A wave of tax-driven overseas deal-making by U.S. companies gained momentum with drugmaker Pfizer Inc's (PFE.N) announcement on Monday that it had made takeover bids for UK rival AstraZeneca Plc (AZN.L), fueling political concerns about tax "reflagging" strategies.
Pfizer said it wants to buy AstraZeneca and merge the two companies into a UK holding company with a UK tax domicile, while maintaining its operational headquarters in New York. It would likely be the largest deal ever done that included such a so-called tax "inversion."
If a deal goes through - which is far from certain given AstraZeneca has so far rejected Pfizer's overtures - it would likely mean a loss of corporate tax revenue for the United States, and a lower effective tax rate for the combined entity than the two companies pay now.
For 2013, Pfizer disclosed an effective rate of 27.5 percent and global cash income tax paid of $2.87 billion, including income taxes paid to the U.S. government and other state and foreign tax authorities, based on company filings.
The Pfizer proposal triggered concern in Washington. "This further demonstrates the urgency for tax reform," said a spokeswoman for Democratic Senator Ron Wyden, chairman of the tax-writing U.S. Senate Finance Committee.
"Now is the time to undertake comprehensive reform to ensure our country stays competitive on a global stage and continues to be the best place for corporate investment," the spokeswoman said.
Governments worldwide are increasingly wary of corporate tax avoidance. The Obama administration earlier this year included a proposal in its 2015 budget to clamp down on deals like the one Pfizer is pursuing. The administration's proposal is unlikely to go anywhere though with Congress deadlocked on tax issues.
The U.S. Internal Revenue Service on Friday issued a separate notice limiting shareholders' tax-free treatment in inversion transactions.
TAX-DRIVEN DEALS RAMP UP
Since the 2008 global financial crisis, about two dozen U.S. companies have shifted their legal tax residences to lower-tax countries via corporate deals, versus about the same number over the previous 25 years, a Reuters review of transactions showed.
Ireland, the Netherlands, Switzerland, Canada and Britain lately have been the most common destinations of U.S. companies seeking new tax domiciles, replacing preferred havens of years past such as Bermuda and the Cayman Islands.
Buying AstraZeneca would allow Pfizer to escape the comparatively high 35-percent U.S. corporate income tax rate.
The United States has one of the highest such tax rates in the world, though most multinational companies pay less than that due to plentiful loopholes.
Pfizer spokeswoman Joan Campion said the UK holding company structure being contemplated "provides for a more efficient tax structure that doesn't subject AstraZeneca's non-U.S. profits to U.S. tax." Campion declined further comment.
Inversions allow U.S. corporations to escape that high rate by moving to a lower-tax country, via an acquisition, a merger or the creation of a new holding company. They can also reduce overall U.S. profits in a process known as "earnings stripping" that involves loading up the legacy U.S. business with tax-deductible debt, said academics and private tax watchdog groups.
The AstraZeneca transaction would also give Pfizer a way to spend some of an estimated $69 billion it is holding abroad under a law that lets U.S. companies shelter overseas earnings from U.S. taxes by keeping them out of the United States.
Another large inversion deal is New York advertising firm Omnicom Group Inc's (OMC.N) proposed $35-billion merger with Paris rival Publicis Groupe SA <PUBP.PA). This transaction is encountering approval delays among European tax authorities.
Omnicom and Publicis announced in mid-2013 they planned to merge into a new corporate holding company to be based in the Netherlands, with operating units staying in New York and Paris.
The merger was described then as tax-free to shareholders of both companies, with each side getting about 50 percent of the shares in the new Dutch holding company. The deal was then expected to close in late 2013 or early 2014.
Last week, Omnicom said Dutch and UK tax authorities had not yet approved the deal, which Omnicom had previously said would save $80 million a year in taxes. A plan to make the company tax resident in the UK while being domiciled in the Netherlands had become a particular stumbling block.
Omnicom-Publicis is more like a merger of equals than it is an inversion, but "the practical impact of this transaction is that the company is achieving a corporate inversion," said Bret Wells, a professor at the University of Houston Law Center who has studied corporate inversions for years.
Though the Obama budget proposal is unlikely to become law anytime soon, it does indicate that the U.S. government is trying to grapple with the question of inversions.
"It's been a decade since the first inversion legislation was enacted and Obama is now trying to tighten the rules," said Steven Rosenthal, a tax expert and senior fellow at the Urban Institute, a policy think tank in Washington, D.C.
"There's a lot of concern about losing U.S. companies to these reflagging operations," he said.
IRS TAKES STEP
The IRS's move last week "further evidences the government's narrow reading of the inversion rules and dovetails with the Obama administration's 2015 budget proposal to narrow the scope of permitted inversions," said international law firm Cadwalader, Wickersham & Taft LLP in an emailed update to clients on tax-related merger and acquisition developments.
"More companies are currently considering inversions by merger, including mergers involving two or more foreign jurisdictions," said Linda Swartz, chair of Cadwalader's tax group. "Companies have become more comfortable with the prospect of inverting as the number of announced deals has steadily increased this year."
The Organization for Economic Co-operation and Development, a Paris-based club of major industrial economies, is studying tax base erosion and the related issue of profit shifting by multinational corporations among units in different countries.
The United States was among members of the G20 nations that endorsed the OECD project. "Profits should be taxed where economic activities deriving the profits are performed and where value is created," said a declaration of the G20 leaders in September after a summit meeting in St. Petersburg, Russia.
The IRS has addressed inversions, which are generally thought to have first emerged in 1982, by trying to define what is and is not a foreign business, and by trying to curb opportunities for earnings stripping, but with little success.
A flurry of deals from 1997 through 2002 saw several major U.S. companies reflag in Bermuda and the Cayman Islands. Congress cracked down with a stricter law in 2004 and the flow of deals dried up for a few years.
The latest wave of deals got under way in 2008 after the financial crisis abated. The wave has continued amid inconclusive IRS efforts to define how much presence a corporation must have in the United States and abroad to be treated as a foreign company for U.S. tax purposes.
(Additional reporting by Tom Bergin and Ben Hirschler in London; Nicola Leske, Olivia Oran, Nadia Damouni, Leila Abboud and Ransdell Pierson in New York; Editing by Martin Howell)