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.
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.
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.
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.