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BNA Insights: The End of Corporate Inversion?



Khalid Sadur, Senior Corporate Tax DirectorKhalid Sadur, Senior Corporate Tax Director at Radius, examines Pfizer’s recent failed bid for AstraZeneca, the future of corporate inversion in the face of renewed government scrutiny, and the place of inversion in the grand scheme of international tax.


The news in May that the American drug maker Pfizer was abandoning its bid to merge with the British firm AstraZeneca ended months of speculation over the future of the two multinationals. It also heartened opponents of corporate inversion, a practice by which a company registered in one country moves its registration to another country with lower corporate taxes.  A merger with AstraZeneca would have allowed Pfizer to migrate its registration to the UK, an aspect of the deal that has caught the attention of regulators.

As tax base erosion and profit shifting come under major scrutiny from the world’s biggest economies, the practice of corporate inversion has once again come under the microscope. While further restrictions on inversion are likely only a matter of time, ending the practice will amount to only a small patch on a global tax framework that’s come up for serious rethinking.

Corporate Inversion – A Brief History

The first notable case of corporate inversion dates back to 1982, when the engineering firm McDermott reincorporated in Panama. After a quiet period, the practice came to greater prominence in the late 1990s, when companies such as Ingersoll-Rand and Fruit of the Loom reincorporated in Bermuda and the Cayman Islands, respectively. In response, lawmakers made it increasingly difficult to carry out an inversion, and the practice went out of vogue.

Today, a U.S. company can only realistically carry out an inversion by merging with an overseas entity. But with post-recession M&A activity picking up and the US corporate tax rate at 35 percent the practice is nonetheless back in fashion. Of the 41 corporate inversions completed by U.S. firms since 1982, 11 have occurred since 2012. The practice has become especially popular with technology and pharmaceutical businesses because of the ease of shifting their highly-taxed intellectual property to a new headquarters. Ireland, with its 12.5 percent corporate tax rate, has become a common destination. (It’s not just the US that’s seen companies migrate from its shores. In 2008, British multinational advertising group WPP moved its headquarters to Ireland as well).

The proposed merger of Pfizer and AstraZeneca with the migration of the newly formed company to the UK falls within this trend. It would have saved Pfizer at least $1 billion in tax annually. Ian Read, Pfizer’s Chairman and CEO, confirmed to a UK Parliamentary committee earlier this year that the tax savings of an inversion were in fact high on the firm’s list of reasons for pursuing a deal.

The Pfizer deal fell apart for business reasons, and the companies are now going through an enforced cooling-off period before either is eligible to approach the other again to rekindle discussions. But by the time they could find themselves back at the table, it might be too late for the drug makers, or anyone else, to take advantage of the inversion loophole. Just as previous waves of inversions led to tighter restrictions, regulators look poised once again end inversion as it’s currently practiced.

Corporate Inversion – Current Proposals

In response to the Pfizer bid, Michigan Senator Carl Levin introduced a bill designed to put an end to inversion. Under his proposals the practice would only be permitted if shareholders of the non-US company held at least 50 percent of the new combined company (at present the ownership threshold is only 20 percent). In essence, the bill would consider US companies to be subject to domestic tax if executive control remained in the US together with 25 percent of sales, employees or assets. These proposals came on the back of President Obama’s budget request to Congress earlier this year, which included measures similar to those outlined by Levin and estimated that over $17 billion in tax revenues could be preserved over the next decade under the rule change.

The rules are also designed to close two significant loopholes that arise from corporate inversion:

  • Booking US income overseas

Currently, a non US resident company can facilitate a shift in profits from the US to another country, even under existing international transfer pricing regulations, despite a significant proportion of the company’s activities and sales arising from within the US

  • Eliminating tax on overseas income

Once an inversion takes place, any overseas income already accrued outside of the US by the company would never need to be remitted back to the US and US tax on these earnings can be avoided altogether. It is estimated that Pfizer has approximately $70 billion of earnings held outside of the US in its overseas subsidiaries. Since the US tax code only taxes these earnings when they are brought back to the US, there is a clear incentive for many US multinationals to keep cash offshore and defer paying any US tax. A corporate inversion, however, takes this one step further and eliminates the tax altogether through a change of residence even though control ultimately remains in the US.

