Wednesday, July 30, 2014

Recent U.S./Foreign Mergers Motivated by Tax Incentives

There is a new face on an old problem — American companies “moving” overseas in part to avoid U.S. taxes — that has increased in popularity in the last several years and recently gained political attention. Last week President Obama and Treasury Secretary Jacob J. Lew called for tax reform to encourage economic patriotism and to deter corporate defectors, calling the overseas moves legal, but immoral.

Two structural features of the U.S. tax code incentivize corporations to move abroad. The U.S. corporate tax rate, at 35 percent, is high compared to the average Organization for Economic Cooperation and Development (OECD) rate of 25 percent, and the average European Union rate of 21 percent. Many corporations effectively pay much less than 35 percent, after factoring in loopholes and deductions, policies that cost approximately $150 billion in untaxed revenue last year. But the reported tax rate is high compared to other jurisdictions and the complexity required to reduce that rate in practice also is a deterrent.

Second, other countries like the United Kingdom become attractive foreign tax locations because they operate under a territorial system that does not tax profits earned outside of the home country. Under the U.S. system, however, returning foreign-earned corporate profits home is a taxable event at high corporate tax rates. As a result, it is estimated that $2 trillion in foreign-earned profits of U.S. corporations sit in foreign bank accounts unavailable for use absent paying taxes.

There are two main ways to achieve an overseas move. A transaction called an inversion where a U.S. company reincorporates overseas becoming, say, a Bermuda corporation, which was popular in the 2000s. Inversions also can happen when a U.S. company forms an overseas affiliate and the original company becomes a subsidiary of the foreign affiliate. The 2004 American Jobs Creation Act prevented companies pursuing inversions from reaping tax benefits of the transactions if the original stockholders retained 80 percent or more of the new company or if there was not substantial business operation in the new location. Treasury regulations have defined “substantial business operations” as meaning 25 percent of corporate activity thus effectively stopping these so-called “naked” inversions as a means to transfer corporate profits overseas.

Another vehicle to move a U.S. company overseas is through a merger with a foreign company, and this is where the recent uptick has occurred. If a larger foreign company buys the U.S. one then both profits and control effectively move overseas in the newly combined company. If, however, a larger U.S. company buys a smaller overseas one, then control may stay effectively in the United States, with only the profits moved overseas. 

For example, in 2012 Cleveland-based Eaton purchased Cooper Industries PLC in an $11.8 billion merger. After the merger, the new company Eaton Corporation PLC, incorporated in Ireland and headquartered in Cleveland, projected savings of $160 million a year as a result of not being subject to U.S. corporate taxes. So far this year, there have been more than a dozen of similar tax-motivated foreign mergers announced including companies like Chiquita, Pfizer and even some interest behind the drug-store chain Walgreens moving to the United Kingdom. 

See the following discussion of foreign mergers in the DealBook earlier this month following the announcement of two multibillion dollar health care mergers:

“With a[n]…. offer worth $53 billion, AbbVie, a big Chicago-based pharmaceutical company, has succeeded in winning tentative approval to buy the Irish drug maker Shire . If completed, it would be the biggest deal of the year. Also on Monday, Mylan Laboratories, based in Canonsburg, Pa., said it would acquire the international generic drug business from Abbott Laboratories in an all-stock deal valued at $5.3 billion and reincorporate in the Netherlands.”

Solutions to curb corporate flight include lowering corporate taxes to a more competitive rate, decreasing the ownership thresholds for inversions from 80 percent to 50 percent, and excluding tax benefits for foreign-based mergers. Congressional Democrats have circulated several proposals, but Republicans have not expressed interest without comprehensive tax reform. Obama included proposals targeted at foreign mergers in his proposed 2015 budget, which includes decreasing the corporate tax rate, decreasing the ownership threshold for inversions and closing some corporate tax loopholes. While congressional action before the end of the year is unlikely, the strong rhetoric of economic patriotism and corporate defectors has the issue primed for the 2014 election debates.

For a great summary on the issue, see the following report issued earlier this summer by the congressional research service.

 -Anne Tucker 

 

http://lawprofessors.typepad.com/business_law/2014/07/recent-usforeign-mergers-motivated-by-tax-incentives.html

Anne Tucker, Corporations, Current Affairs, Merger & Acquisitions | Permalink

Comments

Recently, the Competitive Enterprise Institute calculated that annual federal regulatory costs have risen to an estimated $1.86 trillion. http://cei.org/content/report-finds-regulation-compliance-costs-businesses-186-trillion, http://cei.org/10KC. Although facially, inversions are tax driven I would assert that burgeoning regulatory (hidden tax) costs may play a significant role in offshoring tangible good companies.

My first career having been in a closely held, family, durable goods manufacturing business I can attest that we altered product lines as a direct result of regulatory costs.

Posted by: Tom N | Jul 31, 2014 4:58:35 PM

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