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Pfizer-Allergan: How the US tax code is pushing companies through the exit door

11 December 2015

Matthew Gilleard - ITR

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Pfizer’s $160 billion acquisition of Allergan shows that highly-mobile American companies are still looking to “self-help” action such as inversion as the US tax code fails them on competitiveness.

The Business Roundtable (BRT)  - an association of chief executive officers of leading US companies - has said the deal, which creates the largest pharmaceutical company in the world, is indicative of the non-competitive business environment being cultivated by the US authorities.

"Pfizer’s merger deal is the latest, but not the last, effort by a US-headquartered company to use a self-help solution to compete in the global marketplace," said John Engler, president of BRT. "America’s outdated tax system is once again pushing US headquarters through the exit door."

Piecemeal solutions have been handed down through Treasury Notices, but legislators agree that comprehensive tax reform is the only way to address the broader issues of policy and competitiveness.  

"Ultimately it’s up to Congress to deliver tax policy that better equips companies to compete and succeed by staying in the US," said Ron Wyden, former chairman of the Senate Finance Committee.

"Inversions are a red flag on the urgent need for tax reform," he added. "The only way to get that done, and end the inversion virus that is plaguing our country, is through true bipartisan tax reform."

The Business Roundtable agrees with comments like this coming from Congress and the Administration, which acknowledge comprehensive business tax reform is the only way to stop companies from moving their headquarters to foreign countries via inversion. But, he said, inversions are not the only way in which a lack of US competitiveness manifests itself.

"Inversions are not the only symptom of our outdated tax system: acquisitions of US assets by foreign companies remain at an all-time record level. Piecemeal regulatory and legislative fixes do not solve the problem. Temporary approaches fail to address the systemic anti-competitive nature of the US tax system," said Engler, who wants the corporate tax rate lowered to around the 25% average rate found across OECD countries.

Latest piecemeal action

On November 19, as it became clear that the Pfizer-Allergan transaction would go ahead, the Treasury acted to further reduce the benefits available to companies under inversion by issuing a new round of administrative guidance.

The November 19 Treasury action makes it harder for companies to undertake a corporate inversion by: limiting the ability of US companies to combine with foreign entities using a new foreign parent located in a 'third country’; limiting the ability of US companies to inflate the new foreign parent corporation’s size and therefore avoid the 80% ownership rule; and by requiring the new foreign parent to be a tax resident of the country where the foreign parent is created or organised. This third rule will need to be met to satisfy the rule that at least 25% of the new entity’s business activity is in the home country of the new foreign parent.

"Genuine cross-border mergers make the US economy stronger by enabling US companies to invest overseas and encouraging foreign investment to flow into the US," said Jack Lew, US Treasury Secretary. "But these transactions should be driven by genuine business strategies and economic efficiencies, not a desire to shift the tax residence of a parent entity to a low-tax jurisdiction simply to avoid US taxes." 

Lew said further anti-inversion action should not be ruled out, but acknowledged that "there is only so much the Treasury Department can do to prevent these tax avoidance transactions".

"Only legislation can decisively stop inversions," added Lew.

Aside from failing to stop inversion activity, the continued use of non-comprehensive reform measures, in the form of tweaked guidance, is not providing taxpayers with the certainty they need to operate effectively.

"The inversion rules in the US have been repeatedly tightened in response to the latest headline-grabbing corporate emigration from the US," said Tim Wach, global managing director at Taxand. "However, each time the result has not been an end to inversions, but simply to change their form. Clearly inversions are not the cause of the illness, but a symptom."

"Albert Einstein defined insanity as doing the same thing over and over again and expecting different results," added Wach.

Kevin Brady, who took on the chairmanship of the House Ways and Means Committee on November 5, agrees that the current method of trying to counter inversions is not working.

"Mandating new rules to raise taxes on American businesses simply makes them more attractive takeover targets for foreign corporations. Treasury is contradicting its own call to pursue a more competitive tax code in favour of shortsighted counterproductive triage which will only lock American businesses in an even more uncompetitive tax system," said Brady. "Instead, we should all redouble our efforts to fix our broken tax code." 

Foreign countries wait with open arms

But despite agreement on the need for a tax code overhaul from all sides – including both business and politicians – the legislative environment in Washington means that comprehensive reform is highly unlikely pre-2017.

The uncertainty surrounding US elections will further delay any attempt at tax reform in the US, and inversions (along with tax policy more broadly) could be a key area of political vote-seeking. Hillary Clinton’s recent New York Times op-ed, titled 'How I’d rein in Wall Street’ certainly reinforces this suggestion, while other presidential hopefuls have already begun to wade in on the issue.

"We cannot delay in cracking down on inversions that erode our tax base," said Clinton, who is proposing an 'exit tax’ to hit companies that move their operations overseas.

Wach said the Pfizer-Allergan deal highlights the "impending storm" closing in ahead of the US election campaign. He said the "groundswell of sentiment questioning the lack of a forward-thinking corporate tax policy in the US, continues to grow".

In the absence of comprehensive reform, however, other jurisdictions will continue to benefit from outdated US tax policy that does little to incentivise any feeling of corporate patriotism.

Ireland has been a major beneficiary of US company headquarters being driven overseas, as is the case with the Pfizer-Allergan deal. However, Shane Hogan, tax partner at Matheson in Ireland, is also clear about where the 'blame’ lies. He said inversions "are a product of US tax policy rather than the tax policy of any other country, whether Ireland, the UK or elsewhere".

"Irish tax policy does not target companies for inversion, though Ireland may be a good option for companies looking to establish substantial overseas operations," said Hogan.

Joe Duffy, also a tax partner at Matheson, agrees. He said the Irish tax regime is substance-based and is designed to create jobs in Ireland.

"One of the key tenets of the BEPS Project is to align taxable profits with substance. In this respect, it is anticipated that the Irish tax regime and in particular the 12.5% corporation tax rate and our extensive tax treaty network will continue to attract substance-based foreign direct investment in a post-BEPS environment," said Duffy.






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