Note: If you would like to watch a live video of the Senate hearing, you can do so by clicking this link to the U.S. Senate’s Committee on Finance’s website.
Statement of Allan Sloan, Senior Editor at Large, Fortune magazine
Before the Senate Committee on Finance Corporate Inversions and Other Tax Games
July 22, 2014
Chairman Wyden, Ranking Member Hatch, and Members of the Committee: thank you for inviting me to participate at this hearing. I’m honored to have a chance to address you directly rather than having to write a newspaper or magazine article and hope that you pick it up and read it. Before I proceed, please note that I am speaking for myself alone. I am not speaking for my editors; or for my employer, Fortune magazine; or for Fortune’s parent company, Time Inc. I am also not speaking for the Washington Post, which has run my articles for many years.
Part of the way that I have made my living since becoming a business journalist in 1969 is by writing about strange and complicated transactions designed to allow corporations (and on occasion, individuals or families) to minimize or eliminate tax obligations. I try to do this by explaining these transactions in what I call “a language approaching English.” For example, when the Smucker jelly company acquired Jif peanut butter from Procter & Gamble in a tax efficient transaction, I called it a merger of peanut butter with jelly, rather than a Reverse Morris Trust. When the RJR Nabisco tobacco-grocery conglomerate tried to turn its food company into an independent entity, I talked about RJR trying to separate cookies from cancer.
When I worked at the late, lamented New York Newsday, which was owned by the late, lamented Times Mirror Co., I specialized in writing nasty stories about the tax-dodging tactics of Times Mirror and its controlling family at the time, the Chandlers. After Tribune Co. bought Times Mirror, the Chandlers grew disenchanted and forced Tribune to sell out to Sam Zell. I knew the Chandlers were really angry with Tribune management, because they agreed to have the company do a taxable transaction with Zell. He calls himself the Gravedancer, but I took to calling him the Artful (Tax) Dodger.
I’m telling you this so you can see that I’ve been around the tax avoidance business for a long time and that I’m either intellectually honest enough or foolish enough to bite the corporate hand that feeds me. I used to consider corporate tax avoidance an indoor sport of sorts. Up until inversions, many of the transactions I wrote about amused me—but I’m not amused now.
I consider inversions to be a threat not only to the public fisc, but to the public psyche. Enough of a threat for my editorial superiors at Fortune—who aren’t exactly anti-capitalist—to have asked me to write what turned into Fortune’s recent cover story about inversions, called “Positively Un-American.” (I’ve attached it to the end of this testimony.)
One of the things I find most disconcerting about inversions is that many people aren’t scared of them enough. These are something entirely different from the tax dodges I’m going to describe in a bit. They’re different from the income-shifting games that companies like Apple and Caterpillar play that have gotten so much attention. Inversions have the potential to totally undermine the corporate tax system, because we’re beginning to see the dynamic change from “what’s an inversion?” to “sign me up.”
I have watched corporations and financial markets for more than 40 years, with the eyes of an English major who has learned about business, as opposed to an economics student who started out with theories. I can sense the corporate stampede out of this country coming. And once it happens—which it will, absent some quick action, followed by fundamental corporate tax reform—it will be irreversible.
You don’t have two or three or four years to look at this problem, consider it, listen to all the usual suspects, and legislate. If you don’t do something quickly to halt inversions, by the time you get around to dealing with them as part of corporate tax reform, the corporate tax base will have been so diminished that it will be extremely difficult for you to come up with any sort of revenue-neutral program.
To be sure—which I consider the three most dangerous words in journalism–I don’t have any statistics to support this. That’s because we don’t have any reliable statistics—at least, none that I’m familiar with—about how many inversions we’ve had, how many are pending, how much tax revenue inversions they have cost the rest of us and are likely to cost in the future. (I will elaborate on this problem later in my testimony.) If the projections you hear for individual companies are remotely accurate—I have no idea if that’s the case, no one does—the JCT projection of $19.5 billion of tax revenue lost to inversions over the next 10 years absent legislation is way, way low. Make that way, way, way low. It’s not the staff’s fault—the dynamic has changed.
