are 
outside the U.S. and were never a part of Accenture's U.S. operations. 
Further, the majority of Accenture's partners and employees are not 
U.S. citizens.
    Accenture newly incorporated in Bermuda in 2001; Accenture did not 
reincorporate in Bermuda. Before incorporation, Accenture operated as a 
group of more than 40 locally-owned partnerships and other entities in 
47 countries coordinated by contract through a Swiss-based entity.\1\ 
In 2001, Accenture's 2,500 partners, more than half of whom were non-
U.S. citizens, chose to move to corporate form and seek a public 
listing in order to build the capital structure necessary to fuel the 
company's continued growth. With thousands of partners and employees of 
many nationalities, it was particularly important, as a cultural 
matter, for the organization to select a neutral place of incorporation 
for its parent company. Accenture's partners voted to incorporate the 
parent company, Accenture Ltd, in Bermuda.
    \1\ This structure has been in place since at least 1989, when 
Accenture separated from the Arthur Andersen firms. In 1990, the U.S. 
Securities and Exchange Commission formally recognized Accenture as an 
entity separate and distinct from Arthur Andersen LLP. In August 2000, 
based on an arbitrator's decision in the International Chamber of 
Commerce proceedings commenced by Accenture in 1997, all remaining 
historical contractual ties between Accenture and Andersen Worldwide, 
and as a result, Arthur Andersen, were completely severed.
    On October 1, 2002, the General Accounting Office (GAO) issued a 
report that identified those of the top 100 publicly traded Federal 
contractors incorporated offshore. GAO identified three that ``have 
engaged in transactions that have been characterized as inversions.'' 
\2\ Accenture was not one of the three. GAO also accurately describes 
Accenture's previous structure and incorporation.
    \2\ GAO-03-194R Federal Contractors Incorporated Offshore 
(Washington, DC: October 1, 2002), at 3.
No Income Previously Subject to U.S. Tax was Removed from the U.S. Tax 
    Today, as in the previous structure, each Accenture entity pays tax 
in the country in which it operates. Accenture pays, and has always 
paid, U.S. tax on income generated by its U.S. operations. Accenture 
operates in the U.S. through its subsidiary Accenture LLP. Under the 
prior structure, Accenture LLP paid U.S. taxes through its individual 
U.S. partners. Currently, taxes are paid on income earned by 
Accenture's U.S. subsidiary through the U.S. corporation that owns it. 
Further, none of the income generated by Accenture's non-U.S. 
partnerships or entities was ever subject to U.S. tax. Therefore, no 
U.S. income or non-U.S. income previously subject to tax was removed 
from the U.S. tax base by the incorporation of Accenture. Even the GAO 
recognized that companies incorporated offshore ``may have U.S. based 
subsidiaries that pay U.S. taxes''.\3\
    \3\ Id. At 1.
Accenture Does Not Oppose Enactment of Legislation or Implementation of 
        Regulations to Appropriately Address Tax Issues
    Concerns have been raised that offshore incorporation and 
complicated corporate structures can be used to reduce income in the 
U.S. and thus reduce the payment of U.S. taxes. Accenture did not 
intend to use, and is not using, its structure to achieve ``earnings 
stripping''. Like most multinational companies, Accenture Ltd and its 
subsidiaries engage in usual and customary cross-border transactions in 
the ordinary course of business. These transactions are executed in 
full compliance with all applicable tax laws of the U.S. and other 
countries. To the degree there is a conclusion that the existing U.S. 
tax laws and regulations are not adequate to prevent abuse, Accenture 
does not object to appropriately addressing those concerns. For this 
reason, Accenture is not opposed to S. 2119, the Reversing the 
Expatriation of Profits Offshore Act, approved by the Senate Finance 
Committee on June 28, 2002.\4\
    \4\ By using a 50 percent shareholder ownership threshold to define 
``limited inversions'', S. 2119 may cover certain transactions that are 
not inversions. As the Tax Section of The New York State Bar 
Association stated in Report on Outbound Inversion Transactions, 
``imposing extraordinary remedies at the lower end of the 50 percent-80 
percent scale frequently will not be appropriate and that 
considerations should be given to raising the minimum threshold from 50 
percent to 60 percent to reduce the number of legitimate mergers and 
acquisition transactions caught in their grasp.'' Report No. 1014 
(Albany, NY: May 24, 2002), at 61.
    Accenture also does not oppose the Department of Treasury proposals 
to address earnings stripping.\5\
    \5\ Testimony of Pamela Olson, Acting Assistant Secretary (Tax 
Policy), United States Department of Treasury before the House 
Committee on Ways and Means, on Corporate Inversion Transactions 
(Washington, DC: June 6, 2002), at 3-8.
Accenture Strongly Opposes Efforts to Ban the Award of Federal 
        Contracts to U.S. Subsidiaries of Foreign Companies
    Accenture strongly opposes, however, the proposals to ban the award 
of Federal contracts to offshore entities or their U.S. subsidiaries, 
and is deeply concerned about the unintended consequences on 
communities across America that could result from such a ban. Many of 
Accenture's U.S.-based employees work with Federal, State and local 
agencies to implement technology solutions and provide other services 
that make governments more efficient and effective. Companies that 
completed legal and legitimate transactions in full compliance with 
current law should not be barred on a blanket basis from contracting 
with the Federal government. Such a sanction would be extreme and 
without precedent. Moreover, the Federal procurement system is designed 
to promote the use of contractors ``who have a track record of 
successful past performance or who demonstrate a current superior 
ability to perform,'' while promoting competition.\6\ Eliminating 
world-class competitors on a blanket basis without regard to their 
capability to perform could deprive the U.S. of receiving the best 
goods and services at the best prices.
    \6\ FAR 1.103.
    Thank you for the opportunity to provide our comments on the 
corporate inversion issue.

