US laws fail to halt tax-led shift to Ireland
Payouts to company executives highlight the ineffectiveness of the 2004 law that aimed to stop 'tax rate land grabs', says Zachary R Mider
TEN years ago, the United States authorities passed a law intended to penalise CEOs whose companies shift their legal addresses to tax havens such as Ireland. But it hasn't worked out quite as the Americans planned.
Companies have found ways around the law that create new rewards for executives. When Actavis changed its incorporation to Ireland in October 2013, the New Jersey-based drugmaker helped CEO Paul Bisaro avoid the law's bite by handing him more than $40m of stock as much as three years ahead of its schedule, then promising him an additional $5m to remain with the company.
The payouts to executives highlight the ineffectiveness of the 2004 law, which contained a series of provisions aimed at reducing the tax benefits of reincorporating overseas. In the past two years, a fresh wave of companies has fled the US system to avoid hundreds of millions of dollars in taxes.
The 2004 law has "clearly been a failure" in halting the tax exodus, said Edward Kleinbard, a professor at the University of Southern California's Gould School of Law. "It now has the perverse result of putting money into executives' pockets sooner."
The law imposes a special tax of 15 per cent on restricted stock and options held by the most senior executives when a company reincorporates outside the US. Since the measure took effect, at least seven large companies have disclosed in securities filings that they risked triggering the tax. All shielded their executives from having to pay.
Three of the companies' boards simply picked up the tax bill for their executives, maintaining that the managers shouldn't suffer for a decision that benefits shareholders. At three other companies, including Actavis, the boards helped them avoid the tax altogether by allowing restricted stock to vest early and for options to be exercised. Awarding the equity early raises the risk that the executives might quit or sell their shares, or get paid for meeting goals they never attain.
Since 2012, at least 13 large US companies have announced or completed shifts of legal address, which tax experts call "inversions", to lower-tax nations such as Ireland and Switzerland.
Omnicom, the New York advertising firm, estimates that a planned incorporation in the Netherlands this year, as part of a merger with a French rival, will save the combined company $80m a year. The cost to the US Treasury of the recent wave of address changes may be about $500m a year, estimates Robert Willens, a New York-based tax and accounting consultant.
The statutory US corporate income tax rate of 35 per cent is the highest among developed countries, although many companies end up paying less. Lawmakers in both parties and President Obama have endorsed tax code changes that would lower the rate below 30 per cent, reducing the incentive to reincorporate overseas. Those proposals have been stymied.
Some Democratic lawmakers have introduced legislation that would treat companies managed from the US as domestic even if they are incorporated elsewhere. Democratic senator Carl Levin said last year the change would raise tax revenue by $6.6bn over 10 years. None of those bills has attracted much Republican support or emerged from committee.
An earlier flurry of corporate flights to tax havens triggered the 2004 law. Tyco International, Chicago-based Fruit of the Loom, and Ingersoll-Rand, based in New Jersey, incorporated in Bermuda or the Cayman Islands in the late Nineties and early Noughties.
By the time Stanley Works, the 159-year-old Connecticut toolmaker, announced plans to use a Bermuda address in 2002, lawmakers took notice. They denounced the company's CEO and proposed more than 30 different bills to curtail the practice.
Connecticut's attorney general sued, and union officials organised protests in the company's hometown of New Britain.
"These expatriations aren't illegal. But they're sure immoral," the top Republican on the Finance Committee, Chuck Grassley, said at the time. Stanley Works eventually dropped the Bermuda plan.
Grassley helped shepherd a series of anti-inversion measures into law in the American Jobs Creation Act. Some provisions made it harder for companies to get tax savings from incorporating abroad. Acquiring a mailbox in Bermuda was no longer enough.
One route that remains available involves a foreign merger, as long as the partner is at least one-fourth the size of the US firm. Most of the reincorporations since 2004 have been achieved through acquisitions abroad. They include Liberty Global, a Colorado-based cable operator, and Tower Group, the New York-based insurer.
So many pharmaceutical companies are switching addresses that bankers are pitching takeovers of Irish drugmakers based on the tax benefits. A Bank of America drug analyst dubbed it a "tax rate land grab".
Another provision in the 2004 law imposed the penalty on CEOs. Since the mid-Nineties, the IRS has required stockholders of some companies reincorporating abroad to recognise capital gains on the shares and pay income tax, even if they continue to hold the equity. That rule doesn't apply to the restricted stock or unexercised options of executives, who technically don't own the shares. Some lawmakers saw that as an unjustified boon for the CEOs.
