By Ted Stotzer, Journal of Transnational Law & Policy Member

“Corporate inversions,”[1] essentially a form of tax arbitrage (whereby a domestic corporation purchases[2] or more commonly merges[3] with a foreign rival incorporated in a foreign “tax haven” jurisdiction to reduce or eliminate its tax exposure),[4] are hot right now: according to the Ways and Means Committee “[f]orty-seven U.S. corporations have reincorporated overseas through corporate inversions in the last 10 years, far more than during the previous 20 years combined . . . .”[5] A recent example is the Burger King and Tim Horton merger, which caused significant public outcry and even condemnation from the Executive Branch.[6] However, it is well settled that “[a]ny one [including a corporation] may so arrange [its] affairs [so] that [its] taxes shall be as low as possible; [it] is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”[7] Public corporations seeking to invert to reduce their taxes should not be “shamed” into acquiescing to countervailing (and economically inefficient) public sentiments;[8] rather, if tax reform is desired, it should be effected through a legitimate change in the current tax structure regarding the incorporation of entities and the taxes levied thereon. One such possible restructuring is examined below.

The Internal Revenue Code (I.R.C.) currently uses a “place of incorporation” test in order to designate corporations as domestic. Once designated as such, domestic corporations are thereby subject to taxation on a worldwide basis on all earnings under I.R.C. § 11(a) and I.R.C. § 55.[9] Procedurally, to determine whether a corporation is domestic or foreign, a clear test is used under I.R.C. § 7701(a)[10]; as discussed below, this certainty of application is arguably the strongest advantage of the current formulation.

In contrast to the above regime, the majority of foreign countries use a “place of management” test. Thus, the determination of whether a corporation is domestic or foreign depends upon the inherently facts and circumstances analysis of where the central or key managerial decisions of the corporation are made.

In order to evaluate these dichotomous regimes, a value judgment must be made regarding which of the myriad tax policy goals our nation wishes to elevate. These include but are not limited to fairness, efficiency, economic impact, and revenue raising. Using this general policy rubric, the costs and benefits under the current system must be weighed against the costs and benefits of reform. I argue that while the place of incorporation test provides the benefits of simplicity, clarity, and general ease of administrability, it exalts form over substance and is too formalistic and rigid, making it prone to abuses which do not reflect the economic realities of the situation, thereby decreasing revenue raising and slowly depleting the federal fisc.[11] Additionally, the current minority regime may lead to a “chilling” of international transactions, especially outbound ones, for the profits of a corporation may be taxed by more than one country, under both regimes.[12] The place of management test is more in accordance with the doctrine of substance over form and is more likely to prevent shams or transactions that lack economic substance;[13] however, it suffers from the disadvantage of intrinsic inefficiency. Moreover, reasonable reliance interests predicated on the current regime must act as a thumb on the scale in favor of maintaining the status quo.

Balancing the above considerations, I propose that the U.S. adopt the place of management test. However, it should integrate the current place of incorporation test as an indicium for place of management under the formula, thereby minimizing harm to reasonable reliance interests. Other factors to be considered may include: the location of the “majority” (defined as greater than fifty percent (> 50%)) of the assets of the corporation (using either original basis or fair market value for valuation purposes); where the corporation is headquartered; where the corporation earns the majority of its gross income; and where the majority of the “key persons” of the corporation (defined as directors and officers, or using a more expansive definition for certain industries heavily dependent on intellectual capital) hold citizenship.

This is a rough sketch of a possible solution in order to prevent “abusive” corporate inversions, which are often primarily or even solely driven by tax considerations. As trade and business become increasingly globalized, the reflection of economic realities will be a significant consideration for countries like the U.S., for whom revenue raising is a primary tax policy consideration.

[1] Internal Revenue Serv., Notice 2014-52, Rules Regarding Inversions and Related Transactions (2014) (defining the term “inversion transaction” as “an acquisition in which the foreign acquiring corporation is treated as a surrogate foreign corporation under [I.R.C.] section 7874(a)(2)”).

[2] Either in a “stock” or “asset” sale.

[3] A merger is the more common method because while gain or loss is generally “realized” on the transaction (see Eisner v. Macomber, 252 U.S. 189 (1920), Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955), and I.R.C. § 61 (generally)), it may not be “recognized” under I.R.C. § 354 if 1. The “form” test is met (the transaction falls within one of the seven categories of I.R.C. § 368(a)(1)(A)-(G)), and 2. The “common law” test is met (the transaction (i) must have a business purpose, (ii) there must be a continuity of business, and (iii) there must be a continuity of shareholders).

[4] I.R.C. § 906(a) (“A nonresident alien individual or a foreign corporation engaged in trade or business within the United States during the taxable year shall be allowed a credit under [I.R.C.] section 901 for the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year . . . to any foreign country or possession of the United States with respect to income effectively connected with the conduct of a trade or business within the United States.”) (emphasis added). Tax loopholes can often be best leveraged where there is a tax treaty in place between the foreign country (the place of incorporation) and the U.S., the provisions of which may, and often do, control over the I.R.C. See I.R.C. § 7852(d)(1) (known as the “later in time” rule; for purposes of determining the relationship between a provision of a tax treaty and any U.S. law affecting revenue, neither the treaty nor the law shall have preferential status by reason of its being a treaty or a law – the source of legal authority which is enacted later in time controls). So, for example, the most current U.S. Model Income Tax Convention requires a “permanent establishment,” which is defined as a fixed place of business through which an enterprise is carried on; this is a higher bar than income effectively connected with a U.S. trade or business (I.R.C. §§ 864(c), 882). 2006 U.S. Model Income Tax Convention, art. V, § 1. Therefore, depending on whether the default “permanent establishment” language is adopted in the executed treaty, it is possible that a foreign incorporated entity may avoid taxes entirely (by both the home and host countries) if it does not meet that more exacting standard. See Adam H. Rosenzweig, Harnessing the Costs of International Tax Arbitrage, 26 Va. Tax Rev. 555 (2007).

[5] New CRS Data: 47 Corporate Inversions in Last Decade, Ways & Means Comm. Democrats (July 7, 2014),; see also Robert Litan, Are U.S. Corporate Tax Inversions a Necessary Crisis?, Fortune (July 18, 2014), (stating that “[s]uddenly, the hottest tax arbitrage game is the ‘tax inversion’ ” and citing several recent, multi-billion dollar examples).

[6] Jonathan Allen et al., Buffett Burger King Funds Flip Obama’s Inversion Calculus, BloombergBusiness (Aug. 27, 2014),

[7] Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934) (emphasis added).

[8] Alexander C. Kaufman, How Americans Scared Walgreens Out Of A $4 Billion Tax Dodge, Huffington Post: Business (Aug. 7, 2014),

[9] Subject to various remedial measures to prevent double taxation by a foreign country, e.g. the I.R.C. § 901 foreign tax credit (subject to certain limitations under I.R.C. § 904) or tax treaties with foreign countries.

[10] I.R.C. § 7701(a)(30) states that the term “United States person” refers to both individuals and entities, including domestic corporations and partnerships. I.R.C. § 7701(a)(4) states that “[t]he term ‘domestic’ when applied to a corporation or partnership means created or organized in the United States . . . .”

[11] Rosenzweig, supra note 4.

[12] But see supra note 9.

[13] I.R.C. § 7701(o) (codifying the “economic substance doctrine” iterated in the now infamous Goldstein case).