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.
