Tax revenues vanish as firms move from US to Bermuda

Use of tax shelters is rising, prompting moves in Congress to keep companies home.

Paying as little as possible in taxes has been a hallmark of America's cash-flow culture since the days of the Boston Tea Party. But when the maker of Stanley Tools decides to hammer its nameplate to a door in Bermuda, albeit for fiscally prudent reasons, it strikes some as downright un-American.

In the quest for lower corporate taxes, a growing number of US corporations have laid plans to shift their nominal headquarters to Bermuda. As a result, figures from the US Treasury secretary to shop-floor employees at Stanley Works have joined a debate about just what this says about the US tax code and American business.

To some, it's a sign that firms are being driven out by overtaxation. Others talk overtly about a spreading corporate character flaw.

"These expatriations aren't illegal, but they're sure immoral," declared Sen. Charles Grassley (R) of Iowa recently. "During a war on terrorism, coming out of a recession, everyone ought to be pulling together. If companies don't have their hearts in America, they ought to get out."

With millions of dollars at stake, many are getting out, following their wallets if not their hearts. It's part of a dramatic rise in the use of tax shelters by corporate America.

In 1998, $155 billion in corporate income literally disappeared without Uncle Sam's tax collectors laying a finger on it, according to research by Harvard Business School Prof. Mihir Desai. That amount is the gap between what corporations reported to shareholders and what appeared on the tax returns they filed with the Internal Revenue Service.

Some say it's a "Bermuda tax triangle."

Corporate taxes no longer amount to a large share of the US Treasury's annual intake, but lawmakers aren't turning a blind eye to the trend.

Mr. Grassley and Senate Finance Committee chairman Max Baucus (D) of Montana have introduced two bills aimed at cracking down on such tax shelters: one on the expatriation issue, the other on disclosure rules. Similar House legislation has been introduced by Richard Neal (D) of Massachusetts.

The growth of corporate tax shelters also concerns the Bush administration.

"These transactions can have significant adverse effects on the US economy," a Treasury report warned last Friday.

Bermuda, with no corporate income taxes, is of special concern after decisions by Stanley Works, Ingersoll-Rand, Nabors Industries, and other major companies to establish legal residences there. They still owe taxes on US earnings, but can escape levies on overseas income. Stanley Works, based in New Britain, Conn., says it will slash annual taxes by 28 percent, or $30 million.

"When we have a tax code that allows companies to cut their taxes on their US business by nominally moving their headquarters offshore, then we need to do something to fix the tax code," Treasury Secretary Paul O'Neill said Friday.

While some bills in Congress aim to stop expatriation, O'Neill's criticism is not of business but of the US tax code itself.

Like Bermuda, most European nations tax only earnings within their borders.

Republicans in Congress are staking out a middle position: They propose a temporary moratorium on relocations. That could take some political steam from the issue, they hope.

Corporations will lobby hard against forceful barriers to relocation.

Democrats are expected to use the tax-shelter fuss as a tool in the fall elections. One politically explosive factor: Some executives stand to benefit personally – about as much as their companies will – from the move to Bermuda, according to a report in The New York Times this week.

For the broader economy, the implications of Bermuda domiciles are more psychological than economic.

"It is annoying to us," says Michael Cacace, a Fortune magazine editor in charge of its well-known Fortune 500 list of the largest US companies. The magazine shifted Tyco from its "US" list to its "global" list two years ago. If the flight to overseas tax shelters continues, Fortune may have to change its rules, classifying a company according to where it gets most of its revenues rather than its home of incorporation, Mr. Cacace says.

The morality comment by Mr. Grassley has raised something of a war of words. The Wall Street Journal devoted an editorial to defending the right of companies to take legal steps to avoid taxes.

This is not a new debate.

In 1937, Franklin Roosevelt railed against tax loopholes as "clever little schemes" of rich Americans to reduce their taxes.

In the midst of a campaign, Roosevelt made no distinction between legal tax avoidance and illegal evasion.

J.P. Morgan dismissed FDR's moralistic crusade as misguided, much as the Journal and many tax experts do today. If Congress disapproves, it should just close the loopholes, the argument goes.

However the current debate plays out, one thing seems almost certain to Joe Thorndike of the publication Tax Notes: Clever accountants and tax lawyers will find new loopholes in revised laws, as they have done for more than 200 years in the US.