Tax is part of the M&A rationale

Large mergers and acquisitions always make the headlines, but in the United States the latest proposed deals put corporations into the spotlight for their thinly veiled desire to leave the U.S. for tax reasons. Still, more transactions are expected.  


When Pfizer announced plans to acquire AstraZeneca in a $100 billion deal and move the headquarters of the new firm to the U.K., it was only one of many proposed M&A transactions in part designed to move a U.S. corporation to a more tax friendly domicile. 

There are many incentives for U.S. firms to pursue so-called corporate inversions – transactions that cause a U.S. firm’s headquarters to be moved to a lower-tax country. High U.S. corporate tax rates, a tax system that applies globally and more than $2 trillion in foreign earnings trapped overseas are all part of the rationale to look for overseas merger and acquisition targets.  

While it is unlikely that a U.S. company would decide to migrate exclusively for tax reasons, corporate inversions have been a significant part of the M&A market in the past two years.  

Firms involved in corporate inversions usually cite operational incentives such as business growth and expansion into new markets, but lowering the effective tax rate and enhancing global cash management are an important part of the consideration and motivation for some of the transactions. 

When Endo Health Solutions acquired Canadian firm Paladin Labs last year, the newly formed company based its headquarter in Dublin. Neither company had more than a tenuous link to Ireland, but the country’s corporate tax rate is at 12.5 percent, substantially lower than rates in the U.S. and Canada.  

The deal allows Endo to reduce its effective tax rate from 28 percent to 20 percent, which corresponds to estimated tax savings of $50 million a year. 

Other recent inversions involving Ireland include Actavis, Alkermes, Covidien, Forest Laboratories, Horizon Pharma and Perrigo. The country will also be the legal home of Charlotte, North Carolina-based banana producer and distributor Chiquita. 

In addition to the planned Pfizer AstraZeneca deal, London is the chosen tax domicile for the world’s largest advertising company that would result from a merger of U.S. firm Omnicon with French advertising group Publicis. Starbucks also recently announced it would move its European headquarter to the British capital. 

The U.K., which in the past has been the victim of British corporate inversions to Switzerland, the Netherlands and other European low tax countries, is quickly becoming more attractive as a tax domicile for multinationals with its 21 percent corporate tax rate that will decline to 20 percent next year.  

The British government not only reduced the corporate tax rate from 32 percent, it also brought in new controlled foreign company rules, tax exemptions on dividends and a new intellectual property regime with the express aim of attracting foreign multinationals. 

U.S. corporations view European destinations as favorable from a business, political and legal perspective, as well as a gateway into the European markets. Corporate law in the Netherlands, Ireland or Luxembourg is flexible enough to allow various management forms, and legal expertise to deal with complex inversion transactions is widely available.  

The Netherlands, Ireland and Luxembourg, for instance, all offer an advantageous tax treatment of income derived from intellectual property. The U.K. also applies a low 10 percent rate on profits from U.K. patents, something that appeals particularly to pharmaceutical companies like Pfizer. 

Unlike the U.S., European countries, which are the main destinations for most inversions, impose no taxation on a company’s business activities abroad.  

As a result, inversions can enable U.S. corporations to distribute their offshore cash holdings of untaxed foreign earnings to shareholders. The earnings of a U.S. corporation’s foreign affiliates are still subject to tax in the U.S. if the funds are repatriated, but not if they are held abroad for reinvestment. 

In recent years, these cash holdings continued to build to more than $2 trillion for the companies listed on the Russell 2000 index. 

Shareholders typically demand that unused cash be returned to investors through dividends or that corporations use the funds for share buy-backs. By inserting a foreign corporation between the U.S. firm and its shareholders post-inversion, the cash can be returned to shareholders or used to fund the M&A transaction itself.  

Making effective use of its $57 billion offshore cash holdings is also part of the strategy behind General Electric’s proposed takeover of French company Alstom, although in this case no corporate inversion is planned. 

U.S. legislators have attempted to limit the instances when corporate inversions are completed solely to escape U.S. taxation. Crucially, the tax effect of the corporate inversion is available only if the former shareholders of the U.S. corporation represent no more than 80 percent of the combined company after the M&A transaction. 

In March, the U.S. Treasury Department proposed to amend anti-inversion rules and reduce this rate to 50 percent by Jan. 1, 2015 – a move that would significantly reduce the number of corporate inversion opportunities for U.S. companies.  

Although it is uncertain whether this proposal will take effect, it should serve as an incentive for U.S. corporations to accelerate any corporate inversion plans before the end of the year. 


Starbucks recently announced it would move its European headquarter to London. – PHOTO: AP