Proposed Pfizer deal suggests tax inversions will continue, despite US plans to stop ‘corporate deserters’

Thursday 28 January 2016



Late last year, US pharmaceutical giant Pfizer agreed a deal to acquire the company Allergan for $160bn. If approved by regulators, it should be completed in the second half of 2016 – and be the biggest ever acquisition in the sector.

It’s also one of the most controversial. If the deal goes through, it would enable New York-based Pfizer to move its headquarters to Ireland, where Allergan is based, and benefit from a much lower rate of corporate tax. The new combined entity could cut its tax rate from around 25 per cent for the current year, to about 18 per cent. In 2014, Pfizer paid $3.1bn in US taxes; if it had been headquartered in Ireland, the bill would have been $1bn less.

David Shapiro
Saul Ewing law firm; IBA Taxes Committee

According to President Obama, companies that engineer deals like this – known as corporate inversions or tax inversions – are ‘corporate deserters’ that are being ‘unpatriotic’ by seeking to reduce their contribution to US coffers. His Administration has proposed rule changes in a bid to stop them. Under the current framework, US firms can move their corporate headquarters abroad if they acquire a foreign company and transfer more than 20 per cent of their shares to foreign owners; the Obama Administration suggests raising that threshold to more than 50 per cent.

Hillary Clinton, the frontrunner in the race to secure the Democratic nomination for this year’s presidential election, has also pledged to impose an exit tax on companies that ‘desert’ the US in this way.

But until any of this happens, tax inversions are unlikely to go away.

‘‘Companies are probably more likely to do a transaction right now out of fear that they won’t be able to do it in a year or two’s time

David Shapiro, partner, Saul Ewing law firm; Young Lawyers' Programme Officer, IBA Taxes Committee

‘From the corporation’s perspective, if they are in a business where they’re seeing a lot of growth overseas and where the rest of the world has moved to a taxing model that is radically different to the US, it’s hard to see why the US is attractive as a group headquarters,’ says David Shapiro, an international tax attorney based in the Philadelphia office of Saul Ewing, and Young Lawyers Programme Officer on the IBA Taxes Committee.

‘These things are all the rage,’ adds James Henry, a senior fellow at the Columbia Center on Sustainable Investment and member of the New York Bar.

‘We’ve lost Chrysler, Burger King… ever since 2014, it’s been the season for inversions. It’s going to be difficult to find an effective way to stop these deals as long as we have this disparity in tax rates.’

The Obama Administration may be 'talking a good game', but as things stand, it can’t get anything through Congress, says Henry. The stalemate in Washington DC has prompted Clinton to pledge to use executive powers on tax if elected.

The possibility of future changes means that more tax inversions are likely to happen in the near future. ‘There are concerns that rule changes could make these deals more difficult, so people are trying to act if they qualify under the current rules,’ says Shapiro. ‘Companies are probably more likely to do a transaction right now out of fear that they won’t be able to do it in a year or two’s time.’

These rule changes are expected to include amendments relating to earnings stripping, where firms would lose tax deductions for certain payments made to the new foreign parent. That would raise the US effective tax rate. Currently, the rules are very specific when a company's debt to equity ratio exceeds one and a half to one.

‘If you’re less than one and a half to one, unless you’re borrowing to fund capital projects, you can generally deduct any interest expense,’ says Shapiro. ‘If you’re over that, then you are severely limited in what interest you can deduct.’ The US Treasury is working on proposals to impose additional limits for inverted companies.

Alex Cobham, Director of Research at the Tax Justice Network, is clear on the significance of inversions: ‘They have a high profile because there is such transparency about the unpatriotic nature of what’s being done,’ he says. ‘Their practical impact, in terms of putting the profit somewhere other than where the economic activity takes place, is not fundamentally different from other methods multinationals use to reduce the amount of tax they pay. But people see them and get annoyed by them in a quite different way.’

This means they help to make the case for tax reform, in a way that other issues – for instance, transfer pricing regulations – do not. ‘The increasing number of cross-border mergers driven, at least partly, by tax considerations would seem to indicate the need for wide-ranging tax reform,’ suggests Pascal Saint-Amans, Director of the OECD’s Centre for Tax Policy and Administration.

Concerns about tax inversions were also raised in 2014 when Pfizer proposed a US$119bn merger with the UK’s AstraZeneca. The fact that the AstraZeneca board was not in favour of the takeover proved a major stumbling block, and the deal did not go through. The situation is different this time because Allergan is larger relative to Pfizer than AstraZeneca was.

The firms also had to take note of a recently introduced US rule stipulating that when regulators calculate the percentage of the combined business accounted for by the foreign acquirer, they have to exclude the value of cash and other liquid assets. Pharmaceutical companies generally maintain large stockpiles of cash, so that may have been an unwelcome complication.

‘I don’t think it took AstraZeneca below the threshold, but when a company is close to the limit, then it’s more likely that changes in business operations between signing and closing the deal will radically change the tax consequence,’ says Shapiro.