Corporate Taxes

Earlier this week, one of the largest acquisition and biggest-ever instance of corporate inversion was announced when Pfizer Inc (PFE) agreed to acquire Allergan Plc (AGN) for $160B. This has been painted by the politicians and the media as a way of avoiding corporate taxes, but one has to wonder what is really causing companies to take such steps to begin with. For some background, the deal announced between Pfizer and Allergan will result in Pfizer’s corporate headquarters moved to Ireland and will eventually save shareholders anywhere between 8% and 10% in taxes. The company does not really lose any business or marketshare in the US by doing this and simply reduces its taxes by taking this step. This move raises a few eyebrows since a Dow Jones Index-listed stock is now relocating.

To put things into perspective, the US corporate taxes are some of the highest in the world – and companies are always looking to find ways to cut down on taxes and other expenses. Remember – a company’s main objective is to make money and management which takes steps to save its shareholders unwanted expenses should be applauded.

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Corporate Taxes

The media likes to portray this with language such as “corporate loopholes”, “…the US government is losing…”, or other such negative potrayals, but a more important question to ask is: Why does the US government/IRS thinks that it has the right to tax worldwide income? This is a policy error, simply driving away companies and individuals from a competitive US marketplace.

A government should only tax what a company earns in that country. This is the policy used across the world with the exception of two countries – United States of America and Eritrea. The American tax collection agency – IRS (and Eritrea’s tax collection agency) seems to have gotten it into their heads that they can impose these laws and companies will simply cough up. Guess what, IRS? Companies are more nimble and they will find a way (legally, of course) to get around that system.

This was not a problem when companies were local to the US and most of their revenue came from one country. All taxes were paid there and the appropriate tax credits, if applicable, were used. But this is not the case anymore as companies go more international. Due to globalization, the world continues to shrink. Companies are becoming more global and revenues come from various different countries. This trend will only continue higher as countries sign  more trade laws such as TPP or TTIP, for e.g. The following chart shows how the S&P 500 companies currently generate profits. Only a little over 50% comes from the US and the rest comes from international countries.

MW-DS526_sp_reg_20150819104334_ZH

Some of the high profile companies that have gone the route of tax inversion include Medtronic, which moved to Ireland after buying Covidien plc. Similarly, we have seen Burger King relocate to Canada after acquiring Tim Hortons. Other companies include Sara Lee, OmniCom Group, Liberty Global etc. There have also been reports of Walgreens looking into options to move to Switzerland following its acquisition of Boots Alliance. Pfizer tried to buy AstraZeneca last year but failed, so this deal with Allergan was hardly a surprise – as Pfizer has been looking to acquire and relocate. In addition, Pfizer has been looking to grow its portfolio of drugs as old drugs come off of patents. As companies continue to grow more overseas, we continue to see more tax inversion deals. And unless the US tax laws are reformed, we will continue to see more of such deals.

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Not Just Corporations

This not only applies to corporations, but also individuals. The US and Eritrea are the only two countries that tax based on citizenship rather than residency. There are a few other countries which have slight limited variations of citizenship-based taxation, but nothing like US and Eritrea (read more here). It is no wonder that US citizens, especially high net worth individuals are renouncing their US citizenship by the droves in order to escape this never-ending tax claw. It doesn’t matter if citizens haven’t lived in the US for decades – they still have to file and pay taxes. No one likes taxes and the media is silly to criticize inversions. Just ask yourself – how many people do you know that pay taxes out of patriotism? Unless there is tax reform in the US, we will continue seeing this exodus from US-listed companies and individuals. The winners are the shareholders who save more on their taxes and will happily support management in such moves.

Disclosure: None. My full list of holdings is available here.

10 thoughts on “Corporate Taxes

  1. It doesn’t make much sense to me either R2R. I’m glad you brought up the US individual tax issue, as well. Ex-pats that I know have chosen to give up their citizenship over the issue. The IRS does allow an individual to deduct the tax they paid to foreign countries against the US tax return, but it’s still a hassle and ridiculous.
    -Bryan

    • Ive met a few ppl who are dual citizens – Canada and US and its a complete mess. Every year they are expected to file taxes in the US and most of them havent lived there in decades! The US tax system needs a major overhaul.

      Thanks for stopping by and sharing your thoughts. Hope you are enjoying some turkey 🙂
      R2R

  2. JC says:

    Nice article regarding corporate taxes. The tax system in the US is messed up on both the corporate and individual levels and a much simpler version would make everything so much easier. It’s not a surprise to see many companies at least looking into inversions because so many of the multinationals have billions overseas that can’t be brought back to the US without facing the high tax rates. That’s part of the reason that AAPL has taken on debt in order to pay dividends and do share buybacks. If I remember correctly they can take on debt to access the overseas funds which is a shame that it’s that difficult for them to bring the money back to reinvest or reward shareholders. It should just be pay the taxes where the profits are earned and then do what you want with it. Thanks for the great article.

    • Apple is a good example. They are able to raise debt using the overseas cash as collateral – and those are some really low rates that they are raising money on. So, its working out pretty well on Apple’s part. It still doesnt really provide any visibility on how the overseas cash can be brought back without paying IRS a massive 30% or more in taxes. Like you said, its a shame that the US tax system is in shambles – and companies have to relocate to circumvent this problem. Here’s to hoping someone will come up with a fix to this problem which shouldnt have existed in the first place.

      cheers
      R2R

  3. seanc0x0 says:

    The US tax system is a mess. I was born there but moved away when I was still too young to remember. I’ve never had a passport or used any of the services of the US gov’t, always went there as a tourist on a Canadian passport, etc.

    I never knew I was supposed to be filing taxes and all that. After all, why would I have to pay taxes somewhere I’ve not earned income or even lived in decades, just because I happened to be born there?

    Once FATCA came on the radar and I learned of the obligations of citizenship, I sorted it out and renounced almost immediately. I only want to have to keep track of one country’s crazy tax laws, not two!

    • I hear you, seanc0x0. Ive heard very similar stories from some of my friends who are dual citizens and are fed of up the US tax system even though they havent lived there in decades. Just like you, some have already given up and some are considering giving up their citizenship. US badly needs a tax reform – for now, it doesnt really seem to be on anyone’s radar and seems pretty low on priority list.

      Thanks for stopping by and sharing
      R2R

  4. Simply put – the US in not business friendly. The mass-exudos of business reminds me of how the film industry just gave up on California and started to film everything overseas. It costs less for the studios to ship all the equipment and put everyone, from the grips to security, up in 5 star hotels for a 3 month long film, than it does to film locally because of the permits, fees, and taxes.

    It’s only logical that companies will seek to relocate to more business and tax friendly countries.

    • Thats a good point Devin. The hollywood industry is a prime example for the problems. No wonder, a lot of them choose to film in Canada and portray it as US. I have a couple of friends who do a lot of stunt work for TV series and movies – based in Vancouver. Its a side hustle for them, but they have a lot of fun with it.

      Thanks for stopping by and commenting
      R2R

  5. Amazing article! I had no idea the United States had the highest corporate tax rate in the developed world. Are government is only going to want more – especially as more taxpayers leave the country. I hope this doesn’t become a negative feedback loop.

    • Yeah…the US has routinely outspent constantly raising their debt ceiling funding the endless wars instead of spending it on real needs – like social and healthcare programs. From this side of the border, we just watch and shake our head at the state of affairs in the US. Hopefully, you guys can fix the problems and make progress on things.

      R2R

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