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...changing the place of incorporation of their corporate parent, without the need to make any substantive changes to their business operations or their U.S.-based management structure. Congress and the media have focused significant attention on this phenomenon. Despite this attention, Congress initially enacted only a non-tax provision targeting corporate expatriations--a purported ban on expatriated companies entering into contracts with the Department of Homeland Security. This article addresses this alternative sanction, concluding that it is prototypical symbolic legislation, with no instrumental effect. The article also discusses the extent to which the initial Congressional debate over expatriations may have had indirect instrumental effects by furthering the informal enforcement of social norms. Ultimately, after almost three years of debate, Congress enacted a tax provision intended to deny the desired tax benefits to expatriating corporations. The article also addresses the substantive tax policy implications of this response, concluding that it illustrates the tenuous normative underpinnings of the place-of-incorporation rule for determining corporate residence and the need for Congress to reconsider what makes a corporation "American" in an increasingly globalized world.
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INTRODUCTION
In the past few years, (1) several well-known U.S.-based multinational corporations have engaged in restructurings known as "expatriations" or "inversions." (2) Pursuant to an inversion, a corporate group changes the parent corporation's place of incorporation from a U.S. state, such as Delaware, to a foreign country, such as Bermuda or the Cayman Islands.
It is important to distinguish these corporate expatriations from related phenomena such as "runaway plants" and "outsourcing." The runaway plant phenomenon involves corporations with U.S. manufacturing operations shutting down those operations and shifting production to a foreign location. Similarly, outsourcing involves a corporation eliminating service positions in the United States and instead hiring service workers in a foreign location. In contrast to these phenomena, a corporate expatriation does not involve any immediate change in the physical location of the corporate group's management headquarters, manufacturing operations, services, or other activities. (3) Instead, expatriation merely reflects a formal legal change in the country in which the parent corporation's articles of incorporation are filed. (4)
Recent corporate expatriations have been driven by a desire to reduce U.S. income tax liability. The Internal Revenue Code (Code) (5) imposes significant tax consequences based on a corporation's residence, (6) which is determined solely by its place of incorporation. (7) Accordingly, by changing the place of incorporation of the corporate parent, a multinational group might be able to save millions of dollars in U.S. taxes. (8) For example, Cooper Industries anticipated a $55 million annual tax savings from its expatriation, (9) while Ingersoll-Rand expected a $40 million savings in the first year and larger amounts thereafter. (10)
As might be expected, the prospect of large multinational corporations reincorporating abroad to escape U.S. tax liability has attracted significant media and political attention. In the past three years, more than three dozen bills were introduced in Congress to address corporate expatriations, (11) and numerous legislative hearings and debates occurred. (12)
The expatriation phenomenon has, in effect, become a Rorschach test of international tax policy. In interpreting the causes of and appropriate responses to corporate expatriations, legislators have projected their own tax policy belief systems onto the phenomenon. For example, some legislators view expatriations in a sympathetic light, as an understandable response to an overreaching tax code, and argue that the phenomenon reflects the need to curtail drastically the scope of U.S. international taxation. Others view the U.S. international tax system as fundamentally sound, or perhaps even too limited in its scope, and characterize expatriations as unpatriotic tax avoidance by greedy corporations. The legislative proposals and debates reflect these widely varying viewpoints.
Despite the significant legislative attention given to corporate expatriations over the past few years, Congress initially refrained from enacting legislation directly addressing the tax consequences of corporate expatriations. Instead, Congress initially targeted the phenomenon through non-tax legislation. (13) That non-tax legislation, part of the Homeland Security Act of 2002, (14) purports to prevent expatriated corporations from entering into government contracts with the Department of Homeland Security. (15) Thus, rather than directly addressing the tax provisions and underlying tax policies implicated by corporate expatriations, Congress initially relied on an "alternative sanction"--i.e., a mechanism outside of the traditional civil and criminal sanctions that is used to stop a perceived abuse of the tax law. (16)
For almost two years following the enactment of this alternative sanction, Congress periodically entertained proposals aimed at the tax consequences of corporate expatriations. The House and the Senate each developed, and passed, their own respective tax-focused bills, which adopted significantly different approaches to the phenomenon. (17) The House-favored bill would have limited certain tax benefits associated with expatriations, but in general would have continued to permit corporations to obtain significant tax benefits by expatriating. In contrast, the Senate-favored bill would have eliminated all tax benefits associated with expatriations by, in effect, disregarding the inversion transaction and continuing to treat the corporate group's parent as a domestic corporation. Ultimately, in late 2004, Congress enacted the American Jobs Creation Act of 2004 (AJCA), which contained a tax-focused expatriation provision based largely on the Senate's approach. (18)
This article addresses Congress's responses to corporate expatriations--in particular the initial alternative sanction contract ban and the more recent tax-focused legislation. Applying theories of symbolic legislation and social norms as well as an analysis of the normative tax policy arguments underlying the Congressional responses, the article concludes that these responses reflect an abdication of Congress's responsibility to create a coherent and consistent scheme for taxing multinational corporations in an increasingly globalized economy.
