Pfizer Inc. is trying to acquire AstraZeneca for both tax and strategic reasons.
First, the tax reasons: Internal Revenue Service regulations have made it difficult for companies to leave the U.S. to go to countries with lower corporate tax rates, and mergers offer a way out. Companies such as Pfizer are using a technique called inversion, in which a deal transfers at least 20 percent of a U.S. company to foreign shareholders.
Inversion involves the reincorporation of a company overseas to lower its taxes on income earned abroad. In the case of Pfizer-AstraZeneca, the combined company would move its tax residence to the U.K. from America, making it eligible for British corporate tax rates of 20 percent, versus the U.S. rate of 35 percent. Company executives estimated Pfizer could slash its tax bill by $1 billion annually.
To date, AstraZeneca has rejected Pfizer’s takeover bid, worth $106 billion, calling it inadequate, given its lucrative pipeline of new drugs.
Ian Read, Pfizer’s CEO, denied that tax saving alone drove the deal. He emphasized that the merger would facilitate the development of drugs in areas such as cancer and immune disorders such as rheumatoid arthritis. Pfizer needs an infusion of products because patents have expired on some of its blockbuster drugs.
A Pfizer inversion would also permit the company to spend cash accumulated overseas — $49 billion — without incurring an American tax bill. Ways it could use that hoard include paying dividends and repurchasing shares.
“That (inversion) would still allow me to access the offshore funds and do it in a tax-efficient way,” Pfizer chief financial officer Frank D’Amelio said in a Wall Street Journal article.
If Pfizer “spends the money on a foreign acquisition, the money stays outside the U.S. tax net, potentially forever,” said Heather Self, a tax specialist at law firm Pinsent Masons LLP.
About 1,700 non-financial companies held $1.5 trillion offshore at the end of last year. To repatriate that cash, American companies would have to pay the difference between the U.S. and foreign tax rates.
The Pfizer merger does have a downside. It would trigger a “taxable event” for individuals, mutual funds and hedge funds who own its shares. They would have to pay capital gains tax on their profits, even though they continued to hold their shares.
This past year has brought an appreciable increase in U.S. companies decamping from America. Pfizer would join at least 19 other companies making or contemplating similar transactions since 2012. This includes Chiquita Brands International Inc. and Omnicom Group Inc., the largest U.S. advertising firm, which last week called off its attempt to merge with Paris-based Publicis Groupe SA.
Recently, the benefits of inversions have forced companies to pay premiums to buy other companies. According to Dealogic, a data provider, premiums have recently exceeded 55 percent, compared with the average premium of 20 percent last year. There is one primary reason for the inversion premiums: scarcity — a limited number of acquisition candidates that make sense for an inversion deal.
Pfizer’s Read has voiced frustration about our tax system. As he told the Wall Street Journal in March 2011, “There should be a tax rate that allows us to compete in the global marketplace.”
In March 2013, the Business Roundtable, a conservative group of chief executives, advocated that we lower our corporate tax rates from 35 percent — the highest of any developed nation — to 25 percent. We should also move the nation to a “territorial” system in which foreign earnings are taxed only in the nation where they were earned.
In 2012, President Obama proposed a “grand bargain” to promote middle-class jobs. He recommended cutting corporate taxes to 28 percent if Republicans approved another stimulus package. Instead of spurring productive, effective legislative initiatives, his proposal has languished.
The prospective exodus of Pfizer, the world’s largest pharmaceutical company, highlights Washington dysfunction and the downside of political gridlock.
Originally published in the Sarasota Herald-Tribune
