There was a time when American pharmaceutical companies had finally found a way to access the large reserves of cash they had piling up in places like the Cayman Islands. The process was simple: Acquire a smaller foreign rival, repatriate in the rival's home country and then dip into the offshore money without fear of paying the U.S. corporate tax rate of 35 percent.
But the U.S. Treasury Department effectively undercut that strategy this week, issuing new rules that will make it a lot harder for U.S. companies to tap into offshore cash without paying taxes -- even if they move their headquarters abroad in one of these deals, known as "inversions."
There are more than a dozen inversions currently pending, and it's not yet clear whether the raft of new rules will scuttle any of those deals. But of the pending inversions, those involving pharmaceutical and related industries seem to be most immediately at peril, tax experts told The Huffington Post, because those companies are the most likely to be pursuing inversions as a way to get tax-free access to offshore cash.
"The new rules will make these companies stop and think twice," said Frank Clemente, the executive director of Americans for Tax Fairness, a tax reform advocacy group that opposes inversions.
Among the deals that could be in trouble are those involving AbbVie, a drug company, and Medtronic, a medical device supplier. The two American companies have announced plans to buy smaller Irish rivals and then invert, moving their headquarters abroad for the purposes of taxation. Pfizer's on-again, off-again pursuit of the British drugmaker AstraZeneca could also be imperiled. The three U.S. companies collectively hold more than $100 billion offshore, tax filings show.
Shares of Medtronic and AbbVie fell nearly 3 percent and 2 percent, respectively, on Tuesday. Pfizer's stock was down about 0.5 percent.
A Medtronic spokesman said the company was reviewing the Treasury's actions. A spokeswoman for Pfizer said she had no comment, but noted that the company had previously said it did not plan to make a takeover offer for AstraZeneca. (Discussions have continued behind closed doors, according to news reports.) AbbVie did not respond to a request for comment.
Other companies that have pursued inversions -- including Burger King, which is buying Tim Hortons in Canada, and Chiquita, which aims to acquire Fyffes in Ireland -- may not be dissuaded by the new rules. Neither Burger King nor Chiquita has much cash stored abroad. Tax experts say they may be motivated more by the benefits of a practice called "earnings stripping," in which the U.S. subsidiary of the inverted company gets loaded up with debt in a bid to lower the domestic tax bill.
Tax experts estimate that Walgreens, which had planned an inversion with Alliance Boots of Switzerland, could have saved $4 billion over five years through such a tactic. (Fearing a public backlash, Walgreens later canceled its plan to move its headquarters abroad.)
Drug companies don't have much need for earnings stripping, mainly because they have already mastered the art of making it look as if they make much less money than they actually do.
A favorite big-pharma tax-avoidance method is to set up a subsidiary in a low-tax jurisdiction and then sell that subsidiary the patents for certain drugs. The American parent company then pays the subsidiary royalties for medication sold in the U.S. -- thereby reducing its own domestic earnings and lowering its tax bill. This is how many pharma giants have built such big stacks of cash offshore.
In comments Tuesday, Treasury Secretary Jacob Lew acknowledged that the new rules might stop some inversions, but said they were unlikely to kill the practice entirely.
Comprehensive corporate tax reform by Congress "is the only way to fully rein in these transactions," he said.
CORRECTION: This story has been updated to note that Medtronic is a medical device company, not a drug maker.