Recent news of the Pfizer-Allergan deal collapsing has brought a long-contentious issue back into the spotlight: corporate tax inversions. Corporate inversion (commonly called tax inversion) refers to a company shifting its legal domicile to a lower-tax nation, while maintaining operations in its original country—all in an effort to dodge higher corporate tax rates.
The practice of tax inversions for Corporate America started around 1982, and since then more than 50 U.S. companies have reincorporated to low-tax nations. This brings up two questions today:
- Are the corporate tax inversion days numbered?
- What does this mean for corporate America?
Corporate Inversions in Practice
Let’s take a look at some past inversions and their estimated tax benefits:
- Eaton Corporation: In 2012, Eaton Corporation (ETN), a power management company from Cleveland, decided to buy Cooper Industries which once was an American corporation itself before it shifted its base to Bermuda in 2002 and later to Ireland in 2009. After the purchase, the combined company moved its headquarters to Cooper Industries’ residence in Ireland. As a result, the company expected to pocket $160 million a year in tax savings by 2016.
- Burger King: In late 2014, Burger Kind merged with Canadian coffee chain Tim Hortons forming Restaurant Brands International Inc. (QSR). According to a 2014 study by Americans for Tax Fairness (ATF), following the merger, Burger King could be exempt from paying $117 million in U.S. corporate taxes on its existing un-repatriated overseas profits. Additionally, Burger King could save a whopping $400 million to $1.2 billion in taxes over the four years following its reincorporation in Canada.
- Pfizer-Allergan: The most recent tax inversion stirring a lively discussion came from the collapsed deal of American drug maker Pfizer (PFE). Pfizer planned to relocate its headquarters to Ireland by merging with the Irish pharmaceutical Allergan (AGN). Pfizer reportedly could have saved more than $1 billion a year in tax related costs had it relocated its headquarters. Consequently, the deal was canceled after the U.S. Treasury announced last month the tightening of regulations against inversions.
Is Curbing Tax Inversions Justified?
From a purely economic standpoint, curbing tax inversions is likely justified as not doing so hurts more than it helps. In a statement released this month, the U.S. Treasury expressed concerns over corporations clinching overseas deals only to dodge taxes and are fearful that this could derail America’s growth and development. As a result, the Treasury proposed further tightening of corporate inversion rules with focus on curbing earnings stripping and serial inversions. According to the Congress’s Joint Committee on Taxation, inversions will cost the U.S. Treasury a massive $40 billion over the next ten years. That could constrain public investment and/or compel the government to raise tax burdens on American citizens to make up for the revenue lost due to corporate tax avoidance—generally a bad thing.
Bottom Line for Investors
It isn’t likely that any new legislation on inversions is going to lead to a mass exodus of U.S. corporations, which is what investors need to keep an eye out for. Since the Pfizer/Allergan deal, the story has somewhat faded from the headlines, meaning that the impact of changes at the U.S. Treasury are likely contained for the time being.