Argonaut Group, a niche insurer in San Antonio, was one of the first companies to face the new tax on executives' equity awards. When it acquired a Bermuda address through an acquisition in 2007, Argonaut accelerated its top executives' awards to avoid the tax, recording an estimated $10.5m expense, according to a securities filing. Jazz Pharmaceuticals of Palo Alto, California, did the same for its executives when it shifted to Ireland through a 2012 merger. CEO Bruce Cozadd got $3.1m ahead of schedule.
Eaton, the Cleveland-based manufacturer of electrical equipment, and Perrigo, a drugmaker based in Michegan, opted to pay their executives' tax bills instead.
The cost of these payments can add up because the payments themselves are subject to tax. The total expense was $11.5m for Eaton's CEO, AM 'Sandy' Cutler, and an estimated $9.3m for Perrigo's Joseph Papa. Both companies shifted their incorporation to Ireland through acquisitions.
The board of Endo Health Solutions, a maker of painkillers in Pennsylvania, weighed both options while making plans to acquire a new address in Ireland. The board opted to pay the tax, estimated at $7.8m for CEO Rajiv De Silva, in part because "accelerating the vesting of these performance-based awards could result in unearned compensation being paid" if goals weren't met.
The biggest disclosed payout so far has been to Bisaro at Actavis. After becoming CEO in 2007, the former lawyer embarked on a series of acquisitions, assembling one of the world's largest generic drug companies. When bidding for foreign assets against rivals with lower tax rates, he said last year, he felt "handicapped".
For instance, another serial acquirer, Valeant Pharmaceuticals International, is incorporated in Canada and earns much of its profits through subsidiaries in havens such as Bermuda, achieving an effective tax rate of less than 10 per cent. Before getting the Irish address in 2013, Actavis's effective rate was about 28 per cent.
Bisaro found a solution in May 2013 when he announced the $5bn acquisition of Warner Chilcott, a smaller company that made birth control and acne treatments and was incorporated in Ireland. He estimated the total cost savings from the takeover at $400m a year. He said the combined company's effective tax rate would be about 17 per cent and eventually drop further. On its own, Warner Chilcott's effective rate was about 11 per cent to 12 per cent.
Since becoming CEO, Bisaro has received the biggest chunk of his pay in the form of restricted stock, which doesn't vest until as long as four years after it is awarded. In the meantime, he can lose it if he misses performance targets or quits. In 2012, restricted stock made up about half of his $8.7m in compensation.
Because of the special tax due upon reincorporation, Bisaro's board decided to drop restrictions on Bisaro's stock when the Warner Chilcott deal was completed – even some that he had received in March that wasn't due to vest until 2017. Actavis estimated the value of that stock at $40m in an August 2013 filing and said the total amount for the top five officers was $100.8m. By the time the deal was completed, the stock had gained an additional 13 per cent.
Directors reasoned that the executives shouldn't have to pay a penalty for a transaction that was in the shareholders' interest. The board chose to accelerate the executives' stock awards rather than pay the 15 per cent penalty because the former option was partly tax-deductible.
The accelerated stock award triggered an early tax bill for Bisaro, who reported that about half the stock was withheld for tax purposes. Stock awarded as compensation is usually taxed at the same ordinary income rate as wages. Without the acceleration, he would have faced a similar tax bill in the future, whenever the restrictions lapsed.
The law is a classic example of how the US Congress's attempts to tweak corporate behaviour through the tax code usually backfire, said Kevin Murphy, a professor at USC's Marshall School of Business. "One thing we can always count on is that there will be lots of unintended consequences, usually costly, for shareholders and taxpayers."
Besides rewarding CEOs for corporate tax avoidance, the accelerated payments may upend companies' compensation plans, said one consultant. Restricted shares are designed to be earned over time. "Without restrictions on equity awards, "they can pick up their sticks and leave, and they get to take all that vested stuff with them."
Indeed, Actavis said in 2013 that it would have to make additional payments to retain Bisaro and his team after allowing them to collect their shares ahead of schedule. Shortly after shifting its address to Ireland, Actavis promised Bisaro the $5m cash retention bonus, contingent on his remaining at the company through 2016.
Congress should overhaul the whole corporate tax system rather than targeting address shifts, said Bret Wells, a professor at the University of Houston Law Center. US rules allow foreign companies to dodge taxes on their American profits, a process called "earnings stripping," more easily than domestic companies can, he said. "Inversion transactions should be a wake-up call. They should tell us there's something wrong with our tax system when it's more valuable to be foreign-owned than US-owned."
Two months after Actavis announced the reincorporation to Ireland, Gilbert, the Bank of America analyst, asked Bisaro to comment on the "tax rate land grab that is going on".
"Unfortunately we have a tax structure in the US that puts companies in the States at a disadvantage," Bisaro said. "We won't be at a disadvantage anymore. And I think other companies have to take a look at that. It just makes economic sense."