By Liz Hoffman And John D. McKinnon
Just months after the Obama administration cracked down on
mergers that helped U.S. companies skirt domestic taxes, a wave of
foreign takeovers is steering more tax revenue away from Uncle
Sam.
In deals known as "tax inversions," which spiked in 2014, U.S.
companies acquired foreign rivals and redomiciled in low-tax
countries, reducing the taxes paid back home. The moves sparked an
outcry from lawmakers and others that prompted the Treasury
Department in September to make such tie-ups more difficult and
less lucrative.
But the policy doesn't deal with foreign takeovers of U.S.
companies, which have surged in dollar volume in recent months. As
a result, the U.S. still loses tax revenue, but this time U.S.
companies are being purchased. Once a cross-border takeover is
complete, companies can apply their new, lower tax rates to the
overseas income and use internal loans and other strategies to
further reduce U.S. taxes.
"If you make inversions more difficult, more U.S. companies may
simply be acquired," said Robert Scarborough, a partner at law firm
Freshfields Bruckhaus Deringer LLP.
Take Salix Pharmaceuticals Ltd. Last year, the North Carolina
drug maker tried an inversion. But the deal wasn't completed before
the Treasury changed the rules. Now, Salix is headed toward a
lower-tax jurisdiction, but as prey, not predator, being acquired
by Canada's Valeant Pharmaceuticals International Inc. for $10
billion.
The tax savings Valeant expects to reap by taking Salix into its
fold shows its advantage over a U.S. bidder.
Salix paid 32.6% of its 2013 profits in taxes. Valeant, which
itself flipped from a U.S. to a Canadian company in a 2010 deal,
expects the combined company to pay about 5%. Based on Salix's 2013
pretax income, that is an annual savings of nearly $60 million, or
about $1 per Salix share.
The Valeant deal is "a clear sign that all foreign-owned
businesses have a clear advantage" over U.S. rivals, Sen. Rob
Portman (R., Ohio) said at a Finance Committee hearing last week on
tax policy and U.S. economic growth.
Thanks to lower corporate taxes in many other countries, foreign
companies have long been able to squeeze more savings out of U.S.
targets than a domestic buyer could, meaning they can afford to
outbid U.S. suitors. All five companies vying for Salix were either
foreign or about to become foreign through an inversion, according
to people familiar with the matter.
But inversions gave U.S. companies the chance to compete by
redomiciling in a country with lower tax rates.
Foreign takeovers of U.S. companies have surged lately, hitting
$275 billion last year, according to data provider Dealogic. That
is double the 2013 amount and far outpaces the increase in overall
global mergers and acquisitions, which rose 30% in dollar volume.
The activity shows no signs of slowing, with $41 billion of
transactions struck through the end of February, on pace with
2014.
The moves aren't just tax-driven. The U.S., open to foreign
investment, is viewed as a stable, investor-friendly environment,
particularly amid concerns over slowing growth in China and parts
of Europe. And tax differences that favor foreign companies in U.S.
corporate takeovers are long-standing.
And U.S. companies are still buying their overseas counterparts,
a trend that might be reinforced by the strength of the dollar
against other currencies.
But lately those advantages are becoming more pronounced, with
more countries lowering their tax rates and U.S. companies' foreign
cash piles increasing, making a foreign takeover more
lucrative.
Taxes "aren't the afterthought" anymore in deal making, said
Mihir Desai, a Harvard business and law professor, at a recent tax
conference. "They are, in fact, a leading thought in the design of
these [cross-border] transactions."
The U.K. has shaved seven percentage points off its corporate
tax rate since 2010 and offers special tax perks on income derived
from U.K. patents and other intellectual property. Japan,
meanwhile, has shifted from a U.S.-style tax system, which taxes
corporate profits no matter where they are earned, to one that
generally taxes only income earned in Japan. Germany, Canada,
Switzerland, South Korea and Russia all boast lower corporate tax
rates than they did a decade ago.
A Treasury spokeswoman declined to comment. In a speech to the
Brookings Institution in January, Treasury Secretary Jack Lew
called the new anti-inversion policy a "short-term response to one
symptom" of a tax system he called "unfair, uncompetitive and
overly complicated." He said a tax-code rewrite is "the real
answer" to addressing the various problems it creates, including
inversions.
But Republicans and Democrats still differ widely on the
specifics of a tax overhaul, and businesses remain divided, setting
long political odds for any major change, though some continue to
urge action now.
At least a dozen companies pursued inversions from 2013 through
September 2014, including some well-known American brands like
Burger King Worldwide Inc. Since the Treasury restricted
inversions, the buzz around them has quieted, with just a few small
deals struck.
Meanwhile, many bankers and lawyers expect foreign takeovers of
U.S. companies to accelerate. In addition to Salix, they point to
U.K. drug maker Shire PLC's $5.2 billion recent purchase of NPS
Pharmaceuticals Inc. and the trio of U.S. takeovers struck last
year by Ireland-based Actavis PLC.
Just last week, California-based Emulex Corp. agreed to sell
itself to Avago Technologies Ltd., an acquisitive Singaporean
company that has averaged a 5% tax rate since 2012. It is Avago's
third U.S. acquisition in a little over a year. On Thursday,
Ireland-based Mallinckrodt PLC said it agreed to buy Ikaria Inc., a
maker of a respiratory drug, for $2.3 billion, its second U.S.
takeover in less than a year.
Write to Liz Hoffman at liz.hoffman@wsj.com and John D. McKinnon
at john.mckinnon@wsj.com
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