                  Question Submitted to Patricia Olson

         Question Submitted by Senator Ben Nighthorse Campbell

    Question. In your statement, you mentioned the obvious tax 
disadvantage of domestic companies to compete with foreign 
counterparts. Do you believe the major underlying motivation for 
corporate inversions is the ability compete with foreign competitors? 
If so, do you believe that we should legislate a system that enables 
these corporations to compete internationally when their procedure is 
currently legal?
    Answer. The Administration has concluded an immediate response is 
required that addresses the income minimization strategies associated 
with inversion transactions--strategies that can be employed to reduce 
the inverted company's U.S. tax on its income from its U.S. operations. 
An immediate response is required for two reasons. First, these 
strategies unfairly advantage inverted or other foreign-based companies 
over U.S.-based companies. Second, these strategies have a corrosive 
effect on the public's confidence in the U.S. tax system.
    We cannot just address strategies that inappropriately minimize 
U.S. income, however. We must also address the tax disadvantages 
imposed by our international tax rules on U.S.-based companies with 
foreign operations. The burden imposed by our international tax rules 
on U.S.-based companies with foreign operations is disproportionate to 
the tax burden imposed by our trading partners on their companies' 
foreign operations. The recent inversion activity and the increased 
foreign acquisitions of U.S. multinationals evidence that fact and the 
significant consequences that may have for U.S. businesses and the U.S. 
economy. The U.S. rules for the taxation of foreign-source income are 
unique in their breadth and complexity. It is time to revisit them. Our 
rules should not disadvantage U.S.-based companies competing in the 
global marketplace.
    Our overarching goal is maintaining the U.S. position as the most 
desirable location in the world for incorporation, headquartering, 
foreign investment, and business operations. In short, that means 
keeping jobs in the U.S., creating jobs in the U.S., and bringing jobs 
to the U.S.

                   Question Submitted to William Gale

            Question Submitted by Senator Richard C. Shelby

    Question. Many government contracts are awarded to companies that 
take advantage of offshore tax havens. How can we ensure that companies 
that take advantage of offshore tax havens do not place U.S. companies 
at a competitive disadvantage when there is a competition for federal 
contracts? Do you believe that our current contracting policy gives due 
consideration to U.S. based companies?
    Answer. The best way to ensure that companies that try to take 
advantage of offshore tax havens do not place U.S. companies at a 
competitive disadvantage when competing for federal contracts is to 
stipulate that companies that have their management and executive 
offices housed in the United States will be treated for tax purposes as 
if they were incorporated in the U.S. These companies benefit from 
America's educated workforce, public services, defense, infrastructure, 
and so on, and the companies acknowledge this implicitly by choosing to 
house their corporate offices here. Simply changing the definition of a 
U.S. corporation to one that is based on where their management is 
located, rather than one that files incorporation papers here, would 
solve most of these problems.
    I believe that our current policy toward federal contracting gives 
too much weight to inverted companies if it treats them on an equal 
basis with companies that have not inverted.

                 Question Submitted to Reuven Avi-Yonah

            Question Submitted by Senator Richard C. Shelby

    Question. Many government contracts are awarded to companies that 
take advantage of offshore tax havens. How can we ensure that companies 
that take advantage of offshore tax havens do not place U.S. companies 
at a competitive disadvantage when there is a competition for Federal 
contracts? Do you believe that our current contracting policy gives due 
consideration to U.S. based companies?
    Answer. Companies that take advantage of offshore tax havens have a 
competitive advantage in bidding for Federal contracts because of the 
lower tax costs they face. Given that there is no economic substance to 
such companies' presence in the tax havens, and no meaningful 
difference between them and their U.S.-based competitors other than the 
tax differential, this advantage is unfair. I would therefore support 
banning such companies from bidding on U.S. government contracts.

                         CONCLUSION OF HEARING

    Senator Dorgan. I thank the witnesses for appearing.
    This hearing is recessed.
    [Whereupon, at 12:08 p.m., Wednesday, October 16, the 
hearing was concluded, and the subcommittee was recessed, to 
reconvene subject to the call of the Chair.]