End Tax Inversion!

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Several months ago, when Apple was testifying in front of Congress about why it was paying virtually no federal US tax students in my corporate strategy class wondered – were they doing anything illegal?  So, I explained how the US’s corporate tax system is set up  – giving companies an incentive to set up related companies in other countries, especially in parts of the United Kingdom, which have very small tax rates. We also discussed how it encourages companies to keep profits in bank accounts of these companies because monies staying off-shore aren’t taxed.

The class had a second chance to address it this issue this week when we discussed Pfizer’s $100 Billion takeover bid for AstraZeneca. Usually, strategic acquisitions/mergers work because they allow the resulting company to better focus its resources on its core competences (in this case increasing its share of drugs for cancer immune diseases and emerging markets), and reduce expenses through scales of economy and elimination of redundant expenses (e.g., back office work).  While becoming more strategic and nimble through reduced are motivators for this deal, there’s another major consideration – keeping corporate taxes lower than US rates and using the money that sits outside the US.

Tax inversions allow U.S. companies, which face one of the highest tax rates in the world – a federal tax rate of 35 percent, and an overall rate that can be close to 40 percent including state and local taxes – to move to a lower-tax country by buying or creating a new holding company. Pfizer’s tax rate last year was 27%, AstraZeneca’s was 21%. Further, the UK provides tax credits for research and development, and it has proposed taxing income generated from patents at an even lower 10%.By creating a new holding company in the United Kingdom, the new company would enjoy the lower tax rates and get to use their off-shore funds wisely. More than 70% than 70% of Pfizer’s $49 billion in cash is held abroad.

Another benefit of changing the tax laws to encourage companies’ to stay domiciled in the US is that they would make the keeping companies more competitive. Every percentage point in tax reduction could add $200 million to Pfizer’s net income, according to a Barclay estimate.

Unfortunately, no-one expected anything significant to come from Congress until after the mid-term election, as gridlock reigns and finger-pointing for political advantage is the goal. Yet, both political parties could help address their favorite cause by addressing this issue now. And, while they do nothing the rest of the world realizes how they can benefit from this tax inversion system; for instance, the tax rate in the United Kingdom will drop another 1% next year!

What do you think? If you agree, maybe this is an issue that we can get the Democrats and Republicans to work on together before too many other companies decide to follow the lead of these companies.