The in­verted world of mo­bile cap­i­tal

Financial Mirror (Cyprus) - - FRONT PAGE -

By Laura TyA grow­ing num­ber of Amer­i­can com­pa­nies are seek­ing to move their le­gal head­quar­ters abroad by ac­quir­ing or merg­ing with for­eign com­pa­nies. In the lat­est case, Medtron­ics plans to ac­quire Ir­ish-based Co­vi­dien, a much smaller com­pany spun off by US-based Tyco, and move its le­gal head­quar­ters to low-tax Ire­land, cul­mi­nat­ing in the largest ever “in­ver­sion” or “re­domi­cil­i­a­tion” of a US com­pany. Wal­greens is re­port­edly con­sid­er­ing mov­ing its head­quar­ters to the United King­dom by ac­quir­ing the re­main­ing pub­lic shares of Al­liance Boots, the Swiss-based phar­macy gi­ant.

Such deals re­flect the deep flaws in the United States’ cor­po­rate tax sys­tem. The US has the high­est statu­tory cor­po­rate tax rate among de­vel­oped coun­tries and is the only G-7 coun­try cling­ing to an out­moded world­wide tax sys­tem un­der which the for­eign prof­its earned by US-head­quar­tered com­pa­nies in­cur additional do­mes­tic taxes when they are repa­tri­ated.

By con­trast, all other G-7 coun­tries have adopted “ter­ri­to­rial” sys­tems that im­pose lit­tle or no do­mes­tic tax on the repa­tri­ated earn­ings of their global com­pa­nies. This dif­fer­ence puts US-head­quar­tered multi­na­tion­als at a dis­ad­van­tage rel­a­tive to their for­eign com­peti­tors in for­eign lo­ca­tions. To off­set this, US multi­na­tion­als take ad­van­tage of a de­fer­ral op­tion in US tax law.

De­fer­ral al­lows them to post­pone – po­ten­tially in­def­i­nitely – the pay­ment of US cor­po­rate tax on their for­eign earn­ings un­til they are repa­tri­ated. Not sur­pris­ingly, as their for­eign earn­ings have grown as a share of to­tal earn­ings, and as for­eign cor­po­rate tax rates have plum­meted, US com­pa­nies’ stock of for­eign earn­ings held abroad has soared, now top­ping $2 tril­lion.

The US sys­tem thus im­plies sig­nif­i­cant costs, as com­pa­nies hold more cash abroad, bor­row more to fi­nance do­mes­tic cash re­quire­ments, and in­vest more in for­eign lo­ca­tions. De­ferred earn­ings are “locked out” of the US econ­omy: the govern­ment re­ceives no tax rev­enues from them, and they are not di­rectly avail­able for do­mes­tic use by US com­pa­nies. This un­der­mines their abil­ity to com­pete with for­eign com­pa­nies in ac­quir­ing other US com­pa­nies. It also makes in­vest­ments by US share­hold­ers in do­mes­tic com­pa­nies less at­trac­tive rel­a­tive to in­vest­ments in for­eign com­pa­nies that can dis­trib­ute their for­eign prof­its in the US with­out an additional tax penalty.

Over­all, de­fer­ral dis­torts cor­po­rate bal­ance sheets, im­pos­ing ef­fi­ciency costs on US com­pa­nies that are es­ti­mated to be 5-7% of de­ferred earn­ings. As the stock of de­ferred earn­ings grows, these costs ac­cu­mu­late, and mov­ing le­gal head­quar­ters abroad through cross-bor­der ac­qui­si­tions be­comes a log­i­cal step for US com­pa­nies with a large stock of de­ferred earn­ings abroad. Com­pa­nies like Medtron­ics can then use fu­ture for­eign earn­ings in the US with lit­tle or no repa­tri­a­tion tax. Such com­pa­nies have a strong in­cen­tive to re­domi­cile abroad even to fi­nance their US in­vest­ments.

