The rise of ‘tax inversion’
More and more American businesses are snapping up companies in low-tax countries to make that their official home. British companies are in their sights. Simon Wilson reports.
What is tax inversion?
Corporate tax inversion' describes the process of buying or merging with a foreign company in order to shift your tax domicile to a lower-tax jurisdiction. Most often it refers to big American companies shifting their legal home though not necessarily their top executives or the bulk of their operations to low-tax countries, such as Ireland, the Netherlands, and now the UK.
The tactic is not new. Figures from Bloomberg show that at least 41 US companies have reincorporated in lower-tax counties since McDermott International moved its legal address to Panama in 1982. However, the pace has quickened in recent years, with 11 US firms pulling off the trick since 2012, and another four currently pursuing deals. Tax savings of $1bn a year were a key driver of Pfizer's (failed) attempt to take over UK-based AstraZeneca earlier this year.
Inversion is back in the news this week because AbbVie, a big Chicago-based pharmaceutical firm, has launched a bid for Shire, the third-biggest UK-listed drugs company (which itself, ironically enough, did a tax-motivated flit from the UK to Ireland in 2008).
Why do businesses want to leave America?
Because the land of the free and the home of the brave also has the highest rate of corporation tax of any rich-world economy, at 35% (though in practice many companies end up paying less). America is also one of the few countries that makes its firms pay that rate on profits earned abroad that are then brought back to the US even if that profit was generated by a subsidiary based in a lower-tax jurisdiction.
As a result, big US firms with global businesses have an incentive to keep untaxed cash offshore (and currently have an estimated cash pile of $2trn), as well as an incentive to create or buy a foreign parent company as a way of slashing their tax bills.
Moreover, if they are also under pressure from shareholders to pull off a big deal then, as Matthew Goodman puts it in The Sunday Times, "Say hello to tax inversion, the miracle cure that will tackle all three problems!"
Has the US tried to stop it?
Absolutely. The Internal Revenue Service issued its first rules against tax inversions in 1996, three years after cosmetics firm Helen of Troy pulled off an inversion by creating a shell firm in Bermuda. Congress then tried to stem the practice via legislation in 2004, with laws that required a foreign partner to be worth at least 20% of the combined group for a tax inversion to be legal.
That helped to stem the flow of US firms creating shell companies in places like Bermuda and the Cayman Islands. But it left the door wide open to US multinationals merging with smaller firms in low-tax European countries, for example.
Both Democrats and Republicans have proposed reforms that would discourage inversions such as cutting corporation tax, simplifying the system of allowances, and moving to a territorial' system that taxes only domestic profits. But efforts to date have become bogged down in Congressional deadlock and partisan arguments about broader reforms to the US tax code.
Why are tax inversions becoming more common?
In part because the pharmaceutical industry a sector particularly suited to tax-inversion-type deals due to its global nature and the importance of intellectual property is seeing a wave of consolidation. Also there's a feeling that US legislators may finally be getting their act together, and that much harsher US laws against inversions could be on their way such as a provision that a foreign target must be worth at least 50% of the combined entity.
In March the Obama administration proposed changes designed to remove the tax benefits from foreign takeovers, saving the US Treasury an estimated $17bn in lost taxes. But most tax experts expect it will take at least 12 to 18 months to push through the reforms giving American companies a window of opportunity to do more deals.
Why is the UK becoming a popular location?
Because its rates of corporation tax are low and falling to a uniform rate of 20% for firms from next year. Reforms by the current government also mean UK-based multinationals pay no UK tax on dividends they get from their overseas operations a key driver for tax-shopping businesses.
"Britain is very attractive to foreign firms because it is such an open economy and we have so many good companies [that are potential targets]," says tax lawyer Heather Self of Pinsent Masons. "The government's track record is not to interfere in foreign takeover bids.
Add in a common culture and language, similar legal system, and the size of its financial markets and you can see why it would be the Americans' favoured designation."
Who might the next target be?
"No UK company can be complacent, as the tax benefits allow a big premium to be paid even for those with the highest ratings," says Philip Noblet, merger and acquisition specialist at Bank of America Merrill Lynch. Of 34 European companies identified as potential acquisition targets by Exane BNP Paribas, more than a third are British, says Ben Marlow inThe Sunday Telegraph.
The biggest name on the list is BG Group, with Exxon seen as the most likely suitor. Drug-maker Shire has rebuffed AbbVie for now at least but other US suitors, including Allergan, could be interested. US medical devices maker Stryker has acknowledged that it's mulling over a bid for the UK's Smith & Nephew. And other possible targets include InterContinental Hotels, Weir Group and Meggitt.