For now, U.S. multinationals are coping with uncertainty about the future of inversions. A clause in the proposed $42.9 billion takeover of Dublin-based medical device firm Covidien by Minneapolis-based Medtronic allows either party to terminate the deal if changes in US tax regulation arise that would prevent Medtronic from inverting its registration to Ireland. Whether they’ll have to invoke the clause before a deal can be concluded remains unknown.

Inversion, of course, is just one piece of the larger global tax puzzle, as sovereign governments struggle to rein in tax avoidance by multinationals and erosion of their tax bases.  

Those issues are big ones in the UK, where Parliamentary Select Committees have hauled in executives from multinationals such as Amazon, Google, and Starbucks to question their aggressive tax practices. The UK government has employed carrots as well as sticks, reducing headline rates of corporate tax (from 28 percent to 20 percent over the last 5 years) as well providing companies an exemption on profits earned abroad. The measures have seen some success: WPP relocated back to the UK from Ireland in 2013 and the country has become more competitive in the eyes of multinationals after years in which Ireland was the hot destination for businesses looking to set up shop in the region.

Meanwhile, the G20 has instructed the OECD to prepare a report on Base Erosion and Profit Shifting (BEPS). The BEPS report, when finalized, will probably represent the most significant change in international taxation since the advent of transfer pricing and reflect the transformed nature of global commerce.

Corporate Inversion – The Future

It is clear that most countries frown upon the artificial divergence of earnings purely for tax purposes. Corporate inversions, profit shifting strategies and other tax avoidance practices erode a country’s tax base and can have a wider impact on investment and employment that can potentially far outweigh the simple tax loss to a country. As the global economy becomes more interconnected and technology brings countries closer together, there are real questions to be asked about how governments maintain tax revenue while at the same time encouraging competition and investment.

  • Increased regulation

An obvious method of dealing with the problem is to legislate against harmful tax practices and ensure anti-avoidance laws are both appropriate and effective in maintaining the tax base. Proposals such as Levin’s bill in Congress achieve this objective but fail to tackle the underlying problem, namely the reluctance of companies to repatriate earnings back to the United States. Going beyond further limits on inversion, the US could consider the compulsory repatriation of some of those offshore profits that are currently sitting overseas. Tighter profit-shifting legislation could also be implemented, including restrictions on the holding of intellectual property in tax haven countries.

  • Decreased regulation

There are many proponents who believe that tax reform in the US is long overdue and that laws should, in fact, be relaxed and not tightened to allow US companies to compete with other multinationals based in more favorable tax jurisdictions. The Obama administration has stated the case for reducing the headline corporate tax rate from 35 percent to 28 percent in an attempt to boost investment in the US. It has also suggested providing US multinationals with a one-off repatriation tax holiday to encourage corporations to bring back some of their overseas cash to the US (Moody’s estimates that US firms have a total $1.64 trillion sequestered abroad). While these measures may appear to reduce tax revenues, by encouraging a change in corporate behavior they may well have the opposite effect and the overall tax collected in the US could increase.

In reality, there is no single solution and the likely outcome is a mixture of the strategies outlined above. Moreover, it is probably time for the US to recognize the fact that countries can no longer act in isolation where tax policy is concerned. Worldwide — or at least OECD-wide — cooperation is needed to counter tax base erosion. Significant political will and pressure will be required to reform the US tax system and, in its absence, companies will continue to try and reduce their tax burden — be it by changing their residence or by other means. Ultimately, a single piece of legislation can deliver a fatal blow to the practice of corporate inversion, but general tax avoidance will be far harder to address.

Reproduced with permission from Tax Management Weekly Report, 33 Tax Mgmt. Wkly. Rep. No. 34, 1165, 08/25/2014. Copyright  2014 by The Bureau of National Affairs, Inc. (800-372-1033)