If I thought inversions were really only a $2 billion a year item—not that $2 billion isn’t money—I wouldn’t have written what I did. And if this committee thought it was such a relatively small problem, I would not be testifying here today.
Now, to my testimony. I will talk about some tax-dodging games that I have seen and written about over the years, and hope that they will put the current wave of corporate inversions into historical context. I will also try to demonstrate that these inversions are a vastly more serious threat to public well-being than even the most blatant of these transactions. And finally, I will give you my thoughts about how I would deal with the inversion problem if American voters took leave of their senses and elected me to public office.
Until 1997, these were used as a routine, tax-efficient way to separate companies into their component pieces. A company would stick a business it wanted to unload into a new corporation owned by its shareholders, which is a tax-free transaction. A nanosecond later, a buyer would acquire the new corporation in a tax-free stock-for-stock deal. Company holders would thus end up with shares in both the original company and in the buyer of the business being unloaded.
For example, Affiliated Publications, which owned the Boston Globe, had somehow ended up with a bloc of shares of McCaw Cellular, which was becoming more valuable than the newspaper. So Affiliated did a deal with McCaw, in which McCaw traded its shares in return for shares in an Affiliated subsidiary that owned more shares of McCaw than McCaw issued to acquire the subsidiary. So at the end of the day, Affiliated shareholders owned McCaw shares in addition to their Affiliated shares, and McCaw was able to reduce its number of shares outstanding. No harm, no foul, no capital gains taxes.
But instead of simply confining themselves to tax-efficient separations, which no rational person could oppose, Morris Trusters over reached. They created the “Cash-Rich Morris Trust,” in which corporations got lots of cash in what in effect was a tax-free sale masquerading as a corporate split-up. Disney’s sale of the newspapers it acquired when it bought Capital Cities Communications, and General Motors’ sale of its defense business got the most ink, part of it from me. Congress tightened the rules. But loophole openers then created…
REVERSE MORRIS TRUSTS
These require that shareholders of the selling company end up with a majority stake in the acquiring company — a big disincentive to buyers. But P&G managed to find buyers for three such deals: Smucker in 2002 for Jif; and in 2008 for Folger’s coffee, enhancing Smucker’s breakfast brand presence; and in 2011, a company called Diamond Food for Crisco. I calculated that these transactions saved P&G a combined $2 billion in capital gains taxes. Fortunately for the public fisc, Diamond stock fell apart, the Crisco deal collapsed and P&G unloaded Crisco in what I think was a straight-up, regular sale.
This is another common technique that morphed from being an efficient way to split up companies into something excessive.
A corporation that owned a business that it no longer wanted would turn that business into a new, independent company. Then it would offer shares in the new company to its shareholders in return for some or all of their shares. At the end of the day, the company would have disposed of the business it didn’t want, and reduced the number of its own shares that were outstanding. It was really sort of neat. It was equivalent to a company selling the unwanted business for cash, and using the cash to buy in some of its own shares. But a sale would have generated taxes. A split-off didn’t.
Some notable split-offs were Loews Corp., a conglomerate (in which I now own stock) that did a split-off with its big stake in Lorillard tobacco. McDonalds with Chipotle Mexican Grill. Bristol Myers Squibb with Mead Johnson, which makes baby food. These are all reasonable deals in which a company unloaded an unwanted business in a tax-efficient way, setting the business free to find its destiny.
But naturally, companies—and their advisors—weren’t satisfied with a tax-free separation. So they created….
These are much more like a sale than a simple, tax-efficient separation. The first one of these was in 1999, when the Janus mutual fund company swapped its 28% stake in DST Systems for a small DST business and $999 million of cash. It was a sale in a split-off’s clothing, and the business, which was barely a rounding error in the overall transaction, was a necessary part of the deal to make it tax-free. Liberty Media swapped cash and a few properties to Comcast for $1 billion of Liberty stock that Comcast owned. Time Warner traded a bunch of money and the Atlanta Braves to Liberty for a big piece of Time Warner stock.
