Why Pfizer's 'merger' proves a bitter pill for Ireland
A tie-up with Allergan has made Ireland's low-company tax rate an issue in next year's US presidential election
Last week Pfizer, the world's largest pharmaceutical company, announced that it was merging with Dublin-registered Allergan. The combination of Pfizer, best known for its Viagra anti-impotence drug, and Allergan, the manufacturer of Botox, will create a pharmaceutical giant and, theoretically at least, Ireland's most valuable company with a market value of over $300bn.
So why was the Irish Government less than ecstatic when news broke of the deal? From an Irish point of view, the Pfizer/Allergan tie-up, coming as the race to succeed Barack Obama as US President begins in earnest, couldn't have been worse timed. Both of the front-runners, Hillary Clinton on the Democratic side and Donald Trump for the Republicans, denounced it in the strongest possible terms.
"For too long, powerful corporations have exploited loopholes that allow them to hide earnings abroad to lower their taxes. Now Pfizer is trying to reduce its tax bill even further," said Ms Clinton. "As President, I will fight to reform our tax system to reward growth, innovation, and job creation here in the United States. We cannot delay in cracking down on inversions that erode our tax base."
Mr Trump went even further. "The fact that Pfizer is leaving our country with a tremendous loss of jobs is disgusting," he said.
This is because the "merger", in reality a takeover of Allergan by Pfizer whose shareholders will end up owning at least 56pc of the combined entity which will be called Pfizer, is a so-called tax "inversion". This is where an American company agrees to be "taken over" by a smaller foreign firm and switches its tax residence to the country where the foreign company pays its taxes.
When the deal goes through some time in the second half of 2016, the merged company will pay its taxes in Ireland, where the standard corporate tax rate is just 12.5pc, rather than in the United States, where the federal tax rate of 35pc is the highest in the developed world - the actual tax rate for many American companies can hit 40pc or more when state and local taxes are added.
This means that the savings for Pfizer - and the losses to Uncle Sam - could be significant. Pfizer's effective tax rate was 25.5pc in 2014. The effective tax rate will fall to 17-18pc in 2017, according to Pfizer, saving the company over $1.2bn a year in taxes.
Mindful no doubt of the controversy that would be generated by the announcement of the Allergan deal, Pfizer is probably being conservative. The real tax savings will almost certainly be much, much greater. The first thing to bear in mind is that while Pfizer provided for an effective tax rate of 25.5pc, or $3.1bn, in its published 2014 financial statements, the amount of tax it actually paid was much lower, only $900m.
This is because as an American-registered company, Pfizer is liable for American taxes on its global profits - if and when it repatriates those profits to the United States. In 2014, it set aside $2.2bn to pay American taxes on its overseas profits. This is however an accounting provision rather than a real cash outflow. Pfizer has now piled up a massive $21bn in overseas profits which it is sheltering abroad, perfectly legally, from the IRS.
If the deal with Allergan goes through, not alone will Pfizer be able to stop providing for eventual American tax on its overseas profits, the €21bn which it has already accumulated in non-repatriated overseas profits is freed up for distribution to its shareholders. This has led some analysts to put the eventual tax savings from the deal at up to $3.3bn a year - more than three times what Pfizer has indicated.
If the Allergan deal was a once-off then it mightn't matter so much to this country. But it isn't.
Ever since Texas-based construction company McDermott International switched its registration to Panama 1982, there has been a cat and mouse game going on between tax accountants and lawyers on one side and the Internal Revenue Service on the other.
Since 1982 at least 50 other US companies have followed McDermott's example and switched their registration to a low-tax country. However, what had previously been a relative trickle has turned into a torrent in recent years with 21 companies with a combined value of well over a third of a trillion dollars having made the switch since 2012.
In 2014, inversions moved from the business pages to the front page when that American icon Burger King became "Canadian" following its acquisition of coffee and doughnut chain Tim Hortons and moved its tax residence north of the border.
Another four inversions, including Pfizer's Allergan deal, are pending, making 2015 a record year for switching. Of particular interest to this country is the fact that of these 25 completed or pending inversions, eight came to Ireland. At a time when Apple's Irish tax affairs are being put under the microscope on both sides of the Atlantic and Finance Minister Michael Noonan was forced to scrap the infamous "double Irish" corporate tax loophole that is attracting unwelcome attention to Ireland. A recent survey by financial news service Bloomberg showed that at least 12 of the 20 most valuable "Irish" companies had US roots.
"Companies are fleeing the US. It is not just Ireland. They are also going to the UK, Switzerland and the Netherlands," says PwC managing partner Feargal O'Rourke.
"Given that we are in the middle of a US election campaign, we are being unfairly dragged into an American fight."
The gains to US companies from tax inversions are potentially enormous. A recent paper by Professor Thomas Lys of the Kellogg School of Management calculated that the average gain to a US company switching its tax residence was $2.1bn. Another paper by Elizabeth Chorvat of the University of Illinois concluded that a formerly US company could expect excess returns of 225pc above average market returns in the years following an inversion.
Given the gains that can be achieved from a tax inversion, the real wonder must surely be not that so many US companies have switched their tax residence but that even more of them haven't done so. In recent years a number of proposed inversions have been abandoned in the teeth of fierce political and public controversy.
Last year, US pharmaceutical retailer Walgreen did a U-turn when taking over Boots Alliance. It kept its headquarters in the US rather than executing the tax inversion it had originally envisaged. The Allergan deal is Pfizer's second shot at inversion. In 2014 it pulled the plug on its takeover of UK pharmaceutical manufacturer AstraZeneca, which would have seen Pfizer become a "British" company.
A company's gain is Uncle Sam's loss. As the number of inversions increases, the potential US tax losses multiply. The Ways and Means Committee of the US House of Representatives has estimated that inversions will cost $34bn in lost tax revenue over the next decade.
The furore resulting from the abortive Walgreen and Pfizer inversions prompted the Obama administration to tighten the rules surrounding inversions in September 2014. In order to pass muster with the IRS, shareholders of the overseas company must now have at least a 40pc shareholding in the combined company. Pfizer's deal with Allergan, which will see the former Allergan shareholders owning 44pc of the new Pfizer, was designed to conform to these new rules.
So what are the implications of Pfizer's deal with Allergan for Ireland? Finance Minister Michael Noonan has denied that it casts Ireland's low-tax regime in a negative light.
"We are not pushing for inversion, the IDA never promotes inversion - it's a decision by the two companies. Our interest would be to ensure that not only are there no job losses but that extra jobs are created," he said.
What is undeniable is that the merged Pfizer/Allergan, which will employ over 5,000 people in this country will not be a "brass plate" operation. However, early predictions that the merged company could end up paying an extra €620m a year in Irish corporation tax look overly optimistic.
"If the US wants to stop this then it should take steps to do so. It should put its own house in order. The general consensus is that the US tax system is broken. Something needs to be done", says Mr O'Rourke.
The problem is that next year's presidential election means that normal politics means that normal politics have been put on hold for the duration and that it will be 2017 at the earliest before anything can be done - assuming, of course, that the Republicans and the Democrats can put aside their differences and strike a deal.
In the meantime, this country and our low-tax company tax regime is going to be in the spotlight. No amount of patient explanations by Irish ministers will be heard above the hurly-burly of a US presidential election campaign - when you are explaining you are losing.
The best that ministers and the IDA can do is to grin and bear it and hope that the two US parties can reach a compromise on company tax rates after the election.
Sunday Indo Business