Part I of the article provides background information regarding the U.S. taxation of multinational corporations and the tax consequences of corporate expatriations. Part II then provides relevant details regarding Congress's response to the phenomenon.
Part III analyzes the Congressional response through the lens of symbolic legislation theory. The analysis focuses on the symbolic nature of the alternative sanction purporting to deny future government contracts to inverted corporations, concluding that, like most symbolic legislation, this provision has little instrumental effect. Instead, it is principally intended to allow legislators to claim public credit for having responded to a perceived problem while, at the same time, permitting them to avoid detrimental tax consequences to a politically powerful group of corporations. Part III reaches a similar conclusion with respect to the tax-focused proposal that was favored by the House of Representatives.
Part IV considers whether, despite the lengthy delay in enacting instrumentally effective legislation, the mere fact that Congress debated the issue may have had secondary instrumental effects. In particular, it extends the expressive theory of legislation into an expressive theory of legislative debate to determine whether Congress may have influenced social norms regarding corporate expatriations indirectly.
Finally, Part V focuses on the tax policy implications of Congress's response. In particular, it addresses the expatriation provision of the AJCA. It concludes that this tax provision, by disregarding the expatriated corporation's new foreign place of incorporation, raises fundamental questions as to the central role a corporation's place of incorporation plays under current tax law. It analyzes the tenuous normative justifications for the current place-of-incorporation rule, concluding that the United States should consider alternative rules for determining a corporation's place of residence and should adopt a uniform definition applicable regardless of expatriation status.
I. BACKGROUND--OVERVIEW OF RELEVANT U.S. TAX LAW
A. U.S. Taxation of Multinational Corporations
Two fundamental principles underlie the U.S. taxation of corporations in an international context. (19) First, the United States exercises broad taxing jurisdiction over corporations that are considered domestic residents. Unlike some countries, (20) which generally utilize a "territorial" tax system by taxing corporations only on income that arises within that country, (21) the United States taxes domestic corporations on their worldwide income, regardless of where the income arises. To the extent a foreign country in which the income arises also taxes the same income, the United States allows the domestic corporation to claim a foreign tax credit to alleviate the potential for double taxation. (22) This broad taxation of domestic corporations is often referred to as worldwide "residence"-based taxation because it focuses on the relationship between the corporate taxpayer and the United States rather than focusing on the source of the income.
Under a residence-based system it is, of course, important to distinguish between corporations that are U.S. residents and those that are not. (23) The United States utilizes a place-of-incorporation rule for determining whether a corporation is domestic or foreign. (24) Thus, a corporation is considered a domestic corporation taxable on its worldwide income if it is organized under the laws of one of the U.S. states. (25) In contrast, several of the United States's major trading partners that impose worldwide residence taxation utilize standards other than place of incorporation for determining corporate residence. (26)
In contrast to its broad taxation of domestic corporations, the United States taxes foreign corporations--i.e., corporations incorporated under the laws of a foreign country (27)--only on income connected to U.S. business operations (28) and certain nonbusiness income from U.S. sources. (29) Accordingly, a foreign corporation generally is not subject to U.S. income tax on income that arises outside the United States.
The second fundamental principle underlying the U.S. taxation of corporations in an international context is that the United States generally treats a corporation as a separate taxpayer, distinct from its shareholders. For example, if a parent corporation owns all the outstanding stock of a subsidiary corporation, each corporation generally will be treated as a distinct taxpayer, taxable only on the income that corporation itself earns. (30)
In the absence of special rules, this separate taxpayer treatment might significantly undermine the residence-based taxation principle. For example, a domestic corporation seeking to earn income from foreign sources could establish a wholly owned subsidiary incorporated in a foreign country and have that foreign subsidiary engage in the foreign income-producing activity. To the extent that the foreign subsidiary is respected as a separate entity, the United States would not currently tax the domestic parent corporation on the income earned by its foreign subsidiary. Moreover, the United States would not tax the foreign subsidiary on the foreign income earned by the subsidiary because, as discussed above, the United States only taxes certain U.S.-related income of a foreign corporation. Eventually, when the foreign subsidiary distributes its earnings to the domestic parent as a dividend, the United States would be able to impose tax because the domestic corporation, which is taxable on its worldwide income, would have received dividend income. (31) However, the timing of that dividend distribution is within the control of the domestic parent corporation.
In effect, by interposing the foreign corporation and delaying the distribution of the foreign corporation's earnings, the domestic corporation could defer the U.S. taxation of those earnings. If the distributions were delayed long enough, this deferral of U.S. taxation would approximate a permanent exclusion of the foreign income from U.S. taxation. (32) Accordingly, despite the general standard of worldwide taxation applied to domestic corporations, in the absence of special rules, well-advised domestic corporations effectively could exempt significant amounts of foreign income from the U.S. tax base by utilizing foreign subsidiaries.
