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Free Pfizer! Why Inversions Are Good for the U.S. Free Pfizer! Why Inversions Are Good for the U.S.
(6 days later)
DONALD J. TRUMP wants to build a bricks-and-mortar wall to keep immigrants out of the United States. President Obama wants to build a virtual wall to keep companies from leaving. Neither is likely to work.DONALD J. TRUMP wants to build a bricks-and-mortar wall to keep immigrants out of the United States. President Obama wants to build a virtual wall to keep companies from leaving. Neither is likely to work.
On Monday, the Treasury Department issued new regulations in an attempt to limit “inversions” — in which American companies are acquired by foreign companies, legally lowering the tax burden of American companies. Speaking at the White House, Mr. Obama said, “We shouldn’t make it legal to engage in transactions just to avoid taxes.”On Monday, the Treasury Department issued new regulations in an attempt to limit “inversions” — in which American companies are acquired by foreign companies, legally lowering the tax burden of American companies. Speaking at the White House, Mr. Obama said, “We shouldn’t make it legal to engage in transactions just to avoid taxes.”
And with that, the $152 billion merger between Pfizer and the Irish drug company Allergan was dead.And with that, the $152 billion merger between Pfizer and the Irish drug company Allergan was dead.
Some observers believe that Treasury structured the regulation for the express purpose of killing this deal. Ernest Christian, formerly a lawyer at the Treasury Department, told me that a targeted rule like that erodes trust in government. “It’s like King John going after the peasants’ money hidden in haystacks,” Mr. Christian said. “That’s what led to the Magna Carta.”Some observers believe that Treasury structured the regulation for the express purpose of killing this deal. Ernest Christian, formerly a lawyer at the Treasury Department, told me that a targeted rule like that erodes trust in government. “It’s like King John going after the peasants’ money hidden in haystacks,” Mr. Christian said. “That’s what led to the Magna Carta.”
Since in the United States, statutory corporate tax rates are among the highest in the industrialized world, and America taxes companies on their worldwide incomes, companies in practically any other country make tempting inversion targets. Those in low-tax countries like Ireland are particularly popular.Since in the United States, statutory corporate tax rates are among the highest in the industrialized world, and America taxes companies on their worldwide incomes, companies in practically any other country make tempting inversion targets. Those in low-tax countries like Ireland are particularly popular.
Inversions have been concentrated among pharmaceuticals and medical device companies but are also occurring in other sectors. Burger King merged with the Canadian coffee chain Tim Hortons. Any American company with operations abroad has an incentive to invert, especially if it wants to bring capital back to the United States.Inversions have been concentrated among pharmaceuticals and medical device companies but are also occurring in other sectors. Burger King merged with the Canadian coffee chain Tim Hortons. Any American company with operations abroad has an incentive to invert, especially if it wants to bring capital back to the United States.
What are the Treasury’s changes? First, the regulation does not allow gains from inversions in the three prior years to count toward the size of the foreign company, which has to be of a certain size relative to an American partner for an inversion to take place.What are the Treasury’s changes? First, the regulation does not allow gains from inversions in the three prior years to count toward the size of the foreign company, which has to be of a certain size relative to an American partner for an inversion to take place.
This is precisely what ended the planned merger between Pfizer and Allergan, which grew through a series of inversions, most recently with Irish-based Actavis in 2015. Actavis, originally based in Switzerland, was acquired by Watson Pharmaceuticals in 2012, and the combined company, called Actavis, took over Warner Chilcott in 2013 and became Irish. Then, it took over United States-based Forest Labs in 2014.This is precisely what ended the planned merger between Pfizer and Allergan, which grew through a series of inversions, most recently with Irish-based Actavis in 2015. Actavis, originally based in Switzerland, was acquired by Watson Pharmaceuticals in 2012, and the combined company, called Actavis, took over Warner Chilcott in 2013 and became Irish. Then, it took over United States-based Forest Labs in 2014.
Under the old rules, Pfizer shareholders would have owned 56 percent of the combined company, enough to substantially lower its United States taxes. Under the new rules, Pfizer would own between 60 and 80 percent, subjecting it to much higher United States taxes.Under the old rules, Pfizer shareholders would have owned 56 percent of the combined company, enough to substantially lower its United States taxes. Under the new rules, Pfizer would own between 60 and 80 percent, subjecting it to much higher United States taxes.
