GE, Valeant Deals Fueled by Tax Rules That Favor Foreign AssetsDavid Welch
Prospective deals by General Electric Co. and Valeant Pharmaceuticals International Inc. this week show how the U.S. tax code is helping drive billion-dollar mergers and acquisitions.
GE can tap the $57 billion of cash it has amassed overseas to finance a purchase of most of France’s Alstom SA, a person with knowledge of the matter said. By doing so, GE would take advantage of its overseas profits instead of bringing them back to the U.S., where they would be taxed at a higher rate.
Valeant’s pursuit of rival Allergan Inc. underscores another twist. Many drugmakers are buying companies in low-tax countries and then setting up operations there to avoid U.S. taxes. If the Canadian company succeeds in buying Allergan, the combined entity would have a tax rate in the single digits, Valeant Chief Executive Officer Michael Pearson said. Allergan paid a tax rate of about 26 percent in 2013, data compiled by Bloomberg show.
“You have effectively created an incentive to move to a low-tax country,” said Gordon Caplan, a partner at law firm Willkie Farr & Gallagher in New York. “There is competition between high-tax countries and low-tax countries.”
U.S. companies are keeping cash offshore to avoid paying up to a 35 percent tax rate on profits they earn around the world. They only pay taxes when the cash is repatriated. By spending money overseas, the effective cost for a buyer can also be lowered, making acquisitions easier.
Multinational companies have accumulated $1.95 trillion outside the U.S., up 11.8 percent from a year earlier, according to a Bloomberg News review of filings.
GE would join Pfizer Inc., which has held informal talks to acquire British competitor AstraZeneca Plc, in seeking to tap overseas holdings. Pfizer would change its tax domicile to the U.K. in the proposed deal, said two people familiar with the matter. The arrangement would allow Pfizer to redeploy some of the $69 billion in cash trapped in its overseas businesses, without paying U.S. tax rates on the money.
The GE-Alstom deal would bring overseas acquisitions by U.S. companies in 2014 to more than $75 billion, slightly ahead of last year’s pace, data compiled by Bloomberg show. In the year-earlier period, U.S. companies made $73 billion of deals abroad, the data show.
Drug companies, including Actavis Inc. and Perrigo Co., have been most active in doing mergers and then moving their tax domiciles overseas, in what’s known as an inversion.
Valeant, joined by activist investor Bill Ackman, is offering to buy Irvine, California-based Allergan in a cash-and-stock deal valued at $45.7 billion. To achieve the lower tax rate, Valeant would fold Allergan into the parent company, now based in Laval, Quebec, and relocate some of Allergan’s intellectual property to Ireland, Chief Financial Officer Howard Schiller said at an investor presentation April 22.
Valeant has been paying an effective tax rate of 3 percent to 5 percent in recent years, according to regulatory filings.
In a typical tax inversion deal, a U.S. company buys a foreign company, often based in a low-tax country, like Ireland where corporations pay a rate of 12 percent, and adopts the foreign company’s tax domicile. That allows the buyer to avoid paying tax on income generated from subsidiaries outside the U.S. Over time the acquirer can also shift intellectual property such as patents to that country. Income made from products based on that intellectual property may not be taxable in the U.S., Caplan said.
Alexion Pharmaceuticals Inc. used a similar playbook to lower its taxes for this year. The producer of drugs for a rare blood disorder said in January it was changing its tax status by centralizing its supply chain to Ireland, where the company bought a factory.
Since Alexion only makes one product, shifting manufacturing and intellectual property to Ireland enables the company to lower its tax liabilities, said Kimberly Lee, an analyst at Janney Montgomery Scott LLC.
As a result, Alexion, whose executives manage the company from Cheshire, Connecticut, expects its overall tax rate to fall to 10 percent or 11 percent for 2014, the company said.
Actavis agreed in February to pay $21 billion to acquire Forest Laboratories Inc., setting Forest up for a tax domicile move to Ireland. Before that deal was done, Forest bought Aptalis Inc. so it, too, could move some of its taxable income offshore.
Valeant also bought Bausch & Lomb Inc. for $8.7 billion last year, enabling the company to pull the Rochester, New York-based company into its lower tax base.
These deals often happen in pharmaceuticals or other industries where a lot of a company’s value is in intellectual property, Caplan said. It’s easier to move intellectual property than it is to move factories.
That said, even some industrial companies have changed their tax domicile by acquiring a rival. Industrial equipment maker Eaton Corporation Plc acquired Cooper Industries Plc in 2012 and adopted its Irish tax domicile. That year, Eaton lowered its effective tax rate to 2.5 percent from 12.9 percent a year earlier, according to its annual report.
Eaton paid $31 million in income tax on $1.3 billion in pretax income in 2012 compared with $201 million in income tax on $1.6 billion in pretax income in 2011, data compiled by Bloomberg show.
The Obama administration is keenly aware that American companies are increasingly moving the tax domiciles offshore to reduce their taxes and is moving to make it tougher to avoid the IRS, said Linda Swartz, who heads the tax group at law firm Cadwalader, Wickersham & Taft. Companies now can adopt a target’s domicile if its market value equals at least 20 percent of the value of the combined company. President Barack Obama wants to increase that threshold to 50 percent.
“Interest in inversions has significantly increased since Obama’s 2014 budget proposed stricter limits on inversions, beginning in January 2015,” Swartz said. “While it is not likely that the inversion rules will be amended by year-end, companies seeking to invert can take that risk off the table by closing a deal by Dec. 31st.”
Obama and Republicans in Congress both want to lower the U.S. corporate tax rate, make it harder for companies to shift profits outside the country and generate one-time revenue for the government by taxing the accumulated offshore profits.
U.S. lawmakers have been unable to reach an agreement on the details of international tax changes, with Obama favoring a global minimum tax and Republicans backing a system that would make it easier to bring foreign profits home with little or no incremental U.S. tax.
With major revisions to the tax code unlikely until 2015 at the earliest, companies have an incentive to deploy their offshore cash now. The prospect of eventual changes -- including a one-time tax on accumulated offshore profits -- may cause companies to examine and deploy their foreign cash.
Separately, because foreign cash may eventually get repatriated, spending the money now has added appeal, said Mihir Desai, a professor of finance at Harvard Business School.
“If you can redeploy it actively, then that effectively defers that even longer,” he said.