In order to lessen this ability of domestic corporations to defer U.S. taxation on foreign income through the use of foreign subsidiaries, Congress has enacted several special "anti-deferral" regimes. The most significant of these regimes, particularly with respect to corporate expatriations, is the "Subpart F" regime. (33) In effect, the Subpart F regime cuts back on the separate taxpayer treatment generally afforded to corporations by requiring a domestic corporate parent to include certain income of the foreign subsidiary in its own current income. In particular, if the domestic corporation owns a threshold amount of the foreign corporation's stock (34) and the foreign corporation constitutes a "controlled foreign corporation," (35) then the domestic corporation is required to include currently as its own income certain types of foreign income earned by the foreign corporation even though the foreign corporation has not yet distributed those amounts to the domestic corporation as a dividend. (36)
The domestic corporation in the simple fact pattern discussed above, by owning all the stock of a foreign subsidiary, would be subject to the Subpart F regime. (37) However, the regime does not completely eliminate the treatment of the foreign subsidiary as a separate taxpayer. Rather, the Subpart F regime requires the domestic parent to include in its income only certain types of income (Subpart F income) earned by the foreign subsidiary. (38) Accordingly, the domestic parent is still able to utilize the benefits of deferral with respect to income earned by the foreign subsidiary that is not Subpart F income.
In very broad terms, the types of income earned by the controlled foreign corporation that are considered Subpart F income, and that must therefore be included in the domestic parent's income, include highly mobile passive income, such as interest, dividends, and royalties, and certain business income that does not have sufficient connection to the foreign country in which the foreign subsidiary is incorporated. (39) The types of income that are not considered Subpart F income, and that therefore can continue to receive the benefits of deferral when earned through a foreign subsidiary, include active business income with a sufficient connection to the foreign country in which the foreign subsidiary is incorporated. (40)
B. Tax Consequences of Corporate Expatriations
1. Anticipated Future Tax Benefits to Corporation
The recent wave of corporate expatriations was motivated by anticipated reductions in U.S. income tax liability. (41) These tax savings generally reflected reductions in the U.S. tax on both the foreign income of the corporate group and the U.S.-source income of the corporate group. (42) The following discussion addresses the anticipated tax savings prior to the enactment of the American Jobs Creation Act of 2004.
a. Reduction of U.S. Tax on Foreign Income
The anticipated tax savings with respect to foreign income directly followed from the interaction of the residence-based taxation system and the Subpart F regime summarized in the prior section. As an example, consider a corporate group whose publicly-traded parent is incorporated in the United States and has many subsidiaries incorporated in both the United States and in foreign countries. The corporate parent, as well as each of the U.S.-incorporated subsidiaries, would be treated as domestic taxpayers, and would be taxable on their own worldwide income. Moreover, the corporate parent would be taxable on the foreign income of the foreign subsidiaries to the extent that the income is Subpart F income. (43) In contrast, if the corporate parent of that group were incorporated outside the United States, the Subpart F regime would not apply with respect to foreign subsidiaries of the group (because the ultimate shareholder of the subsidiaries would be foreign, not domestic). (44) Thus, by undergoing an inversion and substituting a foreign-incorporated parent for the U.S.-incorporated parent, the group could avoid future application of the Subpart F regime and ensure that the United States would not impose a corporate-level tax on the foreign income earned by the foreign subsidiaries of the group. (45)
Because inversions attempt, at least in part, to eliminate tax on the corporate group's foreign income, the Treasury Department has referred to the transactions as "self-help territoriality." (46) Several commentators have defended this self-help use of corporate inversions to reduce the U.S. taxation on the group's foreign income, arguing that it is a necessary response by U.S. multinationals who must compete in the global economy against corporations whose home countries utilize a more limited territorial system. (47) Others have strongly criticized this argument as being overly simplistic and misleading. (48)
b. Reduction of U.S. Tax on U.S. Income
In addition to seeking a reduction of U.S. tax on foreign income, corporations expatriated in an attempt to reduce U.S. tax on their U.S. income. Indeed, this goal may have been even more important than the anticipated post-inversion reduction in taxes on foreign income. (49)
