Regan: Taxes spur foreign corporate ‘marriages’
You’ve seen a recurring headline at the top of the business section this year: “ABC Corp. buys XYZ Inc. in multibillion merger.” When one company buys another, it’s typically done because there’s a fundamental belief that the sum is greater than the parts (Apple for Dr. Dre’s Beats Music, for example). Or a belief that the target has a product the acquirer desperately needs (Valeant for Allergan, the maker of Botox). Or, the merger simply takes competition off the market (Comcast for Time Warner Cable — the No. 1 and No. 2 cable companies in America). In sum, there are lots of good reasons for two companies to get married.
But there’s a new reason corporations are merging — and it’s more akin to a mail-order bride arrangement. In these loveless transactions, American companies are buying foreign counterparts to get a new passport — and enjoy the lower corporate taxes that come along with it.
The most recent example of a so-called “inversion transaction” is Pfizer’s $106 billion battle to take over Britain’s AstraZeneca. Pfizer, a 165-year-old blue-chip American health care company with its headquarters in New York City, plans to reincorporate in the U.K. as part of its AstraZeneca acquisition. Pfizer is voluntarily electing to give up its citizenship as a part of this deal — and the U.S. tax code is to blame.
So, why are American multinationals acting like desperate young women in dead-end economies? Because U.S. firms are at a serious disadvantage compared with foreign competitors operating under more favorable tax regimes. The U.S. tax rate for corporate profits is 35%, among the highest in the world. And, that tax applies to profits earned anywhere — regardless of the local rate. So if Pfizer makes $1 of profit in the U.K., it keeps 65 cents. But if AstraZeneca makes a $1 profit in the U.K., it gets to keep 79 cents. Multiply that 14-cent spread many times over, and the transaction could save Pfizer $1 billion a year in U.S. taxes. While Pfizer touts the synergies of its proposed deal and AstraZeneca’s pipeline of new drugs, it’s undeniable that the tax savings are an important reason for the acquisition.
And Pfizer isn’t the only one. Horizon Pharma and Vidara Therapeutics recently merged, and the company relocated to low-tax Ireland. Warner Chilcott and Actavis merged, and again, the company reincorporated in Ireland. The reality is that many key mega mergers are being motivated more by a corporate desire to circumvent hefty U.S. taxes than to create a better company — and nations with better tax policies will be the economic beneficiaries.
There are other ways American corporations can avoid paying taxes at the border, besides foreign M&A. They can simply keep the money overseas. In tax lawyer speak, as long as income earned offshore is “intended to be indefinitely invested” in operations outside the United States, companies don’t need to pay U.S. income tax.
So guess what? Most companies don’t.
Apple is one of the biggest implementers of this offshore tax strategy, and its methods are now on full display thanks to its recent stock buyback announcement. Apple is actually borrowing money to fund its $90 billion buyback even though it has more than $150 billion in cash available — just not on American soil. Most of that money ($132 billion) is held offshore, and it just makes more financial sense to issue debt at 3% a year (and get a tax savings on that expense, mind you) than to bring the money home and pay Uncle Sam 35%. As for an “inversion transaction” deal, Apple’s CFO must be bummed that Dr. Dre’s Beats isn’t incorporated in Ireland, with its slim 12.5% tax rate.
Plenty of others use Apple’s strategy. Rival Microsoft has $88 billion in cash, of which $81 billion is held offshore. Google has $60 billion, of which $34.5 billion is “permanently reinvested” outside the U.S. Estimates peg the total amount of cash left overseas at nearly $2 trillion. That money could benefit sugar daddy-corporations in Europe, which can use their enviable tax rates to find a sexy, new partner in an American multinational. But it comes at a cost: That $2 trillion isn’t going to generate any U.S. tax revenue and, even more disturbing, it won’t be reinvested back into the American economy.
This, coupled with the increase in inversion-style mergers, means it’s time to overhaul the corporate tax code. Rather than penalize businesses for bringing home already taxed overseas profits — we should welcome those funds and all they can do for our economy. Instead, the opposite could happen.
The current rush to complete inversion mergers is being fueled by fear that U.S. multinationals may eventually see Congress limit their ability to relocate overseas or, at the very least, decide to tax all worldwide profits at the full 35% U.S. federal rate, regardless of whether they’re left offshore.
In the meantime, Pfizer and others will be primping and prepping themselves for a foreign romance that’s not very romantic at all.