U.S. drug giant Pfizer's recent effort to merge with much smaller United Kingdom-based AstraZeneca, and then convert itself into a "U.K. company" and avoid U.S. corporate taxes -- even though its U.S. shareholders would continue to own a majority in the merged company -- highlighted a gaping hole in current corporate tax law. With that in mind, Senator Carl Levin (D-MI) and 13 Senate co-sponsors, and Representative Sander Levin (D-MI) and nine House co-sponsors, introduced companion bills yesterday to halt a possible renewed spate of such tax-driven corporate "inversions," whereby corporations shift their headquarters overseas to avoid paying U.S. tax on their foreign earnings.
Congress should approve these bills promptly. Inaction would reward aggressive tax avoidance in at least two ways, because the merged company could:
- More easily book its U.S. profits in tax havens. Even though Pfizer would be headquartered in the U.K., the United States would -- in theory -- still be able to tax the merged company's earnings from its U.S. operations. But Pfizer appears to be expert at using profit-shifting techniques to book profits offshore for tax purposes, even though a large share of its activity and sales is in the United States. "Over the last half decade, Pfizer has put all of its profits outside the United States despite high prices in the United States, more than 40 percent of its sales in the United States, and a heavy concentration of research in the United States," a 2013 analysis by Tax Analysts' Martin A. Sullivan noted. A Congressional Research Service report on the proposed merger concluded that a foreign headquarters could make it even easier for Pfizer to shift its profits out of the United States.
- Avoid ever paying U.S. tax on Pfizer's "offshore" cash. In part because Pfizer has been so good at booking its profits outside of the United States, its offshore subsidiaries are currently sitting on $73 billion of earnings. Under current law, Pfizer can delay paying U.S. tax on those earnings until it brings them back to the United States (by declaring a dividend to shareholders, for example). But if Pfizer merges with AstraZeneca, it can avoid ever paying U.S. tax on the earnings it made when it was a U.S. company. While domestic companies pay taxes every year, a multinational company like Pfizer would be able to defer taxes for years and then change corporate residence (while not changing control) and, thereby, wipe out its U.S. tax liability.
Congress enacted legislation in 2004 to deter U.S corporations from moving their headquarters to tax havens to reap such tax avoidance benefits. These "anti-inversion" rules, however, were too weak, as the intended Pfizer merger shows. The bills introduced yesterday reflect a proposal in the President's budget to strengthen the tax rules for a U.S. company that has merged with a foreign company. The proposal includes a straightforward rule that the merged company couldn't generally be treated as a foreign company for tax purposes if the shareholders of the U.S. company continue to control it.
The bills introduced yesterday would help prevent U.S. companies from using inversions to reap the benefits of aggressive profit shifting by expatriating, and the House and Senate should adopt them promptly. Waiting for broader tax reform legislation down the road would only invite more tax avoidance-driven corporate exits and a fierce lobbying campaign to protect the loophole.