The recent mainstream media coverage of the potential relocation of American drugstore retail giant Walgreens to Europe, in order to pay corporate taxes at a lower rate and increase earnings, is just the latest in a frenetic wave of business activity involving U.S. based conglomerates and their respective foreign counterparts.
Treasury Secretary Jack Lew recently sent letters to members of both houses of Congress to motivate the legislature to pass an injunction or ban on future business transactions that attempt to relocate U.S. corporations overseas in order to reduce their corporate tax rate. This practice is known as tax inversion.
Secretary Lew called upon Congress to take action on tax inversion, invoking the concept of what he termed "economic patriotism," to prevent these corporations from skirting the payment of U.S. corporate taxes. In fact, the erosion of the American corporate tax base is an issue of political concern from some members of Congress, members of the Cabinet, and the White House.
The impetus for the increase in mergers and acquisition activity between U.S. companies and foreign entities in the same industry is due to a proposed change in the rules for these types of transactions.
Currently, a sale involving a U.S. company for the purposes of relocation for tax inversion requires the foreign company or foreign investors involved to own at least 20 percent of the U.S. company in order for the sale and subsequent relocation to be legal.
The Treasury Department, however, recently proposed new rules for these types of industry transactions which would require the foreign entity to own 50 percent of the U.S. company. This proposed rule change has fostered a scenario where the investment banking institutions and hedge fund capital management firms are advising their corporate clients to move quickly on the merger and acquisition process, the rationale being to complete tax inversion deals before rule changes would require their U.S. corporate clients to yield a higher percentage of equity to a foreign entity.
Walgreens to Switzerland?
Walgreens has been headquartered in Illinois for over 100 years and operates over 8,000 store locations in the United States with a presence in every state. The retail drug behemoth raked in $72 billion in sales last year, with Medicare providing a sizeable portion of those sales dollars.
Walgreens is ubiquitously American, yet their advisors at Goldman Sachs, Jana Partners, and other hedge fund management firms have advised the company to move their corporate headquarters from Illinois to Switzerland. In fact, Walgreens CEO Greg Wasson recently met in Paris with hedge fund managers regarding this potential European relocation.
The impetus for this potential relocation stems from Walgreens ownership of Alliance Boots, the top pharmacy retailer in the United Kingdom. Walgreens currently owns 45 percent of Alliance Boots, and if all the regulatory hurdles are cleared with no delays, Walgreens is scheduled to obtain the rest of the British conglomerate in 2015 for a total outlay of $16.2 billion.
Alliance Boots moved their corporate headquarters to Switzerland in 2008 which has saved the company $167 million in taxes each year. That decision has led to protests outside of stores in the U.K. over their tax avoidance, which has hurt their brand image.
Walgreens has been publicly non-committal about their strategic direction regarding a potential tax inversion and corporate office relocation. The political fallout from such a decision is certainly a major concern for Walgreens at this point. Walgreens has daily interactions with American consumers which would be more functional and efficient with a U.S. based headquarters.
The corporate tax rate in Switzerland is estimated to be around 20 percent, and Walgreens currently pays a 35 percent corporate tax rate while their chief competitor, CVS, pays a 39 percent corporate tax rate. Reports indicate Walgreens is concerned about losing customers if they relocate their headquarters because their main competition -- CVS, Target, and Wal-Mart -- will all be based in the United States. It is a situation where Walgreens could increase their earnings per share by 75 percent if they moved to Europe, but the public relations damage may outweigh that increased profitability over the long term.
Big Pharma: Mass Mergers
The recent increase in pharmaceutical industry mergers is being entirely driven by tax inversion activities. Actavis purchased Warner Chilcott in order to complete a tax inversion and relocated their corporate base to Ireland, which consequently lowered their corporate tax rate from 37 percent in the U.S. to 17 percent in Ireland.
The American pharmaceutical companies already are subject to pay U.S. taxes on their foreign earnings, in addition to U.S. corporate taxes, which are the highest in the world. The recent purchase of Shire by Abbvie Pharmaceuticals is another mega-merger with the purpose of completing a tax inversion. The Medtronic acquisition of Covidien is another prime example of this trend to avoid paying corporate taxes.
In fair balance, the rules requiring 20 percent foreign ownership to complete this inversion transaction translates to fewer options for the very large companies. Pfizer has a market cap of $200 billion which means the foreign entity on the other side of the merger would require a market cap of $50 billion at minimum to get the deal approved. That is the rationale for Pfizer's failed pursuit of AstraZeneca because it is one of three companies they can merge with and complete a tax inversion scenario.
In my view, the fallout from tax inversion transactions will translate into more foreign ownership of American corporations, but more important will be the loss of corporate tax revenues. Some well-respected media outlets have estimated the U.S. economy will lose $20 billion in tax revenue from the tax inversion activity which was just recently approved. That revenue goes toward infrastructure improvements such as repairing bridges and highways.
Congress could block future inversion transactions but the political reality is they are gridlocked with mid-term elections upcoming. That means little to no substantive movement legislatively will take place on this matter until 2015.
The increase in merger and acquisition activity by these large corporations is with the intent to force Congress to change the corporate tax level. The current package being proposed would lower the corporate tax rate to 20 percent. Some members of Congress, however, are not convinced lowering the corporate tax rate is the solution.
In the current situation, the U.S.-based company can still benefit from all the other copyright protections and legal protections afforded them under our laws, yet they do not have to pay corporate taxes at the same level, which could be damaging to the overall economic health of the country over the long term. Profits for these companies are counted in billions of dollars, which is a factor most regular Americans cannot comprehend, and they have little empathy for the large corporations in this scenario.
Secretary Lew is calling on Congress to block future tax inversion transactions in the interest of "economic patriotism." Are the actions of these corporations and their investment banking advisors unpatriotic? In a democratic society that is a question we can debate in the weeks and months ahead.
Frank J. Maduri is a freelance writer and journalist with numerous publishing credits across a variety of websites and news organizations. He has a background in the pharmaceutical, healthcare, and political science fields. Frank has been involved in several large scale business transactions with commodities sourced throughout the world.