Second, under the new regulations, Pfizer would lose the benefit of what is known as “earnings stripping,” where an American subsidiary can borrow funds from the overseas parent company and pay tax-deductible interest under United States law, reducing its taxes. The new regulation gives the Internal Revenue Service immense power over this debt.Second, under the new regulations, Pfizer would lose the benefit of what is known as “earnings stripping,” where an American subsidiary can borrow funds from the overseas parent company and pay tax-deductible interest under United States law, reducing its taxes. The new regulation gives the Internal Revenue Service immense power over this debt.
For example, the I.R.S. could declare some or all of Pfizer’s debt to be equity, so the interest payments would be dividends and no longer deductible. It’s important to note that the new earnings-stripping regulations apply not just for inversions, but for a vast array of multinationals’ transactions involving American businesses.For example, the I.R.S. could declare some or all of Pfizer’s debt to be equity, so the interest payments would be dividends and no longer deductible. It’s important to note that the new earnings-stripping regulations apply not just for inversions, but for a vast array of multinationals’ transactions involving American businesses.
This approach was proposed by the Harvard Law School professor Stephen E. Shay in 2014. Writing in Tax Notes, he argued that the Treasury secretary has “direct and powerful regulatory authority to reclassify debt as equity and thereby transform a deductible interest payment into a nondeductible dividend.”This approach was proposed by the Harvard Law School professor Stephen E. Shay in 2014. Writing in Tax Notes, he argued that the Treasury secretary has “direct and powerful regulatory authority to reclassify debt as equity and thereby transform a deductible interest payment into a nondeductible dividend.”
So what’s wrong with these rules? Simply, the government fails to see the benefits of inversion. As Treasury states in the description of the rule: “Typically, the primary purpose of an inversion is not to grow the underlying business, maximize synergies, or pursue other commercial benefits. Rather, the primary purpose of the transaction is to reduce taxes, often substantially.”So what’s wrong with these rules? Simply, the government fails to see the benefits of inversion. As Treasury states in the description of the rule: “Typically, the primary purpose of an inversion is not to grow the underlying business, maximize synergies, or pursue other commercial benefits. Rather, the primary purpose of the transaction is to reduce taxes, often substantially.”
Treasury fails to see that by reducing taxes companies can grow their businesses. A company like Medtronic that has recently inverted to Ireland by merging with Covidien can expand its American operations at lower cost than can its competitors, thus starting a domino effect of inversions within the industry. With lower tax bills, these companies are freer to invest money here.Treasury fails to see that by reducing taxes companies can grow their businesses. A company like Medtronic that has recently inverted to Ireland by merging with Covidien can expand its American operations at lower cost than can its competitors, thus starting a domino effect of inversions within the industry. With lower tax bills, these companies are freer to invest money here.
Our rules also unfairly punish American-based multinationals over their foreign rivals. If an American-based multinational wants to bring back overseas earnings to expand its plant in Wisconsin, or build a new one, the company would have to pay taxes of 35 percent on amounts brought home. If it returned $100 million, only $65 million would be available for investment. Our rules also unfairly punish American-based multinationals over their foreign rivals. If an American-based multinational wants to bring back overseas earnings to expand its plant in Wisconsin, or build a new one, the company would have to pay taxes of 35 percent on amounts brought home, minus the tax paid in the country where the money was earned. If it returned $100 million that hadn’t been taxed previously, only $65 million would be available for investment.
If a foreign-based multinational wanted to invest $100 million in a Wisconsin plant, then all $100 million would be invested in this scheme. Badger State residents and shareholders are better off under foreign investment.If a foreign-based multinational wanted to invest $100 million in a Wisconsin plant, then all $100 million would be invested in this scheme. Badger State residents and shareholders are better off under foreign investment.
The solution is not burdensome new rules, but lower taxes. Inversions are increasing because American taxes are out of line with foreign codes. Until that changes, inversions will continue. Rather than trying to block companies from leaving, President Obama would do better by making America more hospitable to global headquarters.The solution is not burdensome new rules, but lower taxes. Inversions are increasing because American taxes are out of line with foreign codes. Until that changes, inversions will continue. Rather than trying to block companies from leaving, President Obama would do better by making America more hospitable to global headquarters.