A little-mentioned reason for corporate mergers between an American corporation and a foreign company is potential tax savings. The American corporation buys a foreign company and takes advantage of the increased foreign ownership to reincorporate in a country with a lower tax rate. Thus, some American corporations have saved hundreds of millions by engaging in mergers or acquisitions with foreign companies.

One recent example is a California chip maker, Applied Materials, which had a merger with a smaller Japanese rival, Tokyo Electron, and then reincorporated in the Netherlands. The bottom line to Applied Materials: it will go from a 22 percent tax rate to a 17 percent rate. Because the company had nearly $2 billion in profit in 2011, that equates to a savings of about $100 million a year.

Reincorporating in low-tax havens is called an inversion. It’s done in places like Bermuda, the Cayman Islands or Ireland, to name some popular locations. Regulations in recent years have made it more difficult for companies to simply open a new office abroad or move to where they already do business. Thus, most inversions are done through multibillion-dollar mergers and acquisitions involving essentially having to first increase foreign ownership in the American company.

With companies saving millions in taxes by this procedure, the downside is the loss of hundreds of millions to the United States treasury. As a result, the Jobs Creation Act of 2004 included a provision that made it more difficult to invert, requiring that companies have substantial business activity in the foreign country. The final result is that the American company must have an increase in foreign ownership of its stock to at least 20 percent.

However, it’s controversial and perhaps unpatriotic for a company to admit it’s doing this to cut its tax bill. According to a Harvard Law School professor, the savings should be only a side benefit of a strategic rationale for mergers. But the trend continues for corporations in California or other states to reincorporate in European locations like Ireland or the Netherlands, rather than the infamous Caribbean locations. This reality places acute pressure on the Obama Administration to find ways to make it more attractive for companies to forego mergers with foreign reincorporation.

Source: The New York Times, New Corporate Tax Shelter: A Merger Abroad, David Gelles, Oct. 8, 2013