Following the inversion, only the U.S. subsidiaries of the corporate group generally would be subject to significant U.S. income taxation. (50) The corporate group could then engage in various transactions to reduce the taxable income of those U.S. subsidiaries. For example, a subsidiary could be structured to owe significant indebtedness to the foreign parent. The large interest payments from the U.S. subsidiary to the foreign corporation would be deductible in calculating the subsidiary's taxable income, thereby reducing its tax liability. (51) Similar opportunities for reducing a domestic subsidiary's U.S. income exist through the use of structures involving manipulation of royalties, management fees, administrative fees, and transfer prices. (52) Because these approaches enable the domestic subsidiary to shift taxable income away from the domestic subsidiaries that otherwise would be taxed on it, the phenomenon is often referred to as "earnings stripping." (53)
The Code contains several provisions that purport to limit a corporate group's ability to shift income away from domestic subsidiaries using these techniques. (54) For example, section 163(j) aims to limit "interest stripping" by limiting the extent to which a corporation that is excessively leveraged with debt can deduct interest payments to related corporations. (55) Similarly, section 482 and the extensive regulations thereunder attempt to prevent corporations under common control from charging each other non-arms-length prices in an attempt to shift income improperly within the group. (56) However, there is general consensus that these provisions did not significantly reduce the potential opportunities for reducing U.S. tax on U.S. income following an inversion. (57)
Unlike the reduction of tax on foreign income resulting from inversions, which at least has some defenders, (58) this use of corporate inversions to reduce U.S. tax on U.S. income has been uniformly condemned. (59) Even those who defend, or at least express some sympathy for, corporations inverting to reduce U.S. tax on foreign income, tend to criticize the use of inversions to reduce tax on income arising in the United States. (60)
2. Immediate Tax Consequences to Corporation and Shareholders
The anticipated tax benefits for an expatriating corporation did not come without a potential tax cost. In particular, a corporate inversion could generate immediate tax consequences to both the corporation and also to its shareholders. (61)
At the shareholder level, Code section 367 (62) and the Treasury Regulations thereunder could require the shareholders of the domestic parent corporation to recognize gain at the time of the inversion, particularly if the inversion is structured as a stock transaction (i.e., the shareholders exchange their stock in the old domestic parent for stock in the newly formed foreign parent). In effect, the shareholder would be treated as if she sold the stock of the old corporation, with the recognized gain equal to the excess of the fair market value of the stock over the shareholder's adjusted basis in the stock. (63)
At the corporation level, Code section 367 and the Treasury Regulations thereunder could require the old domestic parent corporation to recognize gain at the time of the inversion, particularly if the inversion is structured as an asset transaction (i.e., a transfer of the corporate group assets from the old corporation to the newly formed foreign corporation). Under this transaction, the domestic corporation would recognize gain as if all its assets had been sold for fair market value at the time of the transaction. (64) The corporation might be able to offset some of the tax on this gain by applying a foreign tax credit or net operating losses, thereby reducing the tax cost of the transaction. (65)
As a practical matter, this potential for tax consequences at the shareholder and corporation level did not dissuade numerous corporations from expatriating in the first few years of this decade. This lack of deterrent effect has been attributed to several factors. For example, the fall in the stock market from its historic highs in the late 1990s made the potential section 367 shareholder and corporate taxable gain significantly smaller. (66) The tax impact was further reduced to the extent that the corporation's shareholders were tax-exempt institutions or foreign taxpayers, for which the requirement of gain recognition had no practical effect. (67)
II. THE CONGRESSIONAL RESPONSE TO CORPORATE EXPATRIATIONS
The corporate expatriation phenomenon occupied Congress's attention for almost three years. During that period, more than thirty bills were introduced targeting corporations that engage in inversion transactions. (68) However, despite the strong legislative spotlight focused on inversions, Congress initially enacted only one provision specifically targeting corporate expatriates. (69) That law, rather than focusing on tax consequences, instead addresses an area far removed from tax policy--the ability of the expatriated corporation to enter into government contracts with the Department of Homeland Security. (70) As noted above, (71) this purported contract ban is an example of Congress's recent attempt to impose non-tax "alternative sanctions" in an effort to address perceived abuses of the tax laws. Only after an additional two years of debate did Congress enact legislation targeting the tax consequences of corporate expatriation in late 2004.
The following subparts first explain the Homeland Security alternative sanction, and then summarize the legislative proposals and recently enacted legislation that focus on changing the tax consequences to expatriating corporations.
