NEW YORK -- Over the past two years, ‘tax inversion’ deals have been leading the global M&A sector out of the doldrums while drawing attention to the creative side of accountants and investment bankers.
It’s just the latest battlefield in the world of corporate tax avoidance and provides a note of caution to what would otherwise appear to be an M&A boom.
The controversial process involves a company buying a rival firm in another region of the world, reincorporating in that region and consequently exposing itself to a lower tax rate. It has proven especially popular in the US pharmaceutical sector as American firms seek out the comparatively kind tax regimes of Ireland, the Netherlands and the UK.
These jurisdictions maintain corporate tax rates of 12.5 per cent, 25 per cent and 21 per cent, respectively, comparing favourably to America’s 35 per cent rate.
The most significant example came this week as AbbVie, an $US85 billion US pharmaceutical heavyweight, lobbed a $54bn bid the way of Ireland’s Shire. It's likely to be the largest successful inversion deal to date.
AbbVie is just the latest, and perhaps most persistent (it put forward five bids in two months), in a long line of firms to chase the instant tax reduction of a reincorporation via an offshore acquisition. In the last month alone, similar transactions include Medtronic’s $43bn acquisition of Covidien (which itself redomiciled a few years ago), Salix’s $2bn deal for Cosmo Technologies and Mylan’s $5.3bn purchase of assets from Abbott Laboratories -- as well as Pfizer’s failed $120bn bid for control of Britain’s AstraZeneca.
Since the start of 2013 there have been 19 tax inversion deals made by US companies, a sharp increase in activity given there were just 45 in the previous 25 years.
The developments have placed the healthcare sector on track to trump record M&A activity in 2014. In the second quarter of this year, the value of health technology deals surged more than four times over, from $US43.5bn to $US202bn, accounting for a significant portion of the overall 75 per cent rise in global M&A activity through the first half.
The deals, while perfectly legal, have started to draw the ire of policymakers and the public alike over the past 12 months.
The public, justifiably, asks how a firm that has been built in the US and maintains the bulk of its operations in America can be taxed elsewhere. It’s not a good look.
It runs along similar lines to the tax shifting debate that is a key focus of the upcoming G20 meeting in Australia, which has intense scrutiny on global giants like Apple and Google. The tech behemoths are among the most prominent of the firms that stand accused of shifting untaxed profits to their operations in lower tax regions.
They haven’t gone as far as to pursue tax inversion deals, however, for two reasons: a lack of suitable targets (any deal would need to be for at least 20 per cent of their market value) and public perception.
The US pharmaceutical sector, on the other hand, has an array of European targets, while branding isn’t as important to the likes of AbbVie as it is to Apple.
After all, how many of the countless users of Humira -- an arthritis drug that draws in $10bn in global sales each year (the most of any drug) -- would even know it’s made by AbbVie?
Apple, in contrast, lives and dies on how its brand is perceived.
But both firms are equally entrenched in the divisive tax debate, one which JP Morgan’s Jamie Dimon entered into with passion this week, arguing corporate creativity is a function of a broken tax system.
“I think it is a huge mistake for people to moralise that issue," he said of tax inversion.
“Economics are economics.
"Even if you stop and say 'don't invert,' capital will move away... We need proper corporate taxation."
JP Morgan, incidentally, advised AbbVie on its Shire acquisition, leaving Dimon’s comments open to accusations of a conflict of interest. His firm has also been a marketer of 'creative M&A' (yes, that’s how it’s promoted) since 2012. Still, his taxation point has merit.
Part of the problem is ‘double taxing’, which ensures the offshore profits of US firms are taxed in the country where they are earned as well as when they are returned home. Many firms consequently opt not to bring profits made overseas back to the US, with inversion deals allowing them to access these otherwise untouched profits.
Australian firms, which enjoy a lower corporate tax rate than their Americans rivals, don’t have this issue to worry about due to foreign tax credits from the ATO.
The cost of all the creative accounting schemes in place is now believed to run into the trillions of dollars for governments, making the latest tax inversion fad -- which was, even before the flurry of deals in the last month or so, tipped to cost the US Treasury $20bn over the next decade -- seem like a drop in the ocean.
But the trend serves to highlight the pressure not to get left behind in the corporate world, which served as the reasoning for Actavis CEO Paul Bisaro to move his firm to Europe last year:
“What we’re trying to do is level the playing field,” he argued, a view most likely shared by every executive around the world.
However, making it level is nigh on impossible in such a fractured global tax environment, a point raised by PwC chair Dennis Nally in the AFR earlier this week: "Each country is developing tax policy designed to address the specific economic needs of that country. What’s good for one in terms of economic incentives and job creation has a negative impact on another.”
As the Abbott government dreams the seemingly impossible dream of a global tax treaty that could go a long way to at least capping tax avoidance, the growing creativity in M&A and accounting is only becoming more worrisome as morals are distanced from what is legal.
Daniel Palmer is Business Spectator's North America correspondent.