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Dow Jones Industrial Average officials just made membership requirements for its elite index even more stringent, prompted by a surge in inversion deals made to avoid the high U.S. corporate tax rate.
The committee overseeing the storied blue-chip benchmark just updated the definition for index inclusion. The classification now states that companies that conduct business in the United States but are incorporated abroad are not eligible for admission in the 30-stock index.
The Dow tweaked the language used in its process of accepting components into the coveted index to officially read that member companies must be incorporated and headquartered in the United States. Additionally, the United States must be a company's largest revenue-generating country.
That means the new eligibility requirements clearly exclude companies that have moved overseas via inversion deals.
The index, launched on May 26, 1896, has always consisted of only U.S.-headquartered companies. The new criteria, while perhaps always understood, are now practically written in stone.
"Considering this is one of the oldest indices, and always considered to be a purely U.S. index, we wanted to maintain that legacy," David Carlson, director of U.S. and Canadian equity indexes at S&P Dow Jones Indexes, which oversees the Dow Index, told The Wall Street Journal.
The S&P 500 Index, the Nasdaq Composite, and the Nasdaq 100 all permit foreign-based entities to be included in their indexes.
While the S&P 500 is limited to U.S. companies, it doesn't eliminate companies that move their legal headquarters overseas if they continue to meet other criteria. Currently, 24 companies in the broad-based benchmark are headquartered outside the United States. Four more are incorporated overseas, yet still maintain offices in the United States, according to S&P Capital IQ.
The Nasdaq 100 presently includes 10 foreign companies in its tech-heavy index.
The new wording from the Dow comes amid a burst of tax inversion deals completed over the last five years, and the flurry of such transactions announced year to date.
It also follows new rules implemented this week from the U.S. Treasury Department.
In an inversion, an American-based company reincorporates for tax purposes in a country that boasts a much friendlier tax rate, while still maintaining the bulk of its operations in the United States. Favored destinations include Ireland, the U.K., Canada, the Bahamas, and Bermuda.
Inversions are lucrative in that they allow companies to trim their overall tax burden by avoiding America's hefty 35% corporate tax rate – 40% on average, including state levies – on income earned overseas. The combined U.S. tax rate is double the average in Europe and more than triple the 12.5% rate in Ireland.
According to S&P Capital IQ, at least 35 companies have relocated overseas for tax purposes since 2009. Meanwhile, just 25 did so in the preceding eight years. Officials anticipate as many as 30 new tax inversions by year's end.
But, pending deals have just hit a roadblock…