The battle over corporate inversion deals is heating up, as more U.S. multinational corporations find merger partners abroad that will allow them to move their tax domiciles to countries with lower tax rates.

The Senate Finance Committee held a hearing Tuesday to find out more about the practice, which has been spreading across the pharmaceutical industry and is beginning to hit the retail industry along with others.

“The inversion virus now seems to be multiplying every few days,” said Senate Finance Committee chairman Ron Wyden, D-Ore., in his opening statement. “Medtronic, Mylan, Mallinckrodt and many more deals have either occurred recently or are currently in the works. Medtronic’s proposed $42 billion merger with Covidien was record-breaking when it was announced in June. But the ink in the record books had barely dried when AbbVie announced its intention on Friday to acquire Shire for almost $55 billion.”

It’s not only the large multinationals that are able to find merger candidates. Even a retailer like Walgreens, with local stores across the country, would be able to lower its tax bill considerably if it ends up moving its tax home to Switzerland by acquiring the European drug retailer Alliance Boots, as it has been contemplating.

Democratic lawmakers are not the only ones who are troubled by the inversion wave. Wyden’s counterpart on the Finance Committee, ranking Republican member Orrin Hatch, R-Utah, sees the need for legislation, although like most of his fellow Republicans on the committee, he feels the best way to address the problem is through comprehensive corporate tax reform, including an overall lowering of the rates to make the U.S. more competitive with other countries (see Hatch’s Conditions on Inversion Law Spotlight Partisan Gap).

“Once again, the ultimate answer to this problem—and the only way to completely address the issue of inversions—is to reform our tax code,” he said. “However, as I’ve also said publicly, there may be steps that Congress can take to at least partially address this issue in the interim. While I don’t support the anti-inversion bills we’ve seen thus far, I personally am open to considering alternative approaches, though I do have a few stipulations as to what proposals I’ll consider. For example, whatever approach we take, it should not be retroactive or punitive, and it should be revenue neutral. Our approach should move us towards, or at least not away from, a territorial tax system and should not enhance the bias to foreign acquisitions. Most importantly, it should not impede our overall progress toward comprehensive tax reform. Toward that end, it should not be inconsistent with our House colleagues’ approach.”

Hatch warned Democrats against using corporate inversions as a “political wedge issue,” as it seems to be developing into a campaign issue with the midterm elections approaching in the fall. He pointed to a recent letter from Treasury Secretary Jacob Lew, which he called “politically toned” (see Treasury Secretary Lew Hopes to Prevent Further Corporate Inversion Tax Deals).

Another Republican lawmaker, Sen. Charles Grassley, R-Iowa, used to chair the Senate Finance Committee and talked about some of the reforms the committee carried out in 2004 to stem a tide of inversions to offshore tax havens like the Cayman Islands and Bermuda in the early 2000s.

“The 2004 reforms were never intended to establish a ‘Berlin Wall’ that forever trapped companies in the United States regardless of business needs,” he said. “These reforms were targeted at, and put an end to, egregious abuses epitomized by the Ugland House, which serves as the mailbox headquarters of thousands of corporations. The inversions currently in the news mainly involve a large U.S. multinational merging with a significant, though smaller, foreign company located in a European country. These are not the traditional tax haven countries with little or no corporate tax, but major U.S. trading partners with competitive tax systems and rates.”

A Treasury Department official, Robert Stack, Deputy Assistant Secretary for International Tax Affairs, testified at the hearing, describing how the effort to crack down on corporate inversions ties in with the work that the U.S. is doing in conjunction with the international Organization for Economic Cooperation and Development on base erosion and profit shifting, also known as BEPS.

The OECD is working in conjunction with G-20 finance leaders to stem the tide of multinational corporations using tax strategies to shift their profits to countries where they will have to pay little to no taxes.

“The G-20/OECD BEPS project is made even more challenging by the reality that some of the gaps in the international tax rules are created by countries intentionally seeking to attract mobile income through various special tax regimes,” said Stack. “Left unchecked, these regimes could result in an unproductive race to the bottom in tax competition. When otherwise legitimate practices, such as the desire to subsidize research and development, drop any pretense linking the tax break to activity in the country itself, these regimes become no more than open invitation to strip more highly taxed income from countries like the United States.”

