Pfizer has approved a deal to buy rival drugmaker Allergan for $160 billion, making it the largest pharmaceutical merger ever. Pfizer CEO Ian Read has repeatedly stressed his desire to move his New York-based company to a lower tax jurisdiction through a plan called an inversion. Buying Allergan, which has its legal domicile in Dublin, will allow New York-based Pfizer to relocate outside the U.S. for tax purposes. Inversion occurs when a company relocates its legal domicile to a lower-tax nation (in this case Ireland) while retaining its material operations in its higher-tax country of origin.

In an interview Thursday at the Wall Street Journal’s Viewpoints Discussion Series, Read said Pfizer is at a “tremendous disadvantage” under the U.S. corporate tax code. He argued that Pfizer is competing against foreign companies “with one hand tied behind our back.”

Ireland has a tax rate of 12.5%. Pfizer’s current effective tax rate is 25%.

Tax rationale for inversions

The U.S. is unique among developed nations in both imposing a high corporate income tax of 35% and levying taxes on the profits that domestic corporations collect from their subsidiaries abroad. This “worldwide” system contrasts with the “territorial” system employed by countries such as the United Kingdom and Canada, which generally tax only profits from their domestic operations.

Treasury’s inversion changes

In response to inversions, the Treasury latest guidance makes it harder for a U.S. company to buy a foreign rival in one country and then move to a different one. The Treasury seeks to limit the ability of an inverted company to transfer its foreign operations to a new foreign parent without paying U.S. taxes.

Treasury Secretary Jack Lew renewed his call for a bi-partisan anti-inversion legislation. Lew wrote, “Unless and until Congress acts creative accountants will continue to find new ways for companies to move their tax residences overseas and avoid paying taxes here at home.”

Umer Raffat, an analyst at Evercore ISL, said : “The Treasury Department does not have the power to block an inversion, but it could reduce the economic benefits of such a deal.”

The Treasury’s primary objective is to stop the benefits of earnings stripping. Earning stripping is achieved through intra-company transactions that concentrate deductions in the U.S., with its 35 percent marginal tax rate, and concentrate income in jurisdictions with lower rates.

Partisan argument

Democrats favor immediate curbs on inversions. They want to prevent U.S. companies from changing addresses through mergers with smaller foreign companies.

Republicans resist quick action in favor of an overhaul of the U.S. tax system. They wish to reduce the incentive to invert by taking the following actions:

• Lower the corporate tax rate

• Give companies a discounted rate on repatriating offshore profits (Estimated size $2.1 trillion).

• Remove or lower taxes on U.S. companies’ foreign income.

The prospective exodus of Pfizer, the world’s largest pharmaceutical company, highlights the downside of political gridlock. Instead of letting Pfizer decamp, we need a political compromise that incentivizes Pfizer to stay.

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 U.S. to a “territorial” system in which foreign earnings are taxed only in the nation where they were earned. Lastly, we need to close loopholes.

The Joint Committee on Taxation in May 2014 released its estimate of the revenue gained from passing the “Stop Corporate Inversions Act of 2014.” The JCT estimates that this will raise approximately $19.5 billion from fiscal years 2015 to 2024.

Originally published in the Sarasota Herald-Tribune