Friday, May 2, 2014

Pfizer Wants To Decrease Its Taxes By Moving To Britain

I am reading the following headline at Bloomberg Businessweek: “Pfizer’s $99 Billion Bid for AstraZeneca Is a Tax Shelter.”

No, it is not. This is a tax shelter the same way I am Floyd Mayweather Jr.’s next opponent.

It is sign of a problem, though.

Pfizer is based in New York City. AstraZeneca is based in London. Pfizer has proposed the deal, but AstraZeneca has not yet accepted. The deal may fall yet fall through. There are any number of reasons why a drug company would buy another drug company, but this one would move one of the largest U.S. multinationals to London. The term for this is “inversion.”

Mind you: the Pfizer executives are not moving. They will remain in New York, and Pfizer research facilities will remain in Connecticut. Pfizer will however go from being a U.S.-based multinational to a U.K.-based one. How? There will be a new parent company, and that parent will be based in London. Voila!

Inversions are more complicated than they used to be. In 2004 Congress passed IRC Section 7874, which denies tax benefits to an inversion unless certain thresholds are met. For example,

·       If the former shareholders of the former U.S. parent own 80% or more of the foreign corporation after the inversion, then the inverted company will continue to be considered – and taxed – as a U.S. company.

You can quickly assume that new – and non-U.S. shareholders – will own more than 20% of the new Pfizer parent.

What if you own Pfizer stock? In addition to owning less than 80% of the new parent, code Section 367 is going to tax you when Pfizer inverts. This is considered an “outbound” transaction, and there is a “toll” tax on the outbound. What does that tell you? It tells you that there has to be cash in the deal, otherwise you are voting against it. There has to be at least enough cash for the U.S. shareholders to pay the toll.

Let’s say the deal happens. Then what?

I cannot speak about the drug pipeline and clinical trials and so forth. I can speak about the tax part of the deal, however.

As a U.S. multinational, Pfizer has to pay taxes on its worldwide income. This means that that it pays U.S. taxes on profits earned in Kansas City, as well as in Bonn, Cairo, Mumbai and Sydney. To the extent that a competitor in Germany, Egypt, India or Australia has lower tax rates, Pfizer is at an immediate disadvantage. In the short term, Pfizer would be less profitable than its overseas competitor. In the long term, Pfizer would move overseas. Congress realized this and allowed tax breaks on these overseas profits. Pfizer doesn’t have to pay taxes until it brings the profits back to the United States, for example. Clever tax planners learned quickly how to bend, pull and stretch that requirement, so Congress passed additional rules saying that certain types of income (referred to as “Subpart F” income) would be immediately taxed, irrespective of whether the income was ever returned to the United States. The planners responded to that, and the IRS to them, and we now have an almost incomprehensible area of tax Code.

Take a moment, though, and consider what Congress did. If you made your bones overseas, you could delay paying taxes until you brought the money back to the U.S. Then you would have to pay tax – but at a higher rate than your competitor in Germany, Egypt, India or Australia. You delayed the pain, but you did not avert it. In the end, your competitor is still better off than you, as he/she got to keep more of his/her profit.

What do you do? Well, one thing you cannot do is ever return the profit to the United States. You will expand your overseas location, establish new markets, perhaps buy another – and foreign – company. What you will not do is ship the money home.

How much money has Pfizer stashed overseas? I have read different amounts, but $70 billion seems to be a common estimate.

When Pfizer inverts, it may be able to repatriate that money to the U.S. without paying the inbound toll. That is a lot of money to free up. I could use it.

The U.S. also has one of the highest – in truth, maybe the highest – corporate tax rate in the world. The U.K. taxes corporate profits at 20%, compared to the U.S. 35%. The U.K. also taxes profits on U.K. patents at 10%, an even lower rate. This is a pharmaceutical company, folks. They have more patents than Reese’s has pieces. And the U.K. taxes only the profits generated in the U.K., which is a 180 degree turn from Washington’s insistence that it can tax profits of an American company anywhere on the planet.

Now, Pfizer does not get to avoid U.S. taxes altogether. It will still pay U.S. tax on profits from its U.S. sales and activities. The difference is that it will not pay U.S. taxes on sales and activities occurring outside the United States.

Since 2012 approximately 15 large U.S. companies have moved or announced plans to move offshore. Granted, there are numerous reasons why, but a significant – and common – reason has to be the benighted policy of U.S. multinational taxation. What has the White House proposed to stem the tide? Increase the ownership threshold from 20% to 50% before the company will be deemed based outside the U.S.

Brilliant.  To think that Washington at one time pulled off the Manhattan Project, Hoover Dam and landing a man on the moon. How far the apple has fallen.

The issue of corporate inversion has been swept up as part of the larger discussion on tax reform. That discussion is all but dead, unfortunately, although perhaps it may resurrect after the Congressional elections. The Camp tax proposal wants to move the U.S. to a territorial tax system rather than the existing worldwide system, which is an acknowledgement of the problem and a very good first step. It will not stop Pfizer, but we may able to stop the next company to follow.

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