Pascal Saint-Amans, director of the OECD’s Centre for Tax Policy and Administration, also weighed in on the need for reform. “Over time, the current rules have failed to keep pace with economic developments, and have begun to show weaknesses,” he said in his prepared testimony. “While the key international tax standards are intended to eliminate double taxation by providing for principles to allocate taxing rights on a bilateral basis between the countries involved, they are now facilitating double non-taxation in a significant number of instances. This results from changes in the international economic environment such as the globalization of businesses and economies of countries becoming increasingly intertwined.”

Peter Merrill, a principal in the National Economics and Statistics Group at PricewaterhouseCoopers, provided an overview of how the U.S. rules for taxing international income compare with other advanced economies. He pointed to strategies such as tax deferral and the subpart F regime and how they can be used to mitigate the possibility of double taxation.

But it all comes down to location, location, location. “The combination of a high U.S. corporate tax rate and a worldwide regime which taxes foreign income when remitted to the United States is an important disadvantage to the selection of the United States as headquarters,” said Merrill. “If the United States is chosen as the tax home of the merged entity, distributions to the ultimate parent company of foreign income would be subject to the U.S. repatriation tax—a tax that does not apply if the parent company is headquartered in a country with a territorial tax system. Moreover, by establishing legal headquarters in a country with a territorial tax system, the company will be better positioned as an acquirer of businesses. This can be observed in a number of cross-border merger and acquisition transactions in which the combined company has chosen to be legally headquartered outside of the United States. Based on the experience of the U.K. and Japan, one study estimated that if the United States were to switch from a worldwide to a territorial tax system, the number of cross-border mergers and acquisitions in which the U.S. company was acquirer would increase by 17.1 percent.”

Leslie Robinson, an associate professor at the Tuck School of Business at Dartmouth, does not believe the U.S. corporate tax rate is really the culprit behind the flight of multinational corporations, though. “Public debate surrounding reform of U.S. international corporate taxation often features claims that the current system is not competitive,” she said. “The top U.S. federal corporate income tax rate is 35 percent. At present, this is the highest federal tax rate of all OECD countries, and far exceeds the 23.5 percent average of all other OECD countries. Generally speaking, U.S- based MNCs face this relatively high tax on worldwide profits, whereas non-U.S.-based MNCs face a relatively low tax on domestic profits and no residual home country tax on foreign profits. Thus, a common assertion is that U.S. MNCs are at a competitive disadvantage because they face larger corporate tax burdens than their competitors under a worldwide, rather than territorial, tax system. Yet there is no evidence to support this assertion.”

She noted that the burden associated with the current U.S. system includes both the explicit residual tax on actual repatriations and the implicit cost of avoiding repatriation.

However, much of the pressure on corporations to consider inversion is coming from investors and boards who are pushing companies to consider relocating their tax domiciles in response to competitive pressures. In effect they are asking, “If everybody else is doing it, why shouldn’t they?” Appeals to patriotism can fall on deaf ears in such cases, and as witnesses and lawmakers at the hearing pointed out, the CEOs of such companies may have misgivings about relocating and are not necessarily being unpatriotic. They are simply trying to be responsive to shareholders and would not consider the strategy if it were not available to them and their competitors. (Of course, they’re not necessarily available to small businesses such as local retailers, who are not able to easily merge with an overseas competitor to cut their tax rates and are at a disadvantage when they’re facing a major retail chain that is able to do so.)

Yet at the same time, many of those executives continue to reside in the U.S. and take advantage of the U.S. markets, access to U.S. consumers and transportation infrastructure, and the relative safety and security of the U.S. borders.

The last time that Congress tried to change the rules to discourage corporate inversions, back in 2004, they were able to discourage some companies from relocating abroad, but ultimately enterprising companies and their tax departments and accountants were able to find ways around those rules. Lawmakers want to be able to close the loophole, but they also need to be careful with the rules they devise so they don’t end up prompting companies to move not only their headquarters abroad, but also most of their jobs.