Pfizer’s failed Takeover Bid Sparks Calls for Tax Code Reform
posted Jul 7, 2014 by Paul Oliveira, CPA
Although U.S. pharmaceutical giant Pfizer failed in its bid to acquire rival U.K. drug maker AstraZeneca — at least for now — the move sparked reform proposals in the United States, where the takeover attempt was viewed as another example of corporate maneuvers aimed at making the resulting company a resident of the United Kingdom and subject to that country’s lower corporate taxes.
Around the same time AstraZeneca was beating back the U.S. company’s offer, reports surfaced that Walgreens and several other U.S. companies were pursuing similar deals for tax purposes. Since 2008 about two dozen companies, including Sara Lee and Liberty Global, have moved their headquarters to countries such as Canada, Ireland and the United Kingdom in search of more favorable tax rates.
According to the House Ways and Means Committee, more than 40 U.S. companies have completed inversions during the past decade, costing the U.S. tax base billions of dollars.
As a result, leaders in Washington have called for a review of the current tax code and ultimately tax reform. The proposed approaches to change, however, differ.
The Benefits of Inversion
The Pfizer strategy would have resulted in a corporate inversion, also known as an expatriation transaction. Under these tactics, U.S. corporations either:
- Merge into a foreign company’s U.S. unit and become a wholly owned subsidiary of the foreign corporation, or
- Transfer their assets to a foreign corporation.
This allows the company to avoid U.S. tax on its foreign operations and on distributions to the foreign parent. There are also opportunities to reduce taxable income from U.S. operations by payments of fees, interest and royalties to the foreign entity.
Foreign corporations generally are treated as U.S. companies when these tests are met:
- They complete the direct or indirect acquisition of substantially all the properties held directly or indirectly by a U.S. corporation,
- Shareholders of the U.S. corporation obtain 80% or more of the foreign company’s stock (by vote or value) as a result of holding their U.S. shares, and
- The foreign business and affiliates connected to it by a 50% chain of ownership don’t have substantial business activities in the corporation’s country of incorporation when compared to the group’s total business activities.
The same rule applies where a domestic partnership transfers substantially all the properties of a trade or business to a foreign business and Test 2 and Test 3 are met.
When the transaction satisfies Tests 1, 2 and 3, but the domestic corporation’s shareholders (or partners in a partnership) obtain at least 60% — but less than 80% — of the foreign entity’s stock, the entity is deemed a foreign corporation. However, any gain by the expatriated entity from the transfer of stock or other property, or from licenses, is fully taxable with no reduction or offset for losses, credits or other tax attributes. In addition, those gains remain taxable for ten years without offset, except for inventory and similar property.
The Pfizer Saga
In late April, Pfizer started its unsuccessful bid for AstraZeneca, ultimately offering $119 billion. Pfizer planned to remain headquartered in New York but, for tax purposes, would become an AstraZeneca subsidiary and a U.K. tax resident.
Using that tactic, Pfizer could take advantage of the 21% U.K. corporate tax rate that is scheduled to drop a percentage point next April. Pfizer also would be able to avoid having to repatriate overseas earnings and pay U.S. tax. Pfizer has said it pays an effective 27% tax rate in the U.S.
Although the Pfizer deal seems unlikely to go through, it raised questions on the issue of corporate inversions and sparked action on Capitol Hill and in the White House.
Many in Washington said the Pfizer proposal was further evidence of a broken tax code that highlighted the need for broad reform. Some legislators favored lowering corporate tax rates and generally reworking the code to make it a more globally competitive system. Others said the situation required a swifter, more targeted response than comprehensive reform.
Democratic Senators and Representatives introduced companion bills to curb these corporate tactics. Both pieces of legislation are called the Stop Corporate Inversions Act of 2014. The bills largely mirror a proposal President Obama presented in his fiscal 2015 budget.
The proposed plan would:
- Broaden the definition of an inversion by reducing the 80% test to a greater-than-50% test, and eliminating the 60% test;
- Add a rule under which, regardless of the level of shareholder continuity, an inversion transaction will occur if the affiliated group has substantial business activities in the United States and the foreign corporation is primarily managed and controlled here, and
- Amend the tax code so that an inversion transaction can occur if there is an acquisition either of substantially all of the assets of a domestic partnership or a trade or business of a domestic partnership.
According to the Treasury, the proposal would raise $17 billion in revenue over the next decade.
The House and Senate bills would bar companies from shifting tax residence offshore if their management and control and significant business operations remain in the U.S. The proposals also contain a two-year sunset provision to give Congress time to work on bipartisan comprehensive corporate tax reform.
With the shifting winds in Washington and the number of corporations looking to find a lower-tax home, stay tuned for further developments on this issue. Please contact a member of our International Tax Services Group if you are planning any similar tax-related changes at your company.