A. Alternative Sanctions--Restrictions on Future Government Contracts
In November 2002 Congress passed, and President Bush signed, the Homeland Security Act of 2002, (72) establishing the Department of Homeland Security. Section 835 of that Act (73) contained the alternative sanction addressing corporate expatriations. That section provides, in general, that "[t]he Secretary [of Homeland Security] may not enter into any contract with a foreign incorporated entity which is treated as an inverted domestic corporation." (74)
As originally enacted, this alternative sanction contained important exceptions. The exceptions provided:
The Secretary [of Homeland Security] shall waive [the ban] with respect to any specific contract if the Secretary determines that the waiver is required in the interest of homeland security, or to prevent the loss of any jobs in the United States or prevent the Government from incurring any additional costs that otherwise would not occur. (75)
Critics quickly noted that these exceptions eviscerated the statutory ban. In particular, by providing an exception for any contract that imposes "any additional costs that otherwise would not occur," the provision continued to allow a foreign corporate parent to enter into a contract if it was the low bidder. (76) Several months later, in response to these charges, Congress amended the alternative sanction by eliminating the exceptions concerning loss of jobs or imposing additional costs on the government. (77) Accordingly, only the "in the interest of homeland security" exception remains. Despite this amendment, the current provision still has only limited instrumental impact. The significant instrumental shortcomings of the provision are discussed below in the context of symbolic legislation theory. (78)
Although this article focuses on the congressional response to corporate expatriations, it is interesting to note that several states have also enacted alternative sanctions targeting inverted corporations. For example, in 2003 California enacted a law providing, in general, that "a state agency may not enter into any contract with an expatriate corporation or its subsidiaries." (79) Similarly, North Carolina enacted a provision prohibiting state contracts for goods or services with corporations or their affiliates that incorporate in certain specified tax haven countries after 2001 and the stock of which is principally traded in the United States. (80) Legislators in several other states have proposed similar bills. (81)
In addition to its enactment of the Homeland Security Act's non-tax alternative sanction, Congress also debated proposals and considered numerous bills that would alter the tax treatment of inverted corporations. After nearly three years, Congress ultimately enacted a tax-focused provision in late 2004.
The tax-focused proposals regarding corporate expatriation fell into two broad categories: (a) broad suggestions that the entire U.S. tax regime applicable to international transactions be overhauled, and (b) narrower proposals specifically targeted at the post-expatriation tax consequences applicable to corporate groups that engage in inversion transactions.
1. Broad Proposals to Overhaul Entire International Tax Regime
With respect to the first category, critics of the federal tax system argue that corporate expatriations are merely a symptom of much broader problems underlying the manner in which the United States taxes income earned in an international context. In particular, it is argued that the worldwide residence-based income taxation of corporations hampers the competitiveness of U.S.-based multinational corporations in an ever more globalized world, thereby forcing corporations to expatriate in order to remain competitive. For example, Bill Thomas, the chairman of the House Ways and Means Committee, observed with respect to corporate inversions:
I'm less inclined to say "you can't do it" than I am to treat it as a symptom, examine the underlying disease--and it's the tax code and [its] failure to be even minimally useful to these folk--and deal with the fact that the U.S. is out of sync with the rest of the world[.] ... We are not well equipped to deal with trade in the 21st century; we have to change our tax code. (82)
Similarly, the Bush Administration, as evidenced by the Treasury Inversion Study, (83) views the corporate inversion phenomenon as evidence of a need to reexamine the tax code to make it more favorable for U.S.-based companies competing in an international marketplace. (84) Similar sentiments were expressed in congressional proposals, primarily by House Republicans, to address corporate expatriations. (85)
In response, numerous other commentators argue that the focus on the expatriation phenomenon as a reason to move from a residence-based system to a territorial system is merely a "red herring," (86) or an excuse to "change the subject" away from the earnings stripping that primarily is driving the expatriations. (87) These commentators defend the importance of retaining residence-based worldwide taxation as the general rule for corporations. (88) Indeed, some commentators argue that the worldwide residence-based taxation regime should be strengthened by the expansion of the anti-deferral regimes, such as Subpart F, so that U.S. corporations cannot avoid current taxation on their active business income through the use of foreign subsidiaries. (89)
Because the arguments in favor of and against the broad overhaul of the U.S. international tax system have been discussed in detail elsewhere, this article does not purport to revisit them. Rather, this article assumes that the United States will retain the broad contours of its existing system for taxing corporations in an international setting. (90) Of more interest for purposes of this article are those tax proposals, including the tax provision ultimately enacted, that purport to target the inversion phenomenon without changing the general residence-based income tax regime applicable to corporations. Those proposals are summarized in the following section.
2. Narrow Proposals Targeted at Inversion Transactions
As noted above, legislators introduced more than thirty bills addressing corporate expatriations. (91) The large majority of these proposals targeted the specific tax consequences that flow from corporate expatriations. From these bills, two leading proposals emerged: (i) a proposal passed by the Senate that would have treated the new foreign corporate parent as a domestic corporation following a corporate inversion, (92) and (ii) a proposal passed by the House that would have modified specific provisions of the tax code that affect the tax consequences of certain inversion transactions, but would have respected the new post-inversion parent corporation as a foreign corporation under general Code definitions. (93)
The Senate bill, by continuing to treat the post-expatriation foreign-incorporated parent as a domestic corporation, would have overridden the place-of-incorporation rule in the case of inversion transactions. In so doing, it would have effectively shut down future inversions by removing the potential tax benefits--i.e., the ability to escape the Subpart F regime for income earned through foreign subsidiaries and the ability to shift some U.S. income out of the U.S. tax base. (94)
Although the House provisions might have reduced some tax benefits associated with inversion transactions, the expatriated company still would have been able to obtain the benefits of avoiding the Subpart F regime on future foreign income, as it could have under then-existing law. Accordingly, the House proposal would have had less of an impact on companies contemplating expatriation than the Senate proposal would have had. (95)
C. Enactment of New Tax Provision
As part of the American Jobs Creation Act of 2004 (AJCA), Congress ultimately adopted a tax-focused provision based on the Senate approach. (96) In particular, the AJCA provision treats the post-expatriation foreign-incorporated parent as a domestic corporation, thereby overriding the place-of-incorporation rule in the case of inversion transactions. (97) This continued domestic taint removes the potential tax benefits otherwise available if the corporate parent were treated as a foreign corporation.
