New U.S. Treasury Department rules meant to curb a controversial scheme for dodging corporate taxes may not go far enough, analysts say.
The regulations announced on Monday appeared to be aimed at kneecapping Pfizer’s plan to merge with Irish rival Allergan and reincorporate in Ireland. This would allow the New York-based pharmaceutical giant to take advantage of Ireland's low corporate tax rate when accessing the cash it has stashed overseas. Deals like these are known as a “corporate inversion.”
In that sense, the regulations worked. Pfizer on Wednesday called off the $160 billion deal that would have saved the company as much as $35 billion in taxes owed to the U.S.
Although the new rules may make some inversion deals less attractive, analysts told The Huffington Post that their narrow focus may fail to prevent future corporate inversions, even by Pfizer itself.
“We’re very pleased that these rules appear to kill the Pfizer-Allergan merger,” said Ron Eckstein, a spokesman for the nonprofit Americans for Tax Fairness. “We hope it’s gone for good. But Pfizer has tried three of four different inversion attempts over the last few years, so it’s almost naive to think they won’t try again.”
The new rules target two major loopholes that made it easier for U.S. companies to take advantage of the tax inversion strategy.
One restriction cracks down on “earnings stripping,” which involves a foreign company loading a new U.S. subsidiary with debt. This reduces the subsidiary's taxable income in the U.S., since interest payments on that debt become tax deductible, according to the liberal-leaning think tank Economic Policy Institute. Profits funneled into the new parent company are then taxed at the lower rate in the foreign country.
But Pfizer was planning to take advantage of another loophole closed by the new regulations. Under the previous rules, Pfizer structured its deal with Botox-maker Allergan so that its shareholders would own 56 percent of the newly merged Irish company -- just below the 60 percent threshold the Treasury set in 2014, according to Americans for Tax Fairness. Although there are many ways in which firms can drastically lower the U.S. corporate tax rate, it is still among the highest in the developed world. Pfizer could have avoided paying an estimated $35 billion in U.S. taxes by merging with Allergan: The company planned to funnel the more than $150 billion it has stashed in 151 overseas subsidiaries to its new parent company in a tax dodge known as a “hopscotch loan.”
Allergan is already a hodgepodge of formerly American companies. The firm, now headquartered in Dublin, successfully has merged with three other U.S. corporations in smaller inversion deals over the last three years. Had Pfizer gone through with the merger under the new regulations, its shareholders would have owned about 70 percent of the new company, according to an analysis by Americans for Tax Fairness.
“The Treasury’s regulatory actions continue to provide temporary fixes, which will help reduce the short-term erosion of the U.S. corporate tax base,” Hunter Blair, budget analyst at the Economic Policy Institute, wrote in a blog post. “They deserve credit for using the limited tools available to them in the most robust way to slow this erosion.”
The new regulatory action could go further. One way the Treasury could curb earnings stripping, for instance, is by reclassifying a U.S. subsidiary’s debt as equity.
“Given their limited toolbox, the Treasury was able to apply this reclassification to shareholder dividends and economically similar transactions,” Blair wrote. “However, the proposed regulations do not apply to related-party debt incurred for business investment.”
Legislation passed by Congress may be the only way to stem the flow of U.S. companies moving their headquarters out of the country. But political gridlock caused by vitriolic partisanship dims the prospects of such a bill. Republicans this week were quick to criticize the new Treasury rules, but conservative commentary site Newsmax noted that they lack their own proposals.
“A more effective approach here would be for legislators to look at why this is happening, what incentives exist in our current tax code that are driving this move, and then look to change and reform the tax code,” said Kyle Pomerleau, economist and director of federal projects at the nonprofit Tax Foundation.
“Because there's been a significant amount of gridlock in the legislative process, which is ultimately how you should deal with issues like this, Treasury has pursued a sort of ad hoc approach to tax policy,” he added.
Such a move wouldn’t be unprecedented.
Facing a similar exodus of companies leaving the United Kingdom for low-tax havens like Ireland, Luxembourg or the Netherlands, the U.K. government implemented a series of corporate tax reforms in 2008.
It worked. The total number of U.K. corporations grew to 1.1 million in 2012, and is expected to overtake the U.S. by 2017, according Tax Foundation forecasts. The U.K. now already raises more corporate tax revenue than the U.S.
In 2014, Pfizer aggressively tried to buy British rival AstraZeneca in a $119 billion bid to fall under the U.K.’s reformed tax code. If Congress fails to enact real reform anytime soon, it may well try again.
