As an international tax advisor we are always interested when
the topic of “tax inversion” hits the headlines as was recently the case with
the announcement of the Medtronic for Covidien,
Pfizer for AstraZenca, Questcor for Mallinckrot, and Horizon Pharma for
Vidara Therapeutics deals.
A tax inversion is generally a transaction where a foreign
corporation acquires all the stock or assets of a US corporation, typically for
the purpose of moving the US company out of the domicile of the US for tax
purposes.
These transactions are subject to a great deal of scrutiny
and in order to protect the US corporate tax base, Congress and the IRS have
implemented rules designed to make tax inversion processes costly and in some
cases effectively impossible.
Generally, a US corporation will not be able to escape US
tax domicile without triggering a tax payment to the IRS on the way out if:
a) the US shareholders of the US target company ends up with at least 80% of the foreign acquiring company and,
b) the foreign corporation lacks “substantial business
activities” in the foreign acquiring company’s country of incorporation.
Companies find tax inversion beneficial if there is a lack of
predictable growth in earnings per share from manufacturing and sales efforts
and they have achieved near to maximum efficiencies. These companies will most
likely benefit from harvesting offshore profits by domiciling in a country
where taxes are lower than the US.
Currently, US corporations are able to defer paying US tax
on income from foreign operations by keeping these earnings outside of the US,
though in many cases these US companies have received US research and
development tax credits.
If a US corporation wants to pay higher dividends they have
to bring earnings from foreign operations back to the US (“repatriation of
foreign earnings”) at which point they have to pay the 35% US corporate tax
rate minus the any foreign taxes already paid.
The simple aim of tax inversion is to avoid paying the US
tax on repatriation of foreign earnings and reduce the total tax rate of the US
corporation.
There has been a significant increase in M&A
transactions in pharma, bio-tech and most recently medical device companies. It
is unsure if the increase in tax inversion activity will lead to legislators to
change the advantages of offshore companies given the amount of lost tax
revenue involved and respond to any public outrage if these transactions are
seen as capitalists running off and not paying their rightful dues.
No one knows if the government will take action but there
will certainly be a lot of companies looking at similar transactions and
contemplating going ahead before a new tax code is introduced and these
benefits have gone forever.