III. SYMBOLIC ASPECTS OF CONGRESS'S RESPONSE TO CORPORATE EXPATRIATIONS
A. Symbolic Legislation--In General
Congress's initial legislative response to corporate expatriates--the alternative sanction barring contracts with the Department of Homeland Security--is best understood through the lens of symbolic legislation theory. In addition, this theory sheds light on the tax-focused proposal that was favored by the House of Representatives.
According to this theory, "symbolic legislation serves the needs of the public by indicating that Congress is 'doing something' about a perceived problem and, accordingly, serves the needs of its legislative supporters by making them appear effective and enhancing their chances for reelection." (98) Murray Edelman is credited with laying the foundation for the modern study of symbolic legislation. (99) The author previously summarized Edelman's theory as follows:
Under Edelman's view, for most individuals politics is "a series of pictures in the mind, placed there by television news, newspapers, magazines, and discussions," constituting a "passing parade of abstract symbols." As a result, "most citizens have only a foggy knowledge of public affairs though often an intensely felt one." This observation may be particularly true in the context of tax legislation, where the details are often mired in the densely worded, definition-laden, exception-filled language of the Code. In this context, according to Edelman's theory, the principal function of much legislation, as well as other forms of political participation, is to provide symbolic reassurance to the public, while only a small group of interested, involved persons generally receives any tangible benefit from the legislation. (100)
Subpart B explores the implications of this theory in the context of the Homeland Security contract ban alternative sanction. Subpart C applies a similar analysis to the House's proposed tax legislation addressing corporate expatriations.
B. Alternative Sanctions as Symbolic Political Response
In 2002, during the second session of the 107th Congress, Congress spent considerable time focusing on the perceived problem of corporate expatriations, holding several hearings (101) and entertaining numerous bills. (102) This Congressional attention coincided with extensive coverage of the topic in the popular press. (103) Much of the media attention and legislative debates centered on the symbolic aspects of the phenomenon. For example, critics of inversions characterized the corporations as Benedict Arnolds, (104) traitors, (105) tax dodgers, (106) tax cheats, (107) and participants in a Bermuda beach party. (108) The names of several bills introduced by critics of inversions--including the No Tax Breaks for Corporations Renouncing America Act, the Uncle Sam Wants You Act, and the Corporate Patriot Enforcement Act (109)--as well as the September 11, 2001, retroactive effective date used for several of the bills, (110) reflected this symbolic atmosphere. In contrast, supporters of the corporations argued that the corporations were being forced to expatriate by an overly broad and complex tax Code, (111) favorably comparing a corporation's actions against unfair taxes to "rumrunners of Prohibition days" (112) and the nation's founding fathers. (113)
Despite the spotlight focused on corporate expatriations, as the 107th Congress approached its adjournment Congress had not yet enacted legislation directly targeting the phenomenon. (114) Finally, on the last day of the session, the alternative sanction purporting to ban expatriated corporations from entering into contracts with the Department of Homeland Security was approved by Congress and sent to the President for signature as part of the Homeland Security Act. (115) However, just hours before the legislation was approved by Congress, (116) language was inserted that significantly undermined any instrumental effect the alternative sanction might have had. Specifically, a statutory exception was inserted allowing a waiver of the contract ban to "prevent the Government from incurring any additional costs that otherwise would not occur." (117) Thus, as a practical matter, despite the purported contract ban, a corporate expatriate could enter into Homeland Security contracts as long as it was the low bidder. (118)
This purported ban on Homeland Security contracts was prototypical symbolic legislation. It enabled its supporters to claim credit for some legislation that purported to address a perceived problem, thereby satisfying the general public's demand for action. (119) At the same time, consistent with Edelman's theory, it ensured that the interested, involved group that would actually be affected by the legislation--in this case, corporations that have engaged in an inversion transaction--received their desired result. In particular, given that some legislation was to be enacted, the best outcome for the targeted group of expatriate corporations was a provision that had little, if any, practical effect on their ability to enter into government contracts. As one reporter observed during the course of the Congressional debates over the contract ban provision in 2002, "[r]ecognizing that there may be no way to stop Congress from taking high-profile action on the politically potent issue this year, the businesses are looking for ways to limit the damage." (120)
Several months after the enactment of this alternative sanction, Congress revisited the provision in response to complaints by some lawmakers regarding its ineffectiveness. (121) In February 2003, Congress amended the alternative sanction by eliminating the exceptions concerning loss of jobs or imposing additional costs on the government. (122) Accordingly, only the "in the interest of homeland security" exception remains.
