MarketWatch First Take: Inversions actually may be fair, but there’s still reason to stop them
The U.S. Treasury’s action against inversions has derailed the Pfizer-Allergan deal, and in turn kept the U.S. company’s headquarters in New York instead of Dublin.
That’s a small victory for the U.S. economy. Pfizer’s PFE, +3.00% plan was to keep the “global operational headquarters” in New York but the “principal executive offices” in Ireland. There’s hundreds, maybe even thousands, of jobs that would have left to serve those “principal executives.”
Before condemning Pfizer as would-be corporate villains, however, it’s worth looking at why a company actually inverts in the first place.
Also read: Pfizer walks away from its $ 150 billion Allergan deal
A neater example than the complicated pharmaceuticals business is available. Burger King has, by any reasonable person’s definition, inverted with doughnut chain Tim Hortons to move its corporate tax domicile to Ontario from Miami. (Burger King itself said it’s just two companies getting together to share best practices and services, which will be more believable once doughnuts start getting flame-grilled.)
McDonald’s MCD, -0.17% , by contrast, has not inverted.
Both Burger King and McDonald’s pay the same rate of tax on every dollar they make in profits in the U.S. The headline corporate tax rate is 35%, but in practice there’s various breaks and deductions. Let’s call it a 30% rate.
Both chains also sell hamburgers in Ireland, whose headline tax rate is 12.5%. Let’s say, again for argument sake, that various breaks and credits push the real tax rate there down to 10%.
For Burger King, that’s the end of the road. They made their euros selling burgers to the Irish, they paid their tax, and to Burger King parent Restaurant Brands International QSR, +1.41% , Canada’s tax authorities say, fine with us.
Not so for McDonald’s. The U.S. says, OK, you’ve paid 10% to the Irish authorities on the burgers you sold in Dublin. But you owe Uncle Sam another 20% — the difference between what the U.S. and Ireland charges.
Now here’s what President Obama said on Tuesday about inverters, like Burger King.
“As a practical matter, they keep most of their actual business here in the United States because they benefit from American infrastructure and technology and rule of law. They benefit from our research and our development and our patents. They benefit from American workers, who are the best in the world. But they effectively renounce their citizenship. They declare that they’re based somewhere else, thereby getting all the rewards of being an American company without fulfilling the responsibilities to pay their taxes the way everybody else is supposed to pay them.”
In Burger King’s example, they’re using Irish roads and Irish workers educated in Ireland — and paying taxes to Ireland. There’s some intellectual know-how from the U.S., but that is taxed via transfer pricing, which is a can of worms that will be unopened for now. One can say that Burger King has paid its fair share of what it owes the U.S. for its business in Ireland.
So, back to Pfizer-Allergan. Pfizer said that the deal would have reduced their tax rate to between 17% and 18%. Pfizer, without Allergan’s AGN, +3.19% business, has paid a 23% rate on their last two years of earnings from continuing operations. Let’s just fudge and say there’s a 5% a year savings.
On the $ 9.75 billion Pfizer earned in 2015, that’s nearly $ 500 million a year. That’s not insignificant, but also recall, Pfizer’s was by far the biggest proposed inversion. And to put the number in perspective, last year, the U.S. brought in $ 343.8 billion in corporate taxes.
Obama on Tuesday lumped in inversions with the Panama Papers as examples of the rich not paying their fair share. “Here in the United States, there are loopholes that only wealthy individuals and powerful corporations have access to. They have access to offshore accounts, and they are gaming the system. Middle-class families are not in the same position to do this. In fact, a lot of these loopholes come at the expense of middle-class families, because that lost revenue has to be made up somewhere,” he said.
“Alternatively, it means that we’re not investing as much as we should in schools, in making college more affordable, in putting people back to work rebuilding our roads, our bridges, our infrastructure, creating more opportunities for our children.”
That latter point is of course nonsense. Interest expense as a percentage of federal outlays was 6% last year, the lowest in five years and among the lowest rate in decades. Interest rates are rock bottom. It’s only congressional willingness, not any fiscal constraint, impairing the ability to invest.
All of which is a long way of saying, inversions really don’t make a difference to the corporate tax base, and they’re not really screwing over middle-class families, either.
Slowing inversions is the Band-Aid solution to needed corporate tax reform, which would also encourage U.S. companies to repatriate the trillions of dollars they’ve earned overseas and kept parked there.
With Congress paralyzed, however, the U.S. Treasury applied the fix they could.