Foreign takeovers see US losing tax revenue

Just months after the Obama administration cracked down on mergers that helped US companies skirt domestic taxes, a wave of foreign takeovers is steering more tax revenue away from the US, reports the Wall Street Journal.

In deals known as “tax inversions,” which spiked in 2014, US companies acquired foreign rivals and redomiciled in low-tax countries, reducing the taxes paid back home. The moves sparked an outcry from lawmakers and others that prompted the Treasury Department in September to make such tie-ups more difficult and less lucrative.

But the policy doesn’t deal with foreign takeovers of US companies, which have surged in dollar volume in recent months. As a result, the US still loses tax revenue, but this time US companies are being purchased. Once a cross-border takeover is complete, companies can apply their new, lower tax rates to the overseas income and use internal loans and other strategies to further reduce US taxes.

“If you make inversions more difficult, more US companies may simply be acquired,” said Robert Scarborough, a partner at law firm Freshfields Bruckhaus Deringer LLP.

Take Salix Pharmaceuticals Ltd. Last year, the North Carolina drug maker tried an inversion. But the deal wasn’t completed before the Treasury changed the rules. Now, Salix is headed toward a lower-tax jurisdiction, but as prey, not predator, being acquired by Canada’s Valeant Pharmaceuticals International Inc. for US$10 billion.

The tax savings Valeant expects to reap by taking Salix into its fold shows its advantage over a US bidder.

Salix paid 32.6 per cent of its 2013 profits in taxes. Valeant, which itself flipped from a US to a Canadian company in a 2010 deal, expects the combined company to pay about five per cent. Based on Salix’s 2013 pretax income, that is an annual savings of nearly US$60 million, or about US$1 per Salix share.

The Valeant deal is “a clear sign that all foreign-owned businesses have a clear advantage” over US rivals, Sen. Rob Portman (R, Ohio) said at a Finance Committee hearing last week on tax policy and US economic growth.

Thanks to lower corporate taxes in many other countries, foreign companies have long been able to squeeze more savings out of US targets than a domestic buyer could, meaning they can afford to outbid US suitors. All five companies vying for Salix were either foreign or about to become foreign through an inversion, according to people familiar with the matter.

But inversions gave US companies the chance to compete by redomiciling in a country with lower tax rates.

Foreign takeovers of US companies have surged lately, hitting US$275 billion last year, according to data provider Dealogic. That is double the 2013 amount and far outpaces the increase in overall global mergers and acquisitions, which rose 30 per cent in dollar volume. The activity shows no signs of slowing, with US$41 billion of transactions struck through the end of February, on pace with 2014.

The moves aren’t just tax-driven. The US, open to foreign investment, is viewed as a stable, investor-friendly environment, particularly amid concerns over slowing growth in China and parts of Europe. And tax differences that favour foreign companies in US corporate takeovers are long-standing.

And US companies are still buying their overseas counterparts, a trend that might be reinforced by the strength of the dollar against other currencies.

But lately those advantages are becoming more pronounced, with more countries lowering their tax rates and US companies’ foreign cash piles increasing, making a foreign takeover more lucrative.

Taxes “aren’t the afterthought” anymore in deal making, said Mihir Desai, a Harvard business and law professor, at a recent tax conference. “They are, in fact, a leading thought in the design of these [cross-border] transactions.”

The UK has shaved seven percentage points off its corporate tax rate since 2010 and offers special tax perks on income derived from UK patents and other intellectual property. Japan, meanwhile, has shifted from a US-style tax system, which taxes corporate profits no matter where they are earned, to one that generally taxes only income earned in Japan. Germany, Canada, Switzerland, South Korea and Russia all boast lower corporate tax rates than they did a decade ago.

A Treasury spokeswoman declined to comment. In a speech to the Brookings Institution in January, Treasury Secretary Jack Lew called the new anti-inversion policy a “short-term response to one symptom” of a tax system he called “unfair, uncompetitive and overly complicated.” He said a tax-code rewrite is “the real answer” to addressing the various problems it creates, including inversions.

But Republicans and Democrats still differ widely on the specifics of a tax overhaul, and businesses remain divided, setting long political odds for any major change, though some continue to urge action now.

At least a dozen companies pursued inversions from 2013 through September 2014, including some well-known American brands like Burger King Worldwide Inc. Since the Treasury restricted inversions, the buzz around them has quieted, with just a few small deals struck.

Meanwhile, many bankers and lawyers expect foreign takeovers of US companies to accelerate. In addition to Salix, they point to UK drug maker Shire PLC’s US$5.2 billion recent purchase of NPS Pharmaceuticals Inc. and the trio of US takeovers struck last year by Ireland-based Actavis PLC.

Just last week, California-based Emulex Corp. agreed to sell itself to Avago Technologies Ltd., an acquisitive Singaporean company that has averaged a five per cent tax rate since 2012. It is Avago’s third US acquisition in a little over a year. On Thursday, Ireland-based Mallinckrodt PLC said it agreed to buy Ikaria Inc., a maker of a respiratory drug, for US$2.3 billion, its second US takeover in less than a year.