Despite this amendment, the current provision has only limited practical impact. The alternative sanction prohibits the Department of Homeland Security from entering into a contract with a "foreign incorporated entity" (123) that is treated as an "inverted domestic corporation." (124) As those terms are defined in the statute, the ban generally extends only to the new foreign parent arising from the inversion transaction. It does not apply to any domestic subsidiaries that are part of the inverted group. Thus, following the inversion, the corporate group can continue to enter into Homeland Security contracts through the group's domestic subsidiaries. As Representative Richard Neal complained, the provision "bans only contract applications from the foreign parent, leaving unaffected the U.S. subsidiaries, where U.S. federal contracts are normally managed." (125)
The instrumental ineffectiveness of the contract ban was recently demonstrated in a high-profile contract awarded by the Department of Homeland Security. In May 2004, Accenture LLP, a domestic subsidiary of Accenture Ltd., a Bermuda company, (126) was awarded the $10 billion prime contract by the Department of Homeland Security to develop and implement the new U.S.-VISIT system. (127) This system, which is intended to "help strengthen security at America's borders and modernize the border management process," (128) involves the deployment of "end-to-end management and sharing of data on foreign nationals covering their interactions with federal officials before they enter, when they enter, while they are in the United States, and when they exit." (129) Although the foreign parent, Accenture Ltd., is a Bermuda company that is the successor to a former U.S.-based entity (Arthur Andersen), (130) the contract ban in the Homeland Security Act did not bar the award. (131)
Thus, even the 2003 amendment to the Homeland Security contract ban provision, which purported to eliminate significant exceptions to the ban, itself has the markings of symbolic legislation. Supporters of the amendment are able to claim that they have taken additional steps to combat the perceived problem of corporate inversions. In so doing, they would be acting in accordance with Edelman's theory that the enactment of some legislation, regardless of its effectiveness, may be enough to satisfy the public that the perceived problem of corporate expatriation was addressed. (132)
The amendment is also consistent with the second aspect of Edelman's theory--"that a small group of interested, well-organized persons receive tangible benefits while the public receives only symbolic reassurance." (133) In this situation, the expatriate corporate groups undertook well-organized, well-funded lobbying pressure on legislators. (134) By limiting the instrumental effectiveness of the amendment, Congress enabled these expatriate corporations to continue to enter into lucrative government contracts, despite the purported denial of those contracts under the Homeland Security Act and the 2003 amendment.
Thus, Congress's initial legislative enactment targeting corporate expatriates--which was the only legislative response for nearly three years--is best understood through the lens of Edelman's symbolic legislation theory, rather than as a substantive response to a perceived exploitation of the tax code.
C. House Proposal as Symbolic Political Response
Symbolic legislation theory not only explains the alternative sanctions that Congress has enacted in response to corporate expatriations, but also is relevant in understanding the leading tax-focused proposal favored by the House of Representatives. As discussed supra, (135) the House favored a bill that would have altered two tax consequences flowing from corporate inversion. The bill would have (i) limited the ability of the former domestic parent corporation to utilize tax attributes, such as net operating losses or foreign tax credits, to reduce the tax owed on any gain recognized in an inversion transaction occurring after March 4, 2003, (136) and (ii) imposed an excise tax on certain stock options held by executives of expatriating corporations. (137)
As with the debate leading to the passage of the Homeland Security alternative sanction, supporters of the House bill argued that it would address a perceived problem. However, supporters of this provision defined the perceived problem more narrowly than did the supporters of the alternative sanction contract ban. As discussed supra, (138) these supporters asserted that "corporate inversion transactions are a symptom of larger problems with our current uncompetitive system for taxing U.S.-based global businesses and are also indicative of the unfair advantages that our tax laws convey to foreign ownership." (139) Accordingly, they were less willing to define corporate inversions as necessarily bad and to invoke rhetoric challenging the patriotism of the expatriating corporations.
Nonetheless, apparently recognizing the need to be seen as doing something about inversions, the House Report accompanying the House proposal claimed that the bill "contains provisions to remove the incentives for entering into inversion transactions." (140) Accordingly, at least to some extent, the House proposal can be viewed as satisfying the public's desire to "do something" about a perceived problem in accordance with Edelman's theory. This conclusion is further supported by Edelman's observation that the public generally has only a vague understanding of the intricacies of legislation. (141) Thus, even if the subtleties of the House Republicans' arguments regarding the anticompetitive aspects of the current tax system were lost on the general public, the proponents of the bill could claim that they were "doing something" about corporate expatriations.
In addition to providing the public with some assurance that something was being done to address a perceived problem, the House proposal can be viewed as conforming with the second aspect of Edelman's theory: it ensured that the interested, involved group that would actually be affected by the legislation--in this case, corporations that have engaged in an inversion transaction--received their desired result. In particular, given that some legislation was to be proposed, the best outcome for the targeted group of expatriate corporations would be a provision with little, if any, practical adverse effect on their ability to expatriate.