To be sure, strate­gic rather than tax con­sid­er­a­tions drive cor­po­rate merg­ers and ac­qui­si­tions. The re­cent surge in cross­bor­der M&As to a seven-year high is the re­sult of am­ple cash, strong bal­ance sheets, cheap fi­nanc­ing, and buoy­ant stock mar­kets. But tax con­sid­er­a­tions play a ma­jor role in cor­po­rate de­ci­sions re­gard­ing how ac­qui­si­tions are fi­nanced and where a merged en­tity is lo­cated. Large bal­ances of for­eign earn­ings are avail­able to many US firms to fi­nance their for­eign ac­qui­si­tions, and the com­pet­i­tive dis­ad­van­tages of the US cor­po­rate tax sys­tem mil­i­tate against lo­cat­ing the merged en­ti­ties in the US.

Though Amer­i­can of­fi­cials rail against “in­ver­sions” as un­pa­tri­otic, they are an ef­fi­ciency-en­hanc­ing re­sponse to the flaws in the cor­po­rate tax sys­tem. As the prospects for cor­po­rate tax re­form de­te­ri­o­rate, cross-bor­der merg­ers with re­domi­cila­tion are be­com­ing an at­trac­tive op­tion for many of Amer­ica’s most com­pet­i­tive global com­pa­nies. And the pres­sure on other com­pa­nies to fol­low suit in­ten­si­fies as more in­ver­sion deals are done.

Un­der cur­rent law, US com­pa­nies can move their le­gal head­quar­ters abroad for tax pur­poses by buy­ing a smaller for­eign com­pany as long as the ac­quired com­pany’s share­hold­ers end up own­ing at least 20% of the com­bined com­pany. To dis­cour­age in­ver­sions via cross-bor­der M&A, Pres­i­dent Barack Obama’s ad­min­is­tra­tion and sev­eral Demo­cratic mem­bers of Congress have pro­posed leg­is­la­tion that would in­crease that per­cent­age to at least 50%.

More­over, a merged for­eign com­pany would be treated as a US com­pany for tax pur­poses (re­gard­less of share own­er­ship) if its man­age­ment and con­trol func­tions and a sub­stan­tial share of its eco­nomic ac­tiv­ity – sales, em­ploy­ment, or as­sets – are lo­cated in the US. If en­acted, the leg­is­la­tion would ap­ply these new con­di­tions retroac­tively to in­ver­sions oc­cur­ring from May 2014.

Such poli­cies will not ad­dress the un­der­ly­ing causes of in­ver­sions, will add to the widely ac­knowl­edged dis­tor­tions in the cor­po­rate tax regime, and are likely to have neg­a­tive un­in­tended con­se­quences. To meet the tougher new own­er­ship re­quire­ments, US com­pa­nies might re­spond by break­ing up their busi­ness units into smaller pieces – re­duc­ing their mar­ket value and the re­turns to their share­hold­ers and work­ers. Like­wise, to meet the tougher new man­age­ment and con­trol con­di­tions, US com­pa­nies might re­spond by shift­ing more of these func­tions, and the jobs and in­vest­ment (es­pe­cially in re­search and de­vel­op­ment) as­so­ci­ated with them, to for­eign lo­ca­tions.

The pro­posed anti-in­ver­sion mea­sures would also make it more likely that US com­pa­nies are the tar­get, rather than the ac­quirer, in cross-bor­der M&A deals. Cor­po­rate tax re­form should make the US a more at­trac­tive place for busi­ness ac­tiv­ity; threat­en­ing US cor­po­ra­tions with tougher rules on cross-bor­der M&A and retroac­tive tax in­creases will have the op­po­site ef­fect.

The US should learn from the Bri­tish ex­am­ple. In 2008, sev­eral large UK com­pa­nies threat­ened to re­domi­cile in Ire­land be­cause of its lower cor­po­rate tax rate. The Bri­tish govern­ment re­sponded by cut­ting its cor­po­rate tax rate from 28% to 20% by 2015; in­tro­duc­ing a ter­ri­to­rial tax sys­tem that ex­empts UKbased com­pa­nies’ for­eign earn­ings from do­mes­tic taxation; en­act­ing a “patent box” that pro­vides a 10% cor­po­rate rate on patent-re­lated in­come; and adopt­ing a new 10% non­in­cre­men­tal, re­fund­able R&D tax credit. So far, these in­no­va­tions ap­pear to be at­tract­ing com­pa­nies, in­vest­ment, R&D, and jobs to the UK.

Bold and prompt US ac­tion to re­form the cor­po­rate tax sys­tem is es­sen­tial. Sadly, that is not likely in a deeply di­vided Congress in an elec­tion year.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.