M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

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Tuesday, August 19, 2014

What's driving inversions?

That question is still a bit of a mystery.  Still no real answer, but like the SAT test we can start to eliminate the obviously wrong answers.  From a paper by Ed Kleinbard, Competitiveness Has Nothing to Do With It (h/t Dealbook), we can eliminate the competitiveness canard. Here's the abstract:

Abstract: The recent wave of corporate tax inversions has triggered interest in what motivates these tax-driven transactions now. Corporate executives have argued that inversions are explained by an "anti-competitive" U.S. tax environment, as evidenced by the federal corporate tax statutory rate, which is high by international standards, and by its "worldwide" tax base. This paper explains why this competitiveness narrative is largely fact-free, in part by using one recent articulation of that narrative (by Emerson Electric Co.’s former vice-chairman) as a case study.

The recent surge in interest in inversion transactions is explained primarily by U.S. based multinational firms’ increasingly desperate efforts to find a use for their stockpiles of offshore cash (now totaling around $1 trillion), and by a desire to "strip" income from the U.S. domestic tax base through intragroup interest payments to a new parent company located in a lower-taxed foreign jurisdiction. These motives play out against a backdrop of corporate existential despair over the political prospects for tax reform, or for a second "repatriation tax holiday" of the sort offered by Congress in 2004.

There are a couple of points worth noting.  First, Kleinbard makes the point that is obvious to most tax lawyers - there's a difference between the corporate tax rate of 35% and the effective corporate tax rate.  The former is like paying the rack rate for a room at the Four Seasons.  The second is like getting that same room on Priceline. Kleinbard relies on SEC filings to estimate the effective tax rate for Mylan:

In 2013, Mylan derived about 57 percent of its worldwide revenues (essentially, gross receipts) from the United States, yet, as just noted, told investors that its worldwide effective tax rate was 16.2 percent. Assume, just by way of illustration, that Mylan’s taxable profits followed its revenues as allocated for financial accounting (and presumptively, management) purposes – admittedly, a heroic assumption, thanks to stateless income planning internationally, and tax expenditures domestically – and that Mylan, through adroit domestic tax planning, incurred a 25 percent effective tax rate in respect of its U.S. income (federal and state taxes combined). This would imply that Mylan’s tax expense in respect of its foreign profits was roughly 4.5 percent.

AbbVie is another recent inverter.  What was their effective rate before going offshore? Kleinbard estimate for us:

AbbVie ... reported in its 2013 annual report’s tax footnote an 11.5 percent reduction for 2013 in its global statutory tax rate for “the effect of foreign operations.”  (The effect of foreign operations was a much greater number in 2011 and 2012.) Again, this  means that AbbVie is telling investors and its own managers that it does not operate in a 35 percent tax rate environment at all; to the contrary, AbbVie’s effective global tax rate for 2013  (again, including U.S. taxes on its U.S. domestic income, where permanently reinvested earnings are irrelevant), after some smaller permanent differences in both directions, was 22.6 percent. This is a “permanent” tax discount of about one-third off the headline federal rate, insofar as AbbVie’s investors and management are concerned.

Kleinbard also takes on the idea that inversions are being caused by "trapped cash" off shore.  That's the argument that directors are unwilling to bring foreign profits back to the US because they are unwilling to pay US taxes to make that happen.  Some directors say their fiduciary duties prevent them from bringing that cash back.  I disagree.  In any event, he discounts that the "trapped cash" argument as real.  

Finally, he takes on the competitiveness fable.  He calls the competitiveness claim a claim without fact.  It's worth reading.  

In the meantime, I'm still looking for an answer. 

-bjmq

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