As noted above, (142) several commentators pointed out the instrumental ineffectiveness of the House proposal. For example, the principal proposal to limit the use of tax attributes to offset inversion gain may have had only limited effects, due to a corporation's ability to control the amount of gain recognized in an inversion transaction. (143)
Perhaps of even greater relevance, a provision that might actually have had a significant adverse impact on expatriating corporations was dropped prior to passage of the House proposal, due to significant opposition from business interests. That provision, which had been a part of earlier bills sponsored by Chairman Thomas, (144) would have tightened Code section 163(j) to make it more difficult for certain U.S. subsidiaries to deduct interest payments made to related foreign parties. As discussed supra, such earnings stripping techniques provide opportunities for post-inversion groups to reduce the U.S. income tax on their U.S. income, so a provision limiting this technique might have reduced the incentive for expatriating. (145) Multinational corporations had been lobbying extensively against the inclusion of the proposed tightening of Code section 163(j), and that lobbying ultimately convinced Chairman Thomas to drop that provision from the House proposal, (146) leaving only the relatively benign provisions limiting the use of tax attributes to offset inversion gain and modifying the treatment of stock options held by executives of the inverted corporation. (147) The extent to which the proposal's instrumental effectiveness was undercut at the behest of interested corporate stakeholders, consistent with Edelman's theory, is illustrated by a quotation from a representative of a corporate lobbying group following the removal of the section 163(j) provision from the House proposal: "[w]e're thrilled with the apparent decision to take the earnings-stripping language out of the bill," and following the provision's removal "we expect to be lobbying in support of the [revised] version of the bill as hard as we can." (148)
Thus, the House proposal to address corporate inversions had the hallmarks of symbolic legislation as described by Edelman's theory. It would have allowed supporters to claim to the public that the purported problem of corporate expatriations was being addressed, while the small group of interested taxpayers--the relevant multinational corporations--would receive the tangible result they desired (i.e., a provision with limited adverse tax effects).
IV. SOCIAL NORM-RELATED ASPECTS OF CONGRESS'S RESPONSE
A. Social Norms and Corporations--In General
As the preceding part illustrates, for several years Congress postponed enacting legislation with significant instrumental effects on corporate expatriations. Nonetheless, the absence of such legislation does not necessarily mean that Congress's actions did not affect the corporate inversion trend. Indeed, the mere fact that Congress addressed the issue, thereby raising its public profile, had an impact on corporations contemplating inversions. This part briefly analyzes this secondary effect of Congressional action.
In considering whether to expatriate, a corporation obviously considers the anticipated tax benefits and costs. (149) As discussed above, Congress initially did not enact any provisions that would directly influence this calculation. (150) In addition to the tax benefits and costs, the expatriation decision might be influenced by a less tangible consideration--nonlegally enforceable rules and standards, sometimes referred to as social norms. (151)
An extensive body of literature recognizes that actors are influenced not only by legal rules, but also by social norms. (152) Much of this social norms literature focuses on the extent to which social norms affect the behavior of individuals. (153) However, some recent scholarship addresses the effect of social norms on corporations. (154)
According to the social norms literature, norms "influence[] an actor's preferences either directly, through internalization, or indirectly through the imposition of second-order social sanctions such as shaming or ostracism." (155) To the extent a corporate inversion violates social norms, the impact might be felt at two separate levels. (156) First, it could impact at a personal level the directors or corporate officers involved in the expatriation decision, either through an internalized sense of the incorrectness of expatriation, or through fear of sanctions, such as shaming or ostracism. With respect to the latter, commentators have recognized the importance of communities in defining and enforcing social norms. (157) Corporate directors and officers are members of communities, (158) and to the extent their actions in supporting an expatriation were viewed as violating a community's social norms, they might be subject to sanction by that community. (159)
Second, it could impact the corporation at the corporate level. A corporation, as an entity, cannot internalize a norm in the way an individual can. However, a corporation could be the target of second order sanctions to the extent social norms disfavored a corporate parent changing its place of incorporation in pursuit of tax savings. For example, the firm might experience a backlash from U.S. customers and a possible reduction in revenue. (160) This potential decrease in revenue might, in turn, lower the value of the corporation's stock. (161) Concern over these potential sanctions against the corporation could induce the directors or shareholders to oppose inversion proposals even if the social norms do not influence these individuals at a personal level.
B. The Stanley Works Example
Prior to the announcement of the proposed inversion by Stanley Works in February 2002 (162) and the congressional focus on expatriations soon thereafter, (163) there was reason to believe that social norms would not significantly constrain the corporate expatriation trend. (164) With respect to the pre-February 2002 expatriations, (165) it is difficult to measure precisely the effect of social norms at the corporate director level. However, given that...
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