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What You Need to Know About the Pfizer/Allergan Deal and Tax Inversions

What do you get when you combine Viagra and Botox? Pfizer and Allergan hope that the answer is a lower tax rate.

In a huge merger, pharmaceutical companies Pfizer and Allergan are making the news this week. However, not everybody is happy with the outcome. When this much money is involved, it will always draw a few eyes. But this deal might just highlight huge problems in our corporate tax structure as a whole.

So what exactly do you need to know about this merger and what it means for the country?

The $160 Billion Dollar Merger

Pfizer Inc. and Allergan Plc will likely be combining, in a huge deal nearing $160 billion. The new company will be called Pfizer Plc. Currently, Allergan is estimated to have a market capitalization rate of $122 billion, with the larger Pfizer having a market capitalization rate of $200 billion.

The deal allows Allergan (the Botox manufacturer) to buy Pfizer (the Viagra and Lipitor manufacturer) even though Allergan is a much smaller company.  The current Pfizer Chief Executive Officer, Ian Read, will remain the chairman and CEO of the new company. Allergan president and CEO, Brent Saunders, will remain on as the president and Chief Operating Officer. The 11 member Pfizer board will combine with the four member Allergan board.

Before the deal is finished, the shareholders of both companies will have to vote, and the merger is expected to close mid- to late-2016.

This maneuver has also brought with it a lot of controversy. Why?

Once again, the answer has to do with taxes.

Record Breaking Deal

Let’s put aside the controversy for a second, and talk about some facts about this merger because this wasn’t just your average business deal. This one set a lot of records.

  1. Allergan’s acquisition of Pfizer is the biggest one this year.
  2. More to the point, it is the biggest pharmaceutical acquisition ever, beating out Pfizer’s own acquisition of Warner-Lambert back in 2000 for $116 billion.
  3. Pfizer Plc will now be the biggest pharmaceutical company by annual sales, where it is expected that they will make around $60 billion every year. (This is assuming they don’t have any divestitures.)
  4. Assuming it is allowed to receive the lower tax rate, it will be the biggest move in history to use a controversial process called inversion.

The Tax Controversy

So now back to the controversy. Notice above that I pointed out that Allergan is technically buying Pfizer, at least reportedly. Yet, Allergan is the smaller company by a lot. So why would they buy Pfizer instead of the opposite being true?

You guessed it: taxes.

You see, Allergan is headquartered in Ireland, where as Pfizer is headquartered in the United States. Under the new company, Allergan’s Irish parent company will still be in charge, even though the operational headquarters will be in New York. This means that for tax purposes, the company would be Irish. Which means they will be paying a lot less taxes than they would if they were still headquartered in the USA. In fact, they estimate that after their first year in business, they would have an effective tax rate of around 17 or 18 percent. Currently, Pfizer’s tax rate is reported at 25 percent.

Let’s make up some numbers to see just what this means.

  • Let’s pretend that Pfizer makes $1 billion taxable dollars a year (which is a ridiculously low number, but one that is easier to do math with.)
  • Under their current tax rate, they would expect to pay about $250 million.
  • Under the new, expected rate, they expect to pay around $170 or $180 million dollars.
  • That is a difference of around $70 million dollars.
  • And remember, their real revenue is about 60x what I said above. That means they are really saving (or the US Treasury is losing depending on how you want to look at it) around $4 billion.

So from that point of view, having Allergan be the purchaser is just good business sense. Not everyone believes it should be legal, however.

What Is Inversion?

All of this happened through something called corporate inversion.

A corporate inversion happens when a company reincorporates overseas in order to receive lower tax burden on money made abroad. There were several ways to take advantage of corporate inversion, but in 2004, Congress passed a low restricting how this can be done. However, having a foreign company purchase the American company, even if the foreign company is much smaller, is still a legal way to accomplish this.

Now, just to clarify, this only helps on foreign profits. As a US company, revenue created outside of the country is still taxed within the US, and it can often end up being more expensive overall – this is because the US has the highest tax rates for businesses in the world – at around 35 percent – and is one of the only countries to tax profits wherever they are earned. Thus, by being incorporated abroad, your rates on foreign revenue will decrease.

Technically, this process is legal as long as the companies are being open and honest on their tax forms. However, a big concern is that it is easy to hide or reorganize profits to avoid paying taxes on other income.

For example, look at something called hopscotching. Hopscotching occurs when companies keep money overseas, sending it – or hopscotching it – from country to country, in order to avoid paying US taxes on it.

How does it work? Well, instead of sending money to the US Corporation, income is first funneled through the foreign parent company. The money is then invested in the US, thus avoiding the need to pay taxes on it. It is estimated that roughly $2 trillion is being hopscotched.

What Politicians and Other Government Bodies Think of Corporate Inversion

Over the last several years, many politicians have stated their opinions on this controversial process. And while the White House did not comment specifically on this deal, when asked for a comment, it did reiterate its stance that Congress needs to take legislative action against these techniques.

  • Hillary Clinton. In the wake of the Pfizer/Allergan deal, Clinton came out and said that, if elected, she would propose measures that would make these deals illegal.
  • Barack Obama. The President himself has said that these deals are unpatriotic. He also claims that if you benefit from being an American corporation, you should not try to game the system. As far as policy goes, though, he has been unsuccessful in his efforts to curtail these deals. However, just four days before the merger was announced, he set out to step up his attack on these deals.
  • Bernie Sanders. Sanders has asked the President to put a stop to the deal because of his belief that it will allow yet another American company to hide its profits oversea. Taking it even farther, he has restated his belief that the entire tax structure needs to be evaluated.
  • U. Treasury. The Treasury has tried to limit the benefits of these deals, in order to avoid losing billions in tax revenue, but admits that without legislation from Congress, it is an uphill battle. However, while the Pfizer/Allergan deal will likely avoid these restrictions, the Treasury has made some efforts to change the law regarding corporate inversions. For example, AbbieVie Inc.’s proposed inversion, for around $52 billion, was derailed by these regulations.

Of course, looking at the names above, it is pretty easy to pinpoint which side of the divide this issue lies on. However, what exactly is the problem?

Those against corporate inