News reports and articles in professional tax journals in the early 2000s drew the attention of policymakers and the public to a phenomenon sometimes called corporate "inversions" or "expatriations": instances where firms that consist of multiple corporations reorganize their structure so that the "parent" element of the group is a foreign corporation rather than a corporation chartered in the United States. A May 2002 study by the U.S. Treasury Department concluded that while inversions are not new—the statutory framework making them possible has long been in existence—there has been a "marked increase" in their frequency, size, and visibility. A comprehensive list of firms that have inverted has not been compiled. Some of the more high-profile inversions, however, include Ingersoll-Rand, Tyco, the PXRE Group, Foster Wheeler, Nabors Industries, Coopers Industries, and Stanley Works. (Stanley Works, however, subsequently announced that it would not undertake its planned reorganization.) According to the U.S. Treasury Department, the transactions are increasing in size, scope, and frequency. Firms engaged in the inversions cite a number of reasons for undertaking them, including creating greater "operational flexibility," improved cash management, and an enhanced ability to access international capital markets. Prominent, if not primary, however, is the role of taxes: each of the firms in the above list expects significant tax savings from its reorganization. The tax structure that permits tax savings through inversions has long been a part of the U.S. tax system. The question then arises: why now? One plausible explanation is the decline in the stock market that followed the bull market of the 1990s. As described in more detail below, an inversion is accompanied by a required payment of tax by individual shareholders on capital gains. The capital gains tax may thus serve as a brake on inversions. Lower stock prices, however, may mean that capital gains are smaller and capital gains taxes less onerous. Another suggestion has been that increased globalization of markets has exposed U.S. firms to more competitive pressures, leading them to more avidly pursue tax-saving strategies. And yet another reason is simply momentum: firms may have been reluctant to incorporate abroad for fear of public relations damage. Once several firms undertook reorganizations, the damage potential may have been perceived to have fallen, and other firms followed. The corporate inversions apparently involve little, if any, shifts in actual economic activity from the United States abroad, at least in the near term. (See, however, the section below on "Policy Issues" for a discussion of possible long-run effects.) Bermuda and the Cayman Islands are the location of many of the newly created parent corporations—jurisdictions that have no corporate income tax but that do have highly developed legal, institutional, and communications infrastructures. But the actual headquarters of inverted firms typically remain in the United States, and an inversion does not apparently involve the outflow of capital from the United States abroad or the shifting of corporate jobs to foreign locations. Instead, the chief near-term economic impact of inversions is on U.S. federal tax revenues, which are reduced by the reorganizations, and concern has been expressed about the potential erosion of the U.S. corporate tax base. This has also led some to draw conclusions about their impact on tax equity: unless federal spending is cut or the deficit is increased, the reduction in tax revenue must be made up by tax increases on other taxpayers. Some policymakers have sought a remedy within the existing U.S. system for taxing international transactions. As discussed below in the section on " Alternative Policy Responses and Proposals ," the 107 th and 108 th Congresses have considered a variety of proposals aimed at stemming the growth of inversions. The proposals range from re-imposing U.S. taxes in a manner that would undo the effect of the inversion to more incremental approaches, such as denying the applicability of foreign tax credits and net operating losses to one-time U.S. "toll" taxes that may be triggered by an inversion. The latter, more incremental approach was taken by the enacted version of the American Jobs Creation Act of 2004 ( P.L. 108-357 ). Others view inversions as symptomatic of more general problems with the U.S. tax system that have become evident as the world economy has become more integrated. Rather than disallowing inversions, they recommend a more general reevaluation of the tax code "that drives them to do such a thing." The U.S. Treasury Department views inversions as evidence of competitive problems with the U.S. tax system. The Administration initiated a study of inversions in February, 2002 and issued a preliminary report in May 2002. The report stated that a near-term response to inversions should ensure that inversions "cannot be used to reduce inappropriately the U.S. tax on income from U.S. operations," and thus makes several proposals designed to protect U.S. tax revenues generated by U.S. income. In keeping with its concern for competitiveness, however, the report does not propose more stringent rules for foreign-source income and calls for a reexamination of the U.S. international tax system. Inversions have thus been discussed in terms of tax equity and competitiveness. A more detailed look at their implications for the U.S. tax system in general is presented below in the section entitled "Policy Issues." First, however, it is useful to look at the mechanics of inversions and how they generate tax savings. Although each corporate inversion has unique features, a common reorganization is apparently a "triangular" stock transaction merger, where a new foreign corporation is created that is chartered in a foreign country with low tax rates. The new foreign entity creates a U.S.-chartered "merger subsidiary," owned by the new foreign corporation. The U.S. parent corporation is then merged into the domestic merger subsidiary and becomes a subsidiary of the new foreign parent. For stockholders of the U.S. corporation—for example, individuals, institutional investors, and other firms—shares of the old U.S. parent automatically becomes shares of the new foreign parent. Other forms of inversions are "asset transfers," where the domestic parent transfers its assets to a newly created foreign corporation, and "drop-down" transactions, where the domestic parent transfers its assets to a foreign corporation, but the foreign corporation transfers some of those assets to a domestic subsidiary. To see how inversions such as these generate tax savings, it is useful first to look at the general structure of the U.S. international tax system. In the international context, the United States bases its tax jurisdiction on residence: it taxes corporations chartered in the 50 states or the District of Columbia on their worldwide income, foreign as well as domestic. At the same time, the United States generally exempts corporations chartered in foreign countries from U.S. tax on their foreign-source income. Under the residence system, a firm's U.S. tax on foreign income depends on how the firm's foreign operations are organized, and a result of the system is a feature known as the "deferral principle," or simply "deferral." Under deferral, income that a U.S.-chartered corporation earns directly through a branch that is not separately incorporated is generally taxed by the United States on a current basis since the income is earned by a U.S. "resident." In contrast, foreign income earned through a separate foreign subsidiary corporation is generally not subject to U.S. tax until it is remitted to the U.S. parent corporation as dividends or other income: it is tax-deferred. Because of discounting, this deferral confers a tax benefit on income earned in foreign countries with relatively low tax rates. The system has several additional complicating features. One is the U.S. foreign tax credit, which is designed to alleviate double-taxation where foreign countries tax U.S. firms' foreign income. Under its provisions, the United States permits its taxpayers to credit foreign taxes they or their foreign subsidiaries pay against U.S. taxes they would otherwise owe. The foreign tax credit is generally limited to offsetting U.S. tax on foreign and not domestic income, but if a firm pays sufficient foreign taxes, it may use the credit to eliminate its entire U.S. tax liability on foreign-source income, whether U.S. pre-credit taxes are deferred or apply on a current basis. Another important feature is a set of "anti-deferral" regimes that limit the availability of deferral in some cases. The broadest and most important of these is the tax code's Subpart F provisions that were enacted in 1962 as a means to limit the concentration of passive-investment income by firms in tax havens. Under Subpart F, U.S. parent firms can in some cases be taxed on particular types of subsidiary income, even if it is not repatriated to the U.S. parent firm. Subpart F, however, only applies where a foreign subsidiary is controlled (more than 50%-owned) by those U.S. stockholders who own large blocs (at least 10%) of the subsidiary's stock. The type of income subject to Subpart F is generally income from passive investment and certain types of income whose source is thought to be easily manipulated. A second anti-deferral regime is the passive foreign investment company, or PFIC rules. In contrast to Subpart F, the PFIC provisions apply to foreign corporations that invest intensively in passive-type assets, regardless of the degree or concentration of U.S. ownership and even to income that is not itself from passive investment.