Congress got annoyed, and in 2006 passed legislation requiring that from May 17, 2006 through May 17, 2007, the business thrown into the pot had to be “somewhat more than a quarter” of the consideration being paid, and since then, it has had to be “somewhat more than a third.” So now you’ve got deals tip-toeing right up to that line.
The one that comes screaming to mind involves Graham Holdings (the old Washington Post Co.) and Berkshire Hathaway (which needs no introduction). The exact numbers aren’t yet available, but earlier this month, Graham swapped about $400 million of Berkshire Hathaway stock that it owned, plus about $388 million of cash, plus a TV station that it valued at something like $394 million, for about $1.2 billion of Graham Holdings stock that Berkshire had owned for 40 years or so, and in which it had an ultra-low cost basis. This saved the firms a total of close to $700 million of taxes. (I own shares in both companies, and I like and respect both Don Graham and Warren Buffett.)
The way to stop this silliness is to require that the operating business be at least 80 percent of the transaction. But that’s not our topic today.
This brings us to…..
There’s a huge, huge difference between these games that I’ve described involving Morris Trusts, Cash-Rich Morris Trusts, Reverse Morris Trusts, Split-Offs and Cash-Rich Split-Offs and inversions.
All of these transactions are generally one-time things. They don’t involve a company renouncing its corporate citizenship to save money, but expecting to be treated as if it were a regular, legitimate American company.
The attached article, which underwent rigorous editing (unlike this presentation), explains the history and workings of inversions far better than I could in this testimony. It also has some telling examples of intellectual inconsistency—I don’t want to violate Senate decorum by using the term “hypocrisy”—that the package’s primary editor uncovered with the aid of several of our Fortune colleagues. Plus, the graphics are pretty good.
We’ve now got a tidal wave of inversions—or we will have them unless the people at the podium in this room and your colleagues do something about it. Quickly. Inversions beget inversions, both for competitive reasons and because there’s now a critical mass of players such as corporate raiders (who like to call themselves “investor activists”) who care only about getting a stock’s price up today; investment bankers who get fees from these deals; and all sorts of hangers-on.
We will end up with almost every company capable of doing an offshore deal doing it, and putting increasing pressure on every corporate manager of an inversion candidate who wants to do the decent, economically-patriotic thing, and finds this kind of behavior abhorrent.
Let me offer up a telling piece of history.
The first inversion was in 1983 when McDermott International, a builder of offshore drilling platform and underwater pipelines, moved its domicile to Panama.
In its April of 1984 issue, Fortune carried a short story about McDermott, and mentioned that it had been thrown out of the Fortune 500 for no longer being an American company. It also noted that two Canadian companies—Inspiration Resources and Lafarge Corp.—had moved their domiciles to the U.S., and were added to the 500. You don’t see companies inverting into the U.S. these days, which is a sign that things have changed.
One reason that inversions haven’t attracted much attention until recently is that until Pfizer tried to invert, there hadn’t been any big, household-name firm visibly trying to leave the country. Pfizer trying to go offshore by buying AstraZeneca shocked me into paying much closer attention to inversions, and I think it shocked a lot of people.
One of the problems I ran into almost immediately was answering a basic question: how many inversions have we had. Two of the major sources of lists—the Congressional Research Service and Bloomberg—are flawed. Tracking this stuff is extremely difficult. One of my colleagues at Fortune, a research librarian at a major law firm in his previous life, is trying to assemble a definitive database. But it is taking a lot of time and effort.
Part of the problem is what I call the “never-heres”: companies whose ancestors were U.S. corporations, but that in their current incarnation have always been offshore. Therefore, they get upset when you call them inverters—which we at Fortune have decided to do. And that you should do, too. Examples include Accenture when it was spun off from Arthur Andersen; Seagate (in which I bought stock several years ago, not realizing it wasn’t a U.S. company) when it was relocated after being acquired in a leveraged buyout; Delphi when it reorganized after its bankruptcy.
