Monday, November 23, 2015

Pfizer inversion into Allergan

If I am getting my back-of-the-envelope numbers right, Pfizer is paying the Allergan shareholders about $40 billion more than the market cap for Allegan's shares.

The NYT article from which I deduce this also says that the companies predict annual cost savings of $2 billion per year over the first 3 years. At least if one discounts for managerial incentives to high-ball this number, it clearly leaves a lot of value to be realized from the anticipated U.S. tax savings. (Plus, why should all the business and tax synergies inure to Allergan shareholders, rather than being split?)

The Times article says that Pfizer has $74 billion in offshore earnings. If this money was associated with zero foreign tax credits (from its being in tax havens), and if we apply the Altshuler-Grubert estimate that profitable U.S. companies lose about 7% a year from game-playing to avoid repatriating foreign earnings, one can certainly start to see some of the extra value being made back, at least if they anticipate being able to get around the Treasury's recently-issued anti-"hopscotch" regulations.

Most of the rest of the extra value, if Pfizer is not over-paying, would presumably come from anticipated greater ease in the use of intra-group debt to strip taxable income out of the U.S. on the company's U.S. operations.

The Treasury has just announced a new set of anti-inversion rules, issued of course with Pfizer in their front-view mirror. Obviously they weren't able to stop this deal, assuming it goes through. But whatever the Treasury does (or not) on the anti-inversion front, with or without legislation that would enable them to go further, it is clear that U,S. rules must respond substantively to the incentives that trigger these deals, not just by trying to slam shut the barn door before all the horses get out.

This does not necessarily mean lowering the U.S. marginal tax rate for corporate income. (Whether or not to do that should depend mainly on separate considerations.) After all, even inverted companies are still taxable in the U.S. on their U.S. operations. And a 1986-style rate cut plus base-broadening that left average tax rates on U.S. corporate operations about the same as previously would matter only insofar as tax planning focused on marginal rather than average tax rates.

It also doesn't necessarily mean that the U.S. should adopt territorial rules. (Again, this is really an independent question.) Among other points - and I won't repeat here my general analysis of why the "worldwide versus territorial" framework is unhelpful - the reasons for inverting are more particular than not wanting one's foreign operations subject to home country tax.

More specifically, I would focus on two steps to reduce the incentive to invert, both presumably requiring legislation. The first is imposing deemed repatriation treatment on U.S. companies with high unrepatriated foreign earnings. This could specifically be a tax consequence of inverting, and/or could simply be imposed without regard to such transactions.

Second, I would strengthen residence-neutral anti-earnings stripping rules that address the use of intra-group financial flows to strip profits out of the U.S. By residence-neutral, I mean other than through our controlled foreign corporations or CFC rules (aka subpart F), which U.S. operating companies can avoid by transacting with affiliated parties that are not their subsidiaries. At a minimum, the earnings-stripping rule of Internal Revenue Code section 163(j) could be made more rigorous. But I would also want to look at rules that look at debt and other internal financing for an entire global group, whether it has a U.S. parent or not. Both Germany and the U.K., I gather, have rules of this kind that would likely be worth examining in this regard.


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