Biotech and Pharma

A deal to dodge the tax man in America

Pfizer's chairman and chief executive, Ian Read, is in London this week trying to sell a skeptical public there on his $106 billion takeover plan for rival AstraZeneca. On Tuesday, he is scheduled to testify to a parliamentary committee about a deal that has been described in the British tabloids as "too dangerous" and has raised a bevy of nervous questions about potential job losses.

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The real question, however, is why Mr. Read is not being called to testify in Washington to explain the real purpose of this megadeal: a mega-tax-dodge.

Pfizer's pursuit of AstraZeneca raises a huge public policy red flag. It plans to move its holding company to Britain from the United States so it can achieve a much lower tax rate and use cash that it has held abroad to avoid paying United States taxes.

The deal, if consummated, would most likely deprive the United States government of billions of dollars in revenue over the next decade.

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Pfizer isn't hiding this fact. Mr. Read has repeatedly told his investors about the tax-saving scheme. "It will liberate the balance sheet and tax of the combined companies," he said over the weekend.

More ominously, the deal represents a potential tipping point in a trend among United States companies to acquire foreign competitors and reincorporate abroad in low-tax countries, a process known as an inversion.

An informal survey of bankers indicated that the trend is real. Since Pfizer announced its offer, at least a half-dozen bankers have counted more than 17 incoming calls from Fortune 500 companies requesting an analysis of merger prospects that involve an inversion.

"In light of the significant value that can be created — and the pressure to act before possible future regulatory action lessens the benefit of such deals — the inversion trend can be expected to continue in the near future," Adam O. Emmerich, a partner at Wachtell, Lipton, Rosen & Katz, wrote in a note to his clients.

In Washington, unlike in Britain, where the deal's local implications have kindled some outrage, there has been nary a peep about what the transaction portends here.

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Only a handful of people seem to be taking it even half seriously including Senator Carl Levin, Democrat of Michigan, who issued a statement last week. "It's become increasingly clear that a loophole in our tax laws allowing these inversions threatens to devastate federal tax receipts," he wrote. "We have to close that loophole. I am talking to my colleagues about legislation to close the loophole, which I intend to introduce soon."

He is expected to introduce a bill as early as this week to try to block such deals.

Senator Levin's proposal, however, will most likely be a Band-Aid, not a way to deal with the underlying problem, which probably involves a sweeping reform of the corporate tax code. Earlier this year, President Obama similarly sought to change the law, which allows a company to reincorporate abroad if it acquires a foreign company in a transaction that transfers more than 20 percent of the shares to foreign owners. The president wants to raise the threshold to 50 percent.

But both approaches are the equivalent of placing a velvet rope in front of a hot club, not removing the incentive for heading there in the first place.

Concerns over Pfizer's track record: UK lawmaker
Concerns over Pfizer's track record: UK lawmaker

To better understand what is at stake for Pfizer — and what makes these types of deals so attractive to other companies — consider this basic math: By reincorporating in Britain, Pfizer would most likely save about $200 million a year for each percentage point less it pays in taxes, according to Barclays. Pfizer paid a 27.4 percent rate in the United States; AstraZeneca paid about 21.3 percent in Britain. Those six percentage points could turn into an annual windfall of more than $1 billion. That's not all: It gives Pfizer a revenue-generating asset without having to repatriate any of its $57 billion cash hoard sitting overseas.

The problem isn't simply the lost tax revenue, either. When a company changes its headquarters, jobs invariably leave, too.

The answer is not as simple as lowering the United States corporate tax rate to make it more competitive with foreign competitors. It also involves removing tax loopholes and most likely adopting a system that taxes foreign profits locally.

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"Given all of the existing loopholes in U.S. tax law, I am not sure whether Pfizer will really save that much in U.S. taxes. Rather, the expatriation will likely make Pfizer's life a lot easier from a treasury/financing perspective," said J. Richard Harvey Jr., a professor at Villanova University School of Law and Graduate Tax Program.

While no one wants to engage in a global tax race toward the bottom with countries competing for companies by offering ever lower tax rates, there has to be a middle ground that makes it attractive enough for companies to want to remain here while paying their fair share.

The reality is that many global multinational companies based in the United States are facing slower growth and desperate to find profits wherever they can. If they can easily minimize their tax bills, that is low-hanging fruit.

United States companies also need to fully appreciate the benefits they receive from being here. "Companies that exploit this loophole benefit from the protections and services the federal government provides, including patent protection, research and development tax credits, national security and more," Senator Levin wrote. "They shouldn't be allowed to shift their tax burden onto others."

This may sound radical: Perhaps there should be a moratorium for the next two years on all inversions. Given that it is almost impossible to believe that real tax reform can happen until 2016, there may be real reason to make sure that the inversion trend doesn't continue. Would it have unintended consequences? Of course. But the alternative might be worse.

"Although it would clearly be best to enact comprehensive United States corporate tax reform, in the short run the United States may need to quickly enact legislation to discourage expatriations," Mr. Harvey said. "Otherwise, there may be a rush for the proverbial door."