A contributing problem is that although we have overall Treasury numbers about how much federal corporate tax is collected, we don’t know how much any individual corporation pays for a given year. That’s not one of the dozen-plus tax metrics that publicly-traded corporations are required to disclose. That makes it impossible to do a rigorous analysis of the tax situation of any inverting or would-be inverting company. We can solve this problem—or you can—by asking the SEC or the Financial Accounting Standards Board to require publicly-traded corporations to disclose this information by taking two numbers from their corporate tax returns: taxable income for a given year, and taxes paid for that year. This is easily accessible to companies—though not to anyone else—because all they need to do is look at their tax returns. My estimate is that it would take one person-hour a year per company to generate this information, which companies have refused to give me when I asked. FASB and the SEC have basically blown me off, but they won’t blow you off.
If you talk to companies about inversions, which my Fortune colleagues and I have been doing for several months, you hear things like “this is only part of our strategy, it’s not why we’re doing the transaction.” Or, “we will continue to pay taxes in America.”
This is, forgive me, misleading nonsense. Ask a company why, if inversion isn’t a major purpose of the deal with the foreign company, it’s not doing a straight-up acquisition. Ask how much it would be paying for the foreign company if inversion weren’t part of the package. I haven’t gotten answer to this, but you probably could, especially if you asked them these questions in public. You can also ask inverters if their contract with their inversion partners contains a clause giving the inverter to right to modify or cancel the deal if inversion rules change. I think you’ll get a “yes.”
As for the “we will continue to pay U.S. taxes” story, ask how much the company will pay in U.S. corporate income tax as an inverted company compared to what it would have paid had it not inverted. I can’t get answers to this, but you can. I suspect the answers will upset you.
I know little—almost nothing, actually—about the political dynamics that go into the making of tax legislation. The one thing I can see is that the inversion question is becoming even more politically toxic than most things that I write about.
I saw that House Democrats forced an up-or-down vote by trying to attach the Sander Levin legislation to the depreciation-extender bill. It got voted down on a party-line vote. Of course, I saw Secretary Lew’s letter. And I saw Senator Hatch’s response. With all due respect, this struck me as political theater, not substance. And we need to deal with substance. It would be absolutely tragic if we let the inversion question descend into soundbites, political rhetoric and attack ads.
Looking at this as an outside observer, I think it’s glaringly obvious what need to be done. First, you pass the Levin legislation—I prefer the Senate version, for reasons you’ll see in a bit—to enact changes that would require inversions to change management and shareholder control of inverting companies. You adopt the March 8 cutoff date. No, that wouldn’t be unfair retroactive legislation. Ever since Senator Wyden’s op-ed ran in the May 8 Wall Street Journal, corporate America has been on notice that a May 8 date is on the table. (An aside: when I saw that article in the Journal, I let loose a string of obscenities, because he had written what I had hoped to write as my Fortune-Washington Post column. Being beaten by a competitor is part of the game—but I’d never been beaten to the news by a Senator before.)
If I were you, I would adopt the Senate version of Levin legislation, so that there’s a cut-off date, and so that averting inversions for awhile doesn’t totally remove the pressure to do something about the corporate tax code reasonably quickly. I found aspects of Rep. Camp’s proposal interesting, but I don’t pretend to have any expertise in drawing up tax legislation. That’s what you do. It’s not what I do.
Lookit, as we used to say when I was growing up in Brooklyn. Tax reform has been kicking around Washington for years, but doesn’t seem to happen. You have to do something. It’s not a partisan issue, it’s a national issue.
Inversions are a symptom of the underlying disease, which is the tax code. But as my daughter the ER doctor would tell you if she were testifying, sometimes you have to address the immediate symptom before going on to the cure. If you’re bleeding out, you need to put on a tourniquet, then deal with the wound. You can’t say, “there’s no point in stopping the bleeding if the wound hasn’t been healed.” You can treat the symptom quickly, and spend some time—but not too much—trying to cure the disease. You shouldn’t say that inversions and the code need to be treated simultaneously.
Inversions aren’t an obvious emergency, the way that helping people and businesses recover from floods and hurricanes is. But they are an economic emergency whose outlines are becoming clear to anyone willing to see them. Despite the toxic climate around here, you have occasionally managed to surmount partisanship and spin and accomplish worthwhile things. Please do something about this looming financial disaster before it’s too late.