The Rx Firm Tax Exodus: Is Something Wrong with the U.S. System?

As I read the latest reports of yet another big US Rx firm, this time AbbVie, trying to pull off a “tax inversion” takeover of the Irish-based Shire, I couldn’t help but wonder, what the heck is going on here?

Right now, it feels like most major US corporations, especially pharmas, are literally running away from their U.S. “tax homes” as fast as they can. Is it really possible that U.S. tax policy is so bad that numerous Dow 30 component companies are heading for the exits?

Actually, yes, it is. As Sarah Bloom Raskin, Deputy Secretary for the U.S. Department of Treasury, said recently when asked about this sudden exodus, “Yes. Something is probably wrong with our (U.S.) tax system”. At this point, given what’s going on, I think we would all have to say this may be a bit of an understatement…Something is obviously very wrong with our tax policy.

But why is this happening now? Has U.S. pharma all of a sudden just decided they have had it with U.S. corporate tax policy? No, not exactly. In fact, as the chart below indicates, since 2005, 21 U.S. companies have undertaken “tax inversions” to take advantage of better corporate tax rate climates in foreign countries…and four more, said to be worth $400 billion, are also attempting to do so in 2014.

Courtesy of Bloomberg.com

However, as you look at this chart, a couple of very interesting trends do jump out at you. First, since 2011, of the 16 U. S. corporate tax relocations that have occurred over 50% have headed to Ireland. Second, of the 9 firms that have ‘reloed’ to Ireland, 7 have been pharma/healthcare concerns.

Why Ireland? I’d say it’s pretty simple, really. The U.S. corporate tax rate is set at 35%…(Yes, with all deductions and credits, it usually comes down to an effective rate of about 27%)…while the Irish corporate tax rate is 13%… Right, more than 50% lower.

Any wonder why the U.S. firms are leaving in droves? Here’s how these American trans-nationals are attempting to avoid the “highest corporate tax rate in the world”.

First, they are utilizing a fiscal finesse called a “tax inversion.” The ramped up use of this financial maneuver is what has led Under Secretary Raskin, and many others, to determine that something is “probably wrong” with the U.S. tax system…

But what is a “tax inversion”? According to the U.K. Financial Times:
“A tax inversion is…a legal transaction whereby a company becomes the subsidiary of another company in another country – and, as a result, the original company becomes subject to the tax laws of the foreign country instead of its country of origin.”

Second, what is the benefit of this “tax inversion” action? By setting up the corporation’s “tax home” in a foreign country, which has much lower corporate tax rate, say the 13% rate of Ireland versus the 35% rate of the U.S., the firm saves millions, sometimes billions of dollars in taxation. The net benefit to the firm is obvious.

Lastly, and importantly, there’s this business about “off shore” cash hordes. According to Bloomberg, the U.S. firms that are circling around these “tax inversions” are sitting on an estimated $2 trillion dollars in cash earned outside of the U.S. If they bring those profits home, they face the 35% U.S. corporate tax rate; if they don’t, they keep the cash outside the country, and it essentially lies fallow. However, this cash can be used in the purchase of the foreign “tax inversion” target, or, importantly, it may also be brought back to the U.S. without U.S. tax consequence once the “tax inversion” is in place.

But if this activity has been going on for a decade, or more, as the Bloomberg chart suggests, then why is it suddenly “top of mind” with U.S. Pharma, Members of Congress, and even the President of the United States?

Because an important Dow 30 component and major U.S. corporate taxpayer, Pfizer, attempted to utilize a tax inversion in its failed effort to take over Astra Zeneca. Let’s be clear here, when discussing Pfizer’s “tax inversion” interests, we are not talking about Jazz or Horizon Pharmaceuticals, both of which successfully set up Irish “tax inversions”. No, we are talking about one of the leading industrial concerns in the world that was ready to weigh anchor and blow off the corporate taxation regime of the U.S.A.

Pfizer aside, it’s pretty clear that the icing on the cake is the aforementioned AbbVie situation in which another huge, U.S. Rx concern continues to quietly head for the corporate tax exits. AbbVie’s continuing effort, coupled with Pfizer’s desire to depart, has all of a sudden sent chills through the Washington, D.C. tax policy community. The idea that all of U.S. Big Pharma, not to mentioned many other large U.S. concerns like Monsanto and Medtronic, may be seeking to set up these tax inversion plays has given many in D.C. pause. It goes something like this: “Will they all be able to dodge our U.S. corporate tax rates?”

Predictably, various Members of Congress are speaking out on this prospect. Said Sen. Ron Wyden (D-OR) on June 17th:
“I am not going to sit idly by when those who have the ability to do so can employ these armies of tax accountants and lawyers and figure out how to hot-wire a way to tap into a (tax) loophole.”

But no matter how much Congress fumes and fusses over this exodus of U.S. corporate tax payers it almost doesn’t matter, does it? That’s because the existing corporate tax policies of Ireland, Switzerland, Canada, and now, even the U.K., are enticing these American firms to set up their tax homes and avoid America’s very high corporate tax rates…right now.

And what motivated the rest of the world to move on this corporate tax issue? Well, what country would not want world class firms - that produce world leading products - and hire thousands of locals to staff the new facilities – located in their nation? It’s not rocket science, is it?

Probably the best example of how countries are waking up to these developments is the U.K. The Brits realized what was going on around them in Europe…(Ireland & Switzerland, in particular) and responded by dropping the U.K. corporate tax rate to 21% this year, and 20% in 2015. Additionally, Britain is putting its best foot forward on several other key economic matters:
“Britain is very attractive to foreign firms because it is such an open economy and we have so many good companies…The UK already gets around 40% of the total foreign direct investment because it’s an open economy and the Government’s track record is to not interfere in foreign takeover bids. Add in a common culture and language, similar legal system, and the size of its financial markets and you can see why it would be the Americans’ favoured destination”.

Collectively, there is no doubt these rates & attributes certainly contributed to Pfizer’s attempt to set up their tax home in London.

So you would think with all the stated concern in the U.S., and examples like the U.K. popping up around the world, that the U.S. would be appreciating the fact that it has a corporate tax “problem,” per the statement of the Assistant Secretary of the Treasury.

Given this, one might also think U.S. tax policy writers, from the land of unfretted free enterprise, would decide to get with it and draft new corporate tax laws that would reward large multi-nationals for staying in the United States.

But, unfortunately, that does not appear to be what is happening. Instead, the Administration’s answer is to make foreign “tax inversions” more difficult here in the U.S by demanding that U.S. companies attempting a tax inversion must have 50% foreign ownership of a firm - instead of the current 20% foreign ownership mandate -- and thus making control of the foreign company “iffy” for the U.S. firm.

Frankly, this “let’s-make-it harder-for-them” approach of our law makers is really quite puzzling to me…

Considering that today we have U.S. Rx companies desperately trying to restore their R&D in the face of failing pipelines; using all possible resources to buy existing companies and patents to work their way out of unprecedented patent expiration “cliffs”; managing increased generic competition and burgeoning private/public healthcare efforts that are designed to ratchet down the price of Rxs; and, finally, reducing overhead wherever they can, first by cutting back on the number of employees they have and then, of course, seeking corporate tax relief wherever they can achieve it…you would think Congress and the President would be a bit more thoughtful in this corporate tax matter.

But that does not seem to be the case. Instead, they appear to be intent on making sure these large American businesses receive no corporate tax relief from their home nation…and thus, the foreign “tax inversions” will continue.

So, there is much to ponder here…However, I do think Ms. Raskin has gotten it right. There really is something “probably wrong” with our U.S. corporate tax system. I leave it to you to determine the locus of that problem.