Image Description/Source: Berlin Wall, 1963; Roger
“If history is any guide, it would seem that tax lawmakers may want to think about the current political agenda’s similarities with respect to that of a “new” Berlin Wall–not one built of barbed wire but of prohibitive, restrictive tax laws–and whether such measures make sense in light of the events of the late 1980s.” – Valuentum Securities
Late Monday April 4, the US Department of the Treasury launched an all-out attack on companies pursuing tax inversion deals and a technique called earnings stripping, the latter used as a means to minimize taxes after an inversion. Stating in no uncertain terms that such companies have only been successful due to the “benefits of being based in the United States,” not due to their entrepreneurial spirit, their ingenuity, grit, and perseverance, or efforts to create opportunities and jobs for Americans, Treasury noted that it is “taking further action to make it more difficult to invert,” accusing some companies of “seriel inverting” and “shifting a greater tax burden to American families,” some of them such companies employ. Has Treasury gone off the deep end?
Certainly the agenda is politically charged, and there will be as many opinions on this topic as there are those that can opine, but one thing is clear. The political pressure to tax to replenish government coffers may not stop during the current administration. For one, Democratic presidential frontrunner Hillary Clinton has announced a serious plan to “crack down on inversion deals.” Republican presidential frontrunner Donald Trump seems more sympathetic to businesses, even more understanding, revealing that the flaw rests in the tax code itself and that by cutting the US corporate tax rate to 15%, there’d be no need for companies to move abroad at all. Problem solved? Mr. Trump’s tax plan would also levy a reasonable one-time tax of 10% on overseas profits of US corporations, something that cash-rich entities such as Apple (AAPL) and Cisco (CSCO) may find amenable, in light of the alternative of keeping their cash stashes outside the US. Apple CEO Tim Cook has said repeatedly the US tax code on foreign income is “broken,” but Treasury’s new rules seem to continue to favor anti-business policies.
What’s more, Treasury’s issuance of “formal regulations” aims squarely at one of the largest deals in the pipe: the ~$160 billion transaction involving Pfizer’s (PFE) plans to merge with Ireland-based Allergan (AGN). The new rules by Treasury would “disregard three years of past mergers with US corporations in determining the size of the foreign company…(and)…because Allergan is itself a product of several US inversions,” the deal’s arithmetic wouldn’t make the new combined entity immune to US taxes. Shares of Allergan are cratering ~15% on the trading session April 5 as many speculate the Pfizer tie-up is all but dead. We don’t expect legal action against Treasury by the two companies, and while we’re not discounting further pathways to completion, a merger withdrawal may be forthcoming. We plan to publish an updated report and fair value estimate on Pfizer and Allergan soon.
The number of ways that government agencies can “bust” transactions from anti-competitive means to now making them uneconomical for tax reasons has become startling to say the least. Has the culture in Washington become one in which government officials believe they own all companies in the US in that they have a claim on all future profits via taxes, or is it still one that facilitates the free-flow of commerce through global trade in a truly connected world? In the context of the FBI’s recent demands on Apple, “…FBI Says Can Hack iPhone,” could one finally say in fairness the US government is starting to overstep boundaries and freedoms? No matter one’s opinion of whether businesses should have some protection, federal and state government budgets remain strapped, debt loads have become tremendously burdensome, and social agendas have probably never been more in vogue. You don’t have to get that far into the morning paper to learn about a state raising the legal smoking age to 21, cities trying to ban sugary colas, and the momentum behind the “Fight for $15” movement. The world is changing fast, and in light of yesterday’s announcement, so too are the laws.
Medtronic (MDT) and Burger King (QSR) are examples of recent tax inversion deals that “made it through,” but if you recall, several other tax-inversion deals were scrapped due to last-minute IRS rule-changes in 2014, perhaps the most notable being Abbvie’s (ABBV) axed deal for Shire, but there was also Walgreens (WBA) where, as the Huffington Post put it: “Americans Scared Walgreens Out of a $4 Billion Tax Dodge.” Believe it or not, there was actually a threat of a consumer boycott against the age-old household company. Certainly US government officials and consumers know that Walgreens is a holding in the S&P 500, and most retirement accounts, pensions, and index funds have exposure to the company? In some ways, by blocking tax inversion deals, Treasury is preventing wealth creation for Americans in retirement as the equities that would have benefited from such transactions are punished: Allergan case in point. Is it truly American to restrict the freedom of businesses, and by extension, mobile capitalism in a global economy?
If history is any guide, it would seem that tax lawmakers may want to think about the current political agenda’s similarities with respect to that of a “new” Berlin Wall–not one built of barbed wire but of prohibitive, restrictive tax laws–and whether such measures make sense in light of the events of the late 1980s. For example, why can’t companies leave the US under existing tax laws? And should politicians really be able to change laws ex post-facto, or once a deal or spinoff is announced, as they have now done with the PFE-AGN transaction? Don’t the shareholders own the business, and aren’t the shareholders consumers, too? Isn’t everything inter-connected, and don’t tax inversion deals benefit US-based investors and consumers as arguably incremental capital is filtered through R&D instead of the tax bill? These are great questions.
It’s certainly a tough environment to be a business owner these days, and things will only get more stringent on business freedoms in coming decades, if the pace of social change is any indication. However, if there is one undeniable fact, the US corporate income tax at 35% is the highest in the developed world. In this respect, can one really blame US businesses for wanting to leave to countries that may treat them more “fairly,” or more competitively? Shouldn’t lawmakers’ approach to the “right” answer be more about making America the place where businesses want to stay, to flock to, than erecting tax walls to prevent businesses from leaving? Aren’t there examples in history that teach us that a “Berlin-Wall” type tax code may not be the best approach? It’s for each person to decide.
We’ll keep monitoring developments.