Collapse of Pfizer-Allergan deal will be mourned by few

Except for the firms involved, few in the US or Ireland benefit from inversion deals

Ian Read, chairman and chief executive officer of Pfizer, and Brent Saunders, president and chief executive officer of Allergan. This week’s announcement was seen as being directed particularly at the Pfizer-Allergan deal. Photograph: Michael Nagle/Bloomberg

Ian Read, chairman and chief executive officer of Pfizer, and Brent Saunders, president and chief executive officer of Allergan. This week’s announcement was seen as being directed particularly at the Pfizer-Allergan deal. Photograph: Michael Nagle/Bloomberg

 

As Pfizer and Allergan bowed to the inevitable and dropped their plan for a $160 billion (€140.6bn) deal that would have seen America’s largest pharma group become an Irish-domiciled company, the international view was clear. US treasury secretary Jack Lew had dealt a blow to Ireland with his latest crackdown on a process known as corporate inversions.

The Obama administration has become increasingly irritated by the steady stream of US companies looking to reduce their tax bills by acquiring smaller businesses in other countries and moving their tax domicile there.

Ireland, which is seen as a destination of choice for such companies – largely because of its attractive 12.5 per cent corporation tax rate – has come under particular pressure.

The catalyst that initially pushed Obama’s treasury into moving against such deals was the disclosure that medical device giant Medtronic was proposing to move to Ireland in what was then the largest corporate inversion on record. Covidien, its target, had ironically been established in Ireland as part of the break up of Tyco International which had previously abandoned the US for Bermuda, for tax reasons

Speaking at that time, in July 2014, President Obama said: “If you simply acquire a small company in Ireland or some other country to take advantage of the low tax rate, you start saying ‘we’re now magically an Irish company’ despite the fact that you may only have 100 employees there, and you’ve got 10,000 employees in the United States, you’re just gaming the system.”

Terms like “gaming the system”, “being unpatriotic” and “insidious” have peppered presidential commentary on what is a perfectly legal practice under the laws of the US.

Emergency powers

Medtronic – and frustration at the inability of Congress to agree on how to block inversions – may have triggered the first initiative from Treasury Secretary Lew but, as the practice continued, he has been forced to revisit and strengthen what are effectively emergency powers.

This week’s announcement – the third time Lew has stepped up to the plate on the issue – was seen as being directed particularly at the Pfizer/Allergan deal. The move to dismiss recent acquisitions by fast-growing companies was considered a very pointed reference to Allergan – itself a creature of several corporate inversions.

Sources close to Pfizer say tweaking the deal to circumvent the new rules could have been done but the view was taken that any such move might simply antagonise Treasury into further tightening.

The decision had clearly been taken that, in a presidential year, it was not acceptable for one of the United States’ storied companies to turn its back on the US and, more importantly the Internal Revenue Service, which stood to lose up to $1 billion a year in tax from the company.

Stopping corporate inversions – especially the Pfizer deal – was possibly the only issue on which all the remaining feuding presidential candidates agreed.

A side benefit was that it sent a strong message to Ireland and others to keep their hands off America’s corporate jewels.

The irony is that corporate inversion is of little if any benefit to Ireland. Both acting Taoiseach Enda Kenny and Minister for Jobs, Enterprise and Investment Richard Bruton have said on several occasions that Ireland has no interest in chasing corporate inversions.

A spokesman for the Minister said yesterday: “Ireland does not seek to attract corporate inversion deals, as these deals do not bring any benefits to Ireland, in the form of increased economic activity or job-creation.

“Minister Bruton and IDA Ireland will continue to pursue substance-based investments for Ireland that bring increased economic activity and jobs here.”

He has said previously: “I don’t think there would be any loss to Ireland should there be a change by the US and I think most people would welcome a change.”

His view is reflected by IDA Ireland, where chief executive Martin Shanahan insists: “We do not market Ireland as a location for inversions.”

He said inversions by US companies were “driven by the fact that the US tax system is uncompetitive by international standards”.

“People characterise it as a windfall for Ireland and that is not the case.”

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In fact, as Minister Bruton has said previously, it actually carries a cost burden for Ireland.

Little employment

Companies inverting into Ireland bring precious little employment with them. The inversion itself means establishing a head office presence which, in some cases, is little more than a brass plate. Nor does the inversion itself deliver any revenue for the Exchequer by way of taxes – although some companies, including Pfizer and Allergan, do pay taxes here by virtue of their existing businesses on the ground.

However, what the change of domicile does do is inflate Ireland’s GNP figure. And that, as Prof John FitzGerald wrote in this paper recently, also raises the Irish contribution to the EU budget while conferring no benefit to Ireland.

“Ireland effectively pays a tax to the EU of between €50 million and €100 million a year on the activities of these ‘redomiciled’ companies,” he said.

