Tax Inversions: Why Are They Combining Whoppers and Timbits?
Sep 3, 2014
Why is Burger King’s purchase of Tim Horton’s coffee such a big deal? Well, besides the fact that it involves coffee and donuts. The reason is that it is proposed as an “inversion.” Corporate inversions have been a much-discussed topic in the press and halls of Congress and by the President lately. Indeed, they have been front and center for many companies, as merger and acquisition deal volume attributable to inversions has increased from 1% of total deal volume in 2011 to 66% this year. Including withdrawn deals, inversions were worth up to $152.14 billion in 2013. So far this year, they’ve accounted for $349.37 billion, an increase of more than 200%. So what is an inversion and why are companies so interested in undertaking them?
Contrary to the name, corporate inversions do not involve turning a company upside down. Rather, a corporate inversion occurs when a U.S.-based company merges with a non-U.S. entity with the intention of shifting its headquarters to the foreign location that has a lower corporate tax rate. As a result, inversions have been described as a tax-planning strategy undertaken by companies seeking to reduce their tax burden. Indeed, banks have been advising large U.S. companies to pursue inversions before the tax incentives are changed by legislation.
One motivation for a company to undertake an inversion is indeed to lower its effective tax rate. At a 35 percent federal tax rate, plus state and local taxes, U.S. companies face one of the highest tax burdens in the world (see chart below). Competitors who are located in other countries, such as the U.K. or Ireland, may be able to keep more of what they earn, thereby increasing shareholder value. For companies facing such competition, lower tax rates help them remain competitive in the marketplace. Thus, there may be fundamental economic pressures behind some inversions.
However, it is also clear that not all inversions are motivated by tax incentives. Rather, some companies have compelling business, strategic, or regulatory reasons for shifting their headquarters overseas. Consider, again, the Burger King – Tim Horton’s merger. Both companies have similar effective tax rates of 27 percent, and are of similar size ($9 billion vs. $8 billion). However, post-acquisition, the company expects to do more business in Canada than any other country. In addition, the companies cite other factors, such as increases in scale and sharing Burger King’s global expertise and Tim Horton’s expertise in breakfast business. It has been noted that relocating the headquarters to Canada may make it easier to get the deal through Canadian regulators.
The outcry against inversions has at times been loud: President Obama called inversions “unpatriotic.” Members of Congress have called for tax reforms. For example, the Stop Corporate Inversions Act of 2014 would, among other things, seek to undo the tax benefits if the historical shareholders of the U.S. company own 50% or more of the newly formed foreign entity.
While the patriotism of and motivation behind inversions may be questioned, it appears that executives and shareholders are undaunted. Corporate inversions have continued, and tax reform does not appear imminent. So what do you think of inversions?