The Pfizer-Allergan merger is a tax dodge

24 November 2015 4:27 pm

The big news in business today is the announcement by the big American pharmaceutical company Pfizer that it’s buying the smaller Irish company Allergan. With a price tag of $160 billion, it will create the world’s biggest drug company. It's a merger for baby boomers: Pfizer makes Viagra and cholesterol treatment Lipitor and Allergan makes Botox.

Well actually, legally speaking Allergan is going to be buying Pfizer. And lawyers would say the new company's headquarters is going to be in Dublin even though its "operational" headquarters will be in New York.

It’s called an inversion deal: Pfizer will no longer be paying tax as a US company. Turning Pfizer into an Irish company reduces its tax bill and makes it easier for money to flow out of the corporate treasury and into the pockets of shareholders, instead of paying US tax.

Now everyone says inversion deals are wrong. US Treasury Secretary Jacob Lew says Congress has to pass laws outlawing them. And last week, the US Treasury Department released some administrative guidelines in this area.

The proposed merger has been slammed by Democrat front runner Hillary Clinton and her opponent Bernie Sanders Clinton says the deal leaves "U.S. taxpayers holding the bag" and plans to propose steps to prevent inversions. Sanders says the merger would be a "disaster" for U.S. consumers paying high prescription drug costs. He says the Obama administration should exercise its authority to stop the merger.

But the reality, there’s no law to stop it so President Obama can’t do anything to stop this corporate tax dodging.

A lot of this comes down to the US tax system. The United States, unlike other developed countries, tries to tax US-based corporations on all their profits regardless of where in the world the profits were earned. But here’s the hitch: companies get to deduct the corporate income tax they pay to foreign governments for their foreign profits. As a result, a US-based company can become a subsidiary of a company headquartered in a low-tax jurisdiction like Ireland. That way, it avoids paying US taxes on sales made in foreign countries.

There are two sectors that use this lurk more than others: pharmaceuticals and technology. Think of it: the value of a pharmaceutical company is tied up with its drug patents. By assigning ownership of the patent to a subsidiary located in a low-tax jurisdiction and then have subsidiaries in higher-tax jurisdictions license the patent from it. That way, they can ensure that profits accumulate in low-tax countries even if sales happen in high-tax countries.

Looking at it cynically, you can see why it’s happened. This announcement will boost Pfizer’s stock price.

And that will make the company’s directors and managers, who are compensated mainly in equity, very rich.

Bad luck about US taxpayers. Blame it on the US tax system that allows these rip-offs to happen.