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Deep Tax Cuts Opens Northern Front for U.S. Companies

Aug. 25 (Bloomberg) –- Twenty-First Securities President and Founder Bob Gordon and Adviser Investments Co-Founder and CEO Dan Weiner discuss Burger King’s talks to acquire Tim Hortons and U.S. corporate inversions. They speak on “Taking Stock.” (Source: Bloomberg)

Canada has become the latest frontier for U.S. companies fleeing the high cost of business, spurred by low corporate taxes and a policy that keeps international earnings out of the clutches of the Internal Revenue Service.

Burger King Worldwide Inc. (BKW), the second-largest U.S. burger chain, agreed to buy coffee-and-doughnut company Tim Hortons Inc. today for about C$12.5 billion ($11.4 billion) and move the headquarters of the combined company to Canada. It’s “not fair” that companies can renounce their U.S. citizenship by filling out paperwork, a White House spokesman said yesterday.

The deal, which is still subject to the standard approvals, for Oakville, Ontario-based Tim Hortons follows Valeant Pharmaceuticals International Inc.’s merger with Canada’s Biovail Corp. in 2010, which sparked the latest so-called tax-inversion wave.

Burger King is unlikely to be the last U.S. company to consider moving north even as President Barack Obama and his aides try to curb the practice, tax experts say. In addition to avoiding U.S. taxes on global earnings, companies like Burger King can take advantage of Canadian tax rates that have been cut by about a quarter in the past eight years.

How U.S. Companies Buy Tax Breaks

Photographer: Brent Lewin/Bloomberg

A coffee pot sits on a burner at a Tim Hortons Inc. restaurant in Oakville, Canada. Close

A coffee pot sits on a burner at a Tim Hortons Inc. restaurant in Oakville, Canada.

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Photographer: Brent Lewin/Bloomberg

A coffee pot sits on a burner at a Tim Hortons Inc. restaurant in Oakville, Canada.

“We have now made it a lot more attractive for companies to say Canada is a good place to set up shop,” said Jack Mintz, director of the University of Calgary’s School of Public Policy.

Only income earned within Canada is taxed by the government, said Alex Edwards, assistant professor at the University of Toronto’s Rotman School of Management, noting this territorial system is the more common form of corporate taxation. In the U.S., profits from foreign operations in lower-tax regions are topped up to the federal rate when they’re repatriated, he said.

Tax Layers

“The real bang for the buck here is potential tax savings on Burger King’s non-U.S. earnings,” Edwards said by phone yesterday. “It’s not just the earnings in Canada, it’s the earnings everywhere in the world that might be able to escape that second layer of U.S. tax.”

As a result, Canada is primed for more of these tax inversion deals before the U.S. Congress makes a decision on whether to block them, he said. He noted there was a wave of similar inversion deals in the late 1990s and early 2000s where U.S. companies were domiciling in foreign jurisdictions with holding companies, including in Canada, to get around U.S. tax laws before Congress moved to end those activities.

“What’s driving this is not so much the Canadian tax code but the U.S. tax code,” Edwards said.

Companies that consider actions like an inversion continue to benefit from all of the resources of the U.S., White House spokesman Josh Earnest told reporters yesterday in Washington.

File Paperwork

“It’s not fair for them to just fill out some paperwork that would allow them to just renounce their citizenship” and their tax rate, he said.

Under Canadian law, any foreign investment transaction above C$354 million ($322 million) is reviewed based on the long-term interest of the economy, said Jake Enwright, a spokesman for Industry Canada Minister James Moore.

David Baskin, president of Baskin Financial Services Inc. in Toronto, said he didn’t expect any Canadian government intervention in a deal between Burger King and Tim Hortons because the latter was already owned at one point by Wendy’s Co.

“I can’t see that it’s bad for Canada or Canadians. I don’t see the government stopping this one,” he said in a telephone interview yesterday. Baskin owns Tim Hortons shares, which soared 19 percent yesterday. “If it was good enough for Wendy’s it’s good enough for Burger King.”

Magna Target

Tim Hortons climbed 8.1 percent to C$88.71 at 4 p.m. in Toronto for a market value of C$11.8 billion, after closing 19 percent higher yesterday.

Companies need scale for the transaction to make sense, which limits the options for additional inversions involving Canadian firms, Baskin said.

“You can’t have Wal-Mart taking over a corner grocery store to do a tax inversion and there just aren’t that many sizable Canadian companies,” he said.

Magna International Inc. (MG), North America’s biggest auto parts supplier, might be another inversion target, he said.

Lower corporate taxes may also be an attraction for foreign companies. Canada began cutting its federal corporate tax rate in 2001 under the previous Liberal government. Prime Minister Stephen Harper then took up the baton, dropping the rate in several steps to 15 percent in 2012. Combined with provincial rates averaging 11.5 percent, Canada’s rate of 27 percent is now the second-lowest in the Group of Seven countries behind the U.K.’s 21 percent, according to auditing and tax firm KPMG.

Global Ranking

Canada’s combined rate is still above the 24 percent average for the Organisation for Economic Co-operation and Development, according to the report.

Low corporate tax rates helped the country rise to second place in a Bloomberg ranking of best countries for doing business in January, behind only Hong Kong.

“We are proud that our low tax environment in Canada attracts businesses,” Carl Vallee, a spokesman for Harper, said by e-mail yesterday.

The actual tax savings from a union between Burger King and Tim Hortons is not very big, according to a report from Catharine Sterritt and Bank of Nova Scotia’s Arbitrage Group. Effective tax rates for Tim Hortons and Burger King were 26.8 percent and 27.5 percent respectively in 2013. Burger King gets about 42 percent of its revenue from outside the U.S. and Canada, according to data compiled by Bloomberg.

Obama Criticism

Between mid-June and late-July, when U.S. President Barack Obama began criticizing inversion deals at least five large American firms have announced plans to make such a move, including AbbVie Inc. (ABBV) and Medtronic Inc. (MDT)

Since the start of 2012, at least 21 U.S. companies have announced or completed the deals, comprising almost half the total of 51 such transactions in the past three decades.

Tim Hortons even did an inversion of its own when it incorporated in Canada in 2009 in order to take advantage of the lower tax rate after being spun off from Wendy’s three years earlier.

Canada has taken steps in the past to curb a decline in corporate tax revenue. The government introduced a tax on income trusts in 2006 after companies including Telus Corp. and BCE Inc. tried to join a wave of companies converting to the equity structure to lower their taxes by paying out more of their earnings to shareholders through dividends.

To contact the reporters on this story: Scott Deveau in Toronto at sdeveau2@bloomberg.net; Eric Lam in Toronto at elam87@bloomberg.net

To contact the editors responsible for this story: David Scanlan at dscanlan@bloomberg.net Jacqueline Thorpe

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