Wall Street’s dealmakers called Barack Obama’s bluff on Tuesday with the acquisition by Burger King of a Canadian coffee chain, which could embolden other multinationals looking for similar tax savings to move their headquarters abroad.
Though faced with vocal opposition from the White House to the process known as tax inversions, the bankers and lawyers advising Burger King will have known that the president has a weak hand: without binding legislation from Congress to close the underlying tax loophole that allows such deals, the president had limited options beyond naming and shaming those who exploit it.
Until now, this threat of moral opprobrium in Washington and theoretical risk of future legislation that might require reversing the transaction have been enough to deter several previous attempts.
Drug store chain Walgreens abandoned similar plans to move its US headquarters to Europe when it bought the remainder of Alliance Boots. Pfizer had been examining a similar move as part of its initially-rebuffed approach to AstraZeneca.
But with many multinationals accumulating growing piles of cash in overseas subsidiaries that they are reluctant to repatriate to high tax jurisdictions like the US, there is growing pressure to structure mergers in ways that allow the whole corporate entity to move to a cheaper location.
That the Burger King and Tim Hortons deal was partially funded by Warren Buffett, a billionaire previously noted for criticising the low tax rates enjoyed by the very rich, only served to underscore a view on Wall Street that it is up to lawmakers to change the law if they don’t like its consequences.
Such arrangements have already proven popular elsewhere this year. Among proposed US cross-border mergers, nearly two-thirds are being done for the tax benefit, according to data from Thomson Reuters.
Tax inversions, newly popularized by the law firm Skadden Arps Meagher & Flom four years ago, have taken on a new popularity this year as many corporations struggle to appease shareholders looking askance at growing corporate cash piles. While corporate cash piles act as a bulwark during recessionary times, the recovering economy has made the multibillion-dollar cash hoards look like bad financial management.
Many US corporations have complained loudly about US tax rates, even though it’s rare that they pay the full burden of 35% to 39%. Out of the Fortune 500 of prominent US companies, 288 paid an effective US federal tax rate of just 19.4% between 2008 and 2012, according to advocacy group Citizens for Tax Justice.
The conflict really centres around the profits that US companies generate overseas. These foreign profits have flooded the coffers of US companies, making up the bulk of an estimated $1.5 trillion in excess cash. Some, like Apple, have burned down some of the money by returning it to shareholders in the form of dividends, or have bought back their own stock in an attempt to drive their share prices higher on the open market. Still, the trillions remain out of reach until the companies make peace with the taxes they will have to pay, and Apple CEO Tim Cook has testified to federal officials in favor of a tax holiday.
Until that is resolved, inversions continue. Earlier this year, US healthcare company Medtronic merged with Ireland’s Covidian in a tax inversion which drew little outrage. As more high-profile companies including Walgreen have flirted with the idea, however, the White House has demonstrated its displeasure.
Burger King and Tim Hortons, perhaps seeking to avoid the wrath of Washington, played down the tax benefits in several conference calls with media and investors. Executives said the merger has no tax benefit, and Burger King also said that its current tax rate in the mid-20% range is comparable to the Canadian tax rate.
Still, Burger King and Tim Hortons may protest too much. The US Treasury is already on alert from previous deals, and this pairing is a tasty morsel for federal officials who may wish to make an example of a prominent inversion deal.
The merger “is likely to add fuel to the fire around tax inversions,” wrote Keith Moore, the founder of Wall Street trading-research firm MKM Partners. “With the US Treasury examining ways to curb inversions without specific legislation, this transaction could add to pressure to seek ways to discourage the strategy.”
The tension that has already built around inversions is likely to push the issue to a head in Congress, even in the expected doldrums of an election year. The US Treasury, which controls the Internal Revenue Service, initially said it couldn’t stop the inversions on its own. More recently, Jack Lew said the Treasury was examining “possible administrative actions that could limit the ability of companies to engage in inversions.”