PricewaterhouseCoopers international tax partner Joe Tynan agrees that the immediate impact for Ireland is negative and raises also the prospect of reputational damage to the country as it is inaccurately seen as benefiting from such deals at the expense of taxpayers in the US and elsewhere.

Home audience

And some of the companies themselves have not been averse to playing to their home audience.

“Some of these companies have gone to great lengths to say that nothing has changed and that they are staying in the US, keeping their operational business there,” he says.

Tynan concedes that there some potential benefits for Ireland from such deals down the line as companies facing country-by-country reporting pressure look to add functions to Irish headquarters operations to prove that they are businesses of substance

And, as Shanahan points out, many of the companies concerned, including Pfizer, Allergan, Medtronic, Covidien and Alkermes among others, do have substantial business operations in the State, generally preceding any corporate inversion.

Ian Read put Pfizer’s plight succinctly when he announced the Allergan deal. The US tax system, he said, was asking it to fight in a competitive global market with “one hand tied behind our back”. He might be right but, for the second time in succession, he sorely misjudged the political mood and few in Ireland, outside the financial and legal advisers connected with the deal, will mourn its collapse.

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Corporate inversion: How does it work?

“Corporate inversion” has become a buzzword in the United States for everything from corporate greed to lack of patriotism. But what is it and how does it work?

In essence, corporate inversion is a move by a company to relocate its domicile to another jurisdiction in order to reduce its tax bill – executed by it acquiring a smaller company based in that country.

Despite what US commentators would have you believe, it is not uniquely a feature of American corporate life. Companies can and do move from other countries, but largely for the same reason – tax.

Ireland has become synonymous with the term because it has featured in a disproportionate number of them over the past five or six years. However, it is not alone. The UK, the Netherlands, Switzerland, Israel, Australia and Canada have also proved attractive to companies looking to lower the average tax rate on their earnings.

In some quarters, our 12.5 per cent corporation tax rate has been seen as predatory, allowing Ireland to benefit at the expense of other jurisdictions, especially the United States. Yet that misunderstands the nature of the arrangement.

Under US domicile, companies are subject to US tax on worldwide profit at the prevailing headline rate of 35 per cent – although a study of the accounts of any large multinational will show that actual tax rates applied on earnings are well below this figure.

The sticking point is that profit earned abroad is taxed only when it is repatriated to the US. At that stage, the company pays the Inland Revenue Service the difference between the tax already paid abroad and the 35 per cent figure.

This has led US firms to keep foreign earnings abroad – a sum estimated to be up to $2 trillion.

Inverting does not remove these companies entirely from the US tax net. They continue to pay tax in the US on their US profits – although until the most recent restrictions they could be loaded with debt from their new owners and offset interest on this from US earnings before tax, a practice known as “earnings stripping”.

What inversion does is bring future foreign earnings into play.

But these earnings will already be taxed to some degree in those jurisdictions where they arise. As Ireland’s 12.5 per cent tax rate is lower than that in most other countries, no additional tax is due in Ireland, and therefore there is no “windfall” for the Irish exchequer.

The windfall accrues to the company, not to Ireland Inc.

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Obama’s action : what the US did

The Obama administration has spent much of its final term trying to clamp down on corporate inversion in an environment where such deals are becoming increasing popular and larger in scale.

Frustrated by Congress’s inability to agree any move to curb inversions, the US treasury eventually put what are effectively emergency measures in place.

– September 2014 The first tranche of executive action involved several elements:

Moves to strengthen the requirement that US shareholders can own no more than 80 per cent of the combined entity.

This included discounting “passive” assets such as cash being used to bring the foreign party up to or over the 20 per cent threshold of the combined entity. US companies were also barred from either making extraordinary dividends to shareholders or spinning off assets to artificially reduce the size on the US company in any new entity.

An end to “hopscotch loans” and transfers where US companies effectively moved some of their stockpiled foreign earnings to foreign subsidiaries or parents in an effort to avoid US tax. A threat to impose such measures retrospectively did not materialise. – November 2015 A second set of measures closed the door on new areas, including: Third-country inversions, where a new foreign parent is established for tax reasons in a country other than the ones where the two inverting parties are established. Measures also required the new foreign entity to have a substantial business presence in the country to which domicile is moving.

Expanding the exclusion of passive assets to include any “asset stuffing” to enlarge the size on new foreign parent companies.

Further measures to avoid moving stockpiled earnings or assets out from under the liability to US tax.

– April 2016 The treasury this week imposed the strictest controls yet. They include: Discounting any acquisitions in the past three years for the purposes of assessing the size of the proposed foreign parent, effectively making it more difficult to hit the 20 per cent minimum target.

Ending “earnings stripping”. This is where the new foreign parent lends money to the company’s US business and interest on that loan is discounted from the US group’s earnings before liability to US tax is calculated.

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