The U.S. corporate tax system is coming apart at the seams.
It is built on the presumption that companies headquartered in the United States have their legal domicile in the United States. Twenty years ago it was unthinkable that any U.S. company would move abroad. Now under pressure from private equity firms, boards of directors, and competitors, it may become unthinkable if they don't consider it. In the summer of 2014, every major U.S. company must give the option serious consideration or risk being left in an uncompetitive tax position. With each inversion deal that gets done, the case for other companies to take the plunge becomes more compelling.
In the latest development, Medtronic is acquiring Irish-based Covidien (itself a recent spinoff of U.S.-based Tyco) so that it can free itself of all the tax complications of being legally domiciled in the United States. On June 15 the two companies announced that their boards had unanimously approved a definitive agreement to do the deal.
As with the proposed but failed Pfizer acquisition of U.K.-based AstraZeneca, the primary motivation for this deal is not an immediate cut in U.S. taxes---as will be the case if high-tax Walgreens buys the U.K-based drugstore chain Boots.
Like pharmaceutical and high-tech companies, medical device companies are loaded with intellectual property. Under U.S. law, it is easy to move these highly profitable assets to tax havens and avoid U.S. tax as long as those profits are not distributed as dividends back to the U.S. parent. The table below shows that Medtronic is better than most at this. Its average effective tax rate over the last two years was 18 percent--significantly below that of most of its U.S. and foreign competitors.
The main benefit to Medtronic after the inversion will be that the billions of profits it generates outside the United States each year can now be deployed to pay dividends and to buy other U.S. companies without paying U.S. tax. And when it buys other U.S. companies, those companies’ foreign profits can also be moved outside the U.S. tax net. Medtronic is establishing a tax-efficient platform for future mergers and acquisitions.
Meanwhile, back in the unreal world of Washington, the leaders of the Senate Finance Committee -- Chair Ron Wyden and ranking member Orrin Hatch -- are moving at a snail’s pace. Rather than directly dealing with these fast-breaking developments, they are using the public outcry against these deals to ignite interest in their otherwise moribund efforts at tax reform. On June 5 they announced that after they hold two other hearings, they will then hold a July hearing on tax system modernization. They may have to move more quickly than that or a haphazard and unprincipled tax reform will take place on its own.
