Merger activity has exploded this year, and a key factor behind many of the deals is the ability to use cash stockpiles held overseas. Cash and profits stashed overseas avoid being subject to the U.S. corporate tax rate of 35 percent. It is estimated that foreign subsidiaries of U.S. companies have accumulated $2 trillion in profits on which they have paid no U.S. tax.
Pfizer’s recently proposed mega-merger to acquire U.K.-based AstraZeneca for $99 billion allows the company to put its prodigious $35 billion in foreign-held cash to work. If the merger is completed, Pfizer will move its headquarters to the United Kingdom in a transaction called an “inversion.” Inversions are currently allowed when at least 20 percent of a company’s common stock is foreign-owned.
While the company would be domiciled in Britain in name only, Pfizer is making the move because its combined federal and state tax rate in the United States is nearly 40 percent, compared with a 21-percent rate in the U.K. One analyst calculated that Pfizer saves $200 million for each percentage-point less in taxes.
At least 50 U.S. companies have completed mergers that allowed them to reincorporate on foreign soil, and nearly half of these inversions have occurred in the past two years. The list includes Chiquita Brands, ad agency giant Omnicom, Tyco, Transocean, and Valeant Pharmaceuticals. Walgreens is being pushed by an activist shareholder to invert when it completes its merger with British-based Alliance Boots.
The inversions are taking place in tax-friendly countries like Ireland, where the corporate tax rate is 12.5 percent, and in Britain and the Netherlands. To no surprise, the White House has proposed to eliminate inversions in its 2015 budget by requiring foreign ownership of more than 50 percent of post-merger businesses. Thus, there might be a rush to complete more of these transactions by year-end.
Another strategy for tapping foreign-held cash is borrowing money in the U.S. bond market, in what has been called “synthetic cash repatriation.” Apple just did this by issuing $12 billion in new bonds, which followed a similar $17 billion bond sale by the company one year ago.
The 10-year bonds Apple issued will cost the company 3.46-percent interest, yet the strategy circumvents bringing overseas cash back into the U.S. at the 35-percent tax rate. Apple has earmarked the bond cash for its program to return $130 billion to shareholders via dividend increases and share buybacks. The company has a massive $151 billion in cash, 88 percent of which is held offshore.
One notable exception is eBay, which announced it intends to bring back most of the $9 billion in cash it holds overseas and incur a $3 billion tax bill, for a net $6 billion. It is unclear why eBay didn’t use a bond-issuance strategy like Apple. Perhaps since eBay already has $4 billion in debt, there was concern about its credit ratings. Or maybe it is an indication that eBay foresees no change in U.S. tax policy and needs the cash for U.S. operations.
U.S. companies complain that foreign rivals have a competitive edge with their lower tax rates. Clearly, our politicians need to address foreign tax rate differentials as part of an overall program of comprehensive tax reform.•
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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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