The widely-discussed $54.6 billion acquisition of Dublin-based Shire by AbbVie is officially canceled, having crumbled after a notice by the U.S. Treasury Department to tighten tax rules that deter U.S. companies from moving their legal headquarters to countries with lower business taxes.
The decision by Shire’s board of directors to approve the breakup with AbbVie called for a final step: AbbVie paying Shire a $1.635 billion breakup fee.
“Whilst we are disappointed that the offer will not now complete, we continue to enjoy excellent prospects as we execute our plan to double Shire’s product sales to $10 billion by 2020,” Susan Kilsby, Shire chairman, said Monday after the markets closed.
Treasury’s actions on tax inversions have halted one pending deal, modified another and prompted renewed calls for Congress to act on providing broad-based reform of both corporate and personal income taxes. President Obama and Jack Lew, his treasury secretary, have labeled companies that relocate their legal headquarters overseas “unpatriotic”—a charge that is less about greedy companies wanting to lower their taxes and more about reducing the U.S. corporate income tax rate of almost 35%—the highest in the world. Many European countries have 20% to 27% corporate rates, with less stringent tax rules, compared to the U.S. tax code, which dates back to the 1950s.
Last spring, Pfizer unsuccessfully attempted to acquire AstraZeneca, to take advantage of lower taxes as a U.K.-headquartered company. Using an inversion, Pfizer, based in New York City, would have seen its corporate tax rate drop to 21.3% from 27.4%—a savings of about $1 billion a year, according to Sen. Tom A. Coburn, M.D. (R-Okla.), writing in Forbes magazine.
“By overhauling the tax code, ending corporate loopholes, lowering tax rates and treating everyone fairly, Congress could stop the mass exodus of capital and tax revenue,” wrote Coburn. “Our system is hopelessly outdated. We need a corporate tax system that reflects 2014—rather than 1954—economic realities.”
The U.S. imposes what amounts to a worldwide taxation system that taxes American companies’ foreign income as part of their domestic taxes, while the rest of the world uses a “territorial” tax system. A U.K.-headquartered company pays only U.K. taxes on its British income. By contrast, a U.S. company pays U.S. taxes on all income—including all income earned overseas—a notable distinction that some in Congress want to change, citing the worldwide tax system puts American firms at a competitive disadvantage.
Currently, foreign income is taxed only when the money is brought back to American shores—a key reason why many U.S. companies avoid bringing back their overseas earnings if in a country with a lower tax rate. These businesses, many of them in the pharma and biotech sector, have an estimated $2 trillion abroad in unremitted earnings, according to the Center for Budget and Policy Priorities, a Washington, D.C.-based, nonprofit budget and tax policies think tank.
Earlier this month, after Treasury announced its crackdown on inversion deals, Medtronic said it was restructuring the financing for its $43 billion acquisition of Covidien, which will allow it to reincorporate in Ireland and reduce its tax bill. The Minneapolis-based company had planned to use overseas cash to help pay for the deal until Treasury’s new rules ended a practice that amounts to a company lending itself money it has in foreign banks, known as hopscotch loans, to pay for the deal. Medtronic announced it instead would borrow $16 billion in external financing to complete the deal, whose terms remain unchanged.
In a statement, Medtronic chief executive Omar Ishrak stressed the Covidien deal still makes sense even without all the tax benefits, citing that despite the additional financing expense the strategic benefits of the transaction remain compelling.
Medtronic also said it still plans a modified inversion, by reincorporating in Ireland as a holding company—Medtronic plc—while running the business from its operational headquarters in the U.S.
The Treasury’s inversion actions also have affected smaller U.S. companies that planned to take advantage of relocating their domiciles in Europe. Salix Pharmaceuticals of Raleigh, N.C., which makes drugs to treat gastrointestinal disorders, ended its plans to merge with Swiss-based Cosmo Pharmaceuticals, known for two drugs to treat ulcerative colitis. Both companies cited a “changed political environment” that no longer would allow Salix to move its tax domicile abroad. Salix said it will pay a Cosmo a $25 million breakup fee.
What’s missing in the corporate tax discussion is the fact that European countries have a corporate tax plus a second national tax, the Value Added Tax (VAT)—essentially a consumption tax akin to U.S. state sales taxes. Under European Union law, the VAT rate, which varies per country, must be at least 15%. Thus, countries in Europe always have two nationwide sources of tax revenue, said Richard Ainsworth, director of the graduate tax program at the Boston University School of Law.
“For the U.S.,with just a single corporate tax, we have a high rate but with federal deductions on a variety of business items—like accelerated depreciation, employee health plans, mortgages and research credits—it seems to work out,” said Ainsworth. “As for getting tax reforms from Congress, the last major one was in the second term of a wildly popular president: Ronald Reagan. So President Obama is in the same position, but is he wildly popular?”