Making Cent$ of Tax Inversions

Forget politics. The business world is now the greater hotbed of strange bedfellows.

While it cannot top the eccentricity of an Obama-Clinton or Gowdy-Gutierrez partnership, Corporate America nevertheless has spawned its fair share of peculiar pairings in recent years: Argonaut Group Inc.-PXRE Group Ltd. (2007); Biovail Corp.-Valeant Pharmaceuticals (2010); Eaton Corporation plc-Cooper Industries plc (2012); Endo International plc-Paladin Labs Inc. (2013); Horizon Pharma Inc.-Vidara Therapeutics International Ltd. (2014); AbbVie-Shire plc (2014); Mylan Laboratories-Abbott Laboratories (2014); Medtronic Inc.-Covidien plc (2014), and most recently, Burger King-Tim Hortons.

The strangest aspect of these matchups is not the alliances themselves, but rather the amalgamation of former rivals (Abbott and Mylan, for example, regularly battled for generic drug market share while Medtronic and Covidien tussled for surgical technology supremacy).

Not surprisingly, there’s a method behind the frenemies’ collective madness—namely, a shared desire to free themselves from the competitively crippling U.S. corporate tax rate.

Eaton Corporation, Endo International, Horizon Pharma and Valeant are among 21 companies that have merged with foreign competitors and reincorporated abroad since the start of 2012. The tax-dodging trick is more than 30 years old, but a spate of inversion deals this year has prompted the Obama administration to demand a Congressional remedy to the problem.

“Congress may take some action that could negate some of the benefits to these tax inversion deals, but that’s still up in the air right now,” Venkat Rajan, advanced medical technologies principle analyst at Frost & Sullivan, told Medical Product Outsourcing.

“The reason [inversions] make sense for device companies like Medtronic and some of the pharma companies is they have certain expectations for revenue that will be coming from outside of the U.S. They are making significant investments into markets in Asia, Latin America and other parts of the world. As those revenues come in and you have a shift of revenue from the rest of the world versus the U.S., there’s the potential that money can get double-taxed under the current [tax] code. But if you’re headquartered in Ireland or some of these other places, then essentially that revenue falls outside of the [U.S.] corporate tax rate.”

Though its name may imply otherwise, inversions are perhaps the simplest of financial tactics. Companies that undertake an inversion are merely moving their legal address outside the United States for tax purposes. Physically, nothing moves; it’s business as usual for American operations, employees and customers. The change of address, however, enables firms to move some profits to their new homeland and pay fewer taxes to Uncle Sam. 

The Joint Committee on Taxation claims inversions could cost the U.S. government $19.46 billion over the next decade. But the true impact is virtually impossible to predict due to unreliable corporate tax data and the variables in individual business plans.

Complicating efforts to assess the economic impact of tax inversions is the ways in which companies bypass the U.S. tax code.
Corporations, for instance, can lower their tax bills by transferring pre-tax income from their U.S. operations to their foreign parent entities through intercompany debt. Or, they can simply keep cash overseas (the money only becomes taxable once it is brought back to the United States). Stashing money abroad, in fact, is one of the most popular choices: Thirty Fortune 500 companies hold nearly $1.2 trillion overseas, according to data from the U.S. Public Interest Research Group (PIRG). The hoarders include Johnson & Johnson ($51 billion abroad); Abbott Laboratories ($24 billion); Medtronic ($20.5 billion); Baxter International ($12.2 billion); Boston Scientific Corp. ($11.9 billion); Danaher ($10.6 billion), 3M ($9.7 billion); Stryker Corp. ($7 billion); Agilent Technologies ($6.1 billion); Thermo Fisher Scientific ($6 billion) and Becton Dickinson and Co. ($4.4 billion).

“Our tax code is broken and it’s hurting the public,” said Dan Smith, tax and budget advocate for the U.S. PIRG Education fund and co-author of the report, “Offshore Shell Games 2014.” “We’ve made it too easy for American multinationals to dodge taxes by setting up shell companies in tax havens. We simply shouldn’t allow companies that use American roads, and benefit from America’s education system and large consumer market, to take a free ride at the expense of the rest of us.”

Consumers, however, still make out better than shareholders. Internal Revenue Service rules dictate that investors of companies purchasing foreign entities and moving overseas pay capital gains if they hold 50 percent or more of shares.

Such is the case for Medtronic, which announced its intention in June to purchase Covidien for $43 billion. Once the deal goes through, shareholders will be stuck with a significant tax bill—up to 33 percent in California (including state tax) and 29.7 percent in Minnesota, where Medtronic currently is headquartered.