Recent activity involving the movement of corporate ownership overseas has gotten the attention of many in Congress.  Some decry these transactions, known as inversions, as unpatriotic and even traitorous based on the fact that the off-shore movement deprives the U.S. Treasury of some tax revenue.  Others, however, see the transactions as a consequence of our tax code which stands alone among G-8 countries and taxes corporations on worldwide earnings.  Both sides see the solution in a reform of the U.S. tax system, although it is unclear if each has the same solution in mind.  But any proposal that does not result in a net reduction in corporate taxes would be like the proverbial rearranging of the Titanic’s deckchairs.

Frustration with the situation is palpable on Capitol Hill.  Some see an immediate need to do whatever it takes to stem the trend.  In addition to proposals that would remove most tax incentives from inverting, some see a solution in denying government contracts to inverted companies on the theory that a corporation should not benefit from the US government’s business if it does not pay its taxes. 

This is not new.  The issue first gained prominence in the early 2000’s when The Stanley Works, an American manufacturer with a household name, considered inverting.  It didn’t but others did.

Just as now, Congress considered amending the tax code.  During this time, the tragic events of 9/11 occurred and the Department of Homeland Security was established.  Corporations that inverted were made ineligible to receive contracts with DHS.  Ineligible corporations, called inverted domestic corporations, were foreign corporations that acquired a domestic company and, after the acquisition, satisfied two requirements.  First, at least 80 percent of the foreign corporation was owned by former owners of the domestic company, and, second, neither the foreign corporation nor its affiliates had substantial business activities in the foreign corporation’s country of organization.  Several years later, Congress extended that ban to every federal contract funded through appropriations bills.

For its proponents, the ban has not had the desired effect in part because it is difficult to determine who is covered by the ban.  For example, some do not meet the 80 percent test; others claim to never have been U.S. corporations and could not by definition have inverted.  In fact, a number of corporations that show up as “inverted” if one Googled the term are not covered by the ban and legitimately have millions of dollars of government contracts.    

Today, in reaction to reports that numerous inversions are under consideration, some in the House have devised another ban to send an even stronger message.  This provision, added so far to four appropriations bills, looks not to where a corporation is domiciled for tax purposes but where it is incorporated.  Stated simply, a corporation that is based in either Bermuda or the Cayman Islands but was once incorporated in the US is ineligible for government contracts. 

This new ban is not likely to be any more effective.  For one thing, most inversions do not occur in Bermuda or the Cayman Islands. The provision probably is limited to those two nations because the US does not have a treaty to provide equal access to government contracting with those countries as it does with the countries where most inversions do occur. 

It would appear that these bans are designed to both stem the tide of inversions and to punish those that do.  But who is really being punished?

A corporation is nothing more than its shareholders and employees.  By denying government contracts to businesses geographically located in the U.S. because its tax domicile is in another country, Congress is punishing the U.S. citizens who own shares in the inverted corporation, often in retirement accounts, and workers, many of whom are in embattled manufacturing industries who make products that will be ineligible for sale to the U.S. government.  Although inverted, those corporations pay significant amounts of taxes on all of income earned in the US. 

Ironically, at the same time that these corporations are ineligible for U.S. government contracts, foreign corporations have tens of millions of dollars in government contracts.  These companies, taxed under a territorial system in their host countries, typically pay much less in taxes to the Treasury and have far fewer workers in the US.  Yet because of treaty obligations, such as the Government Procurement Act, foreign companies cannot be denied access to US government contracts.  Adding further to the irony, by limiting the number of corporations eligible for contracts, the US may wind up paying more for products and having fewer products and services from which to choose.

The frustration over inversions is understandable.  But denying government contracts to inverted companies hurts US workers, citizens and ultimately the government itself.  These are unintended consequences of trying to address a problem indirectly.  Reforming the tax code is the solution.

Spulak is a partner and chair of King & Spalding’s Government Advocacy & Public Policy group.  He served as staff director and general counsel of the House Rules Committee and General Counsel of the House.