Tax Inversions Wrap Up

There has been a recent surge in anti-tax inversion legislation discouraging companies attempting to shift corporate subsidiaries or headquarters to low-tax or tax-free countries. The issue was subjected to a great deal of publicity in April 2014 during the failed hostile takeover by Pfizer (NYSE:PFE) for AstraZeneca (NYSE:AZN) when Pfizer attempted to shift its tax base to Britain via a behemoth $120 billion takeover. This move infuriated Congress and the Corporate Inversion Act of 2014 was introduced as a bill in late September. The earlier tax laws stated that companies can move overseas if foreign shareholders own at least 20 percent of their stock under the current law. The new bill would raise that threshold to 50 percent for two years.

Tax inversions are essentially a form of tax avoidance. They are driven by a combination of factors, but I believe that the most prevalent factor is that the US tax code in particular seeks to impose income tax on profits earned abroad by American corporations. This creates a strong incentive for American companies with large overseas markets to seek to re-characterize themselves as foreign corporations if they want to return foreign earnings to stockholders without double taxation. Also, at 35%, the United States has the highest nominal corporate tax rate in any of the world’s developed economies. This rate sits 14% higher than the OECD (Organization for Economic Co-operation and Development) average and entails billions of dollars of potential corporate profits lost to the public coffers for American multinational companies.

Historically, however, inversion laws have remained lax in terms of intellectual property and the benefit of this is seen mainly in the tech and pharmaceutical industries. Both these industries possess a large amount of intellectual property rights or patents and have similar tax saving incentives. The Irish Government recently closed the infamous ‘Double Irish’ loophole. This controversial loophole has been used by multinational companies such as Apple and IBM in the past and essentially enables the possibility of zero-tax royalty payments between Ireland registered subsidiaries of these companies. Put simply, the Double Irish strategy got its name by allowing corporations with operations in Ireland to make royalty payments for intellectual property to a separate Irish- registered subsidiary. That subsidiary, which is incorporated in Ireland, is typically physically located in countries like Bermuda or Luxembourg, which have no corporate income tax. The result ends up being a 0% tax on revenue derived from intellectual property for Irish-registered, but not necessarily Irish-located, firms. For Apple, the company used the intricate tax law and concessions made by the Irish government to declare its Cork headquarters as not being a tax resident of any country.

Another example of anti-tax inversion legislation came about in the news recently. In light of the Obama administration and the U.S. Treasury department’s new rules to combat tax inversion, biopharmaceutical company AbbVie (NYSE:ABBV) terminated its $54 billion acquisition bid for the Ireland headquartered Shire Pharmaceutical (NASDAQ:SHPG). This deal could have been the largest tax inversion deal of all time and could have lowered AbbVie’s tax bill significantly by reincorporating it in Britain. However, the deal fell through and AbbVie will now pay Shire a $1.6 billion post-termination breakup fee. Since AbbVie backed out of the deal, Shire’s stock price has slumped more than 26 percent. This led Paulson & Company, the hedge fund that owns more than 4 percent of Shire, to propose it as an acquisition candidate for Allergan, the Botox-maker fending off a hostile bid from Valeant Pharmaceuticals and Pershing Square Capital Management.

In my opinion, anti-tax inversion legislation does create an iron grip on corporate incentives to acquire foreign subsidiaries but as an upside keeps corporate excess in check by repatriating profits to the home country. However, new anti-tax inversion sentiment is not the end of international M&A as there are several other incentives involved. For example, the new tax inversion rules in the U.S. can make the potential acquisition of AstraZeneca less attractive for Pfizer. Although its last bid failed, Pfizer is likely to make another attempt at it, in my view. Pfizer is looking for new avenues for growth and considering the current industry situation; investment in Oncology (where AstreZeneca is strong) makes sense. In fact, Pfizer’s revenues related to oncology drugs jumped 16% globally in Q3 2014, sustaining the growth rate observed in the second quarter and representing an acceleration compared to the first quarter. For the first nine months, the segment’s revenue growth stood at roughly 13%. The figure is the highest among the company’s primary business segments, with vaccine sales racing past that of oncology drugs only in the third quarter. There is no doubt that Pfizer intends to strengthen its Oncology pipeline, and AstraZeneca can help it with that. The incentive for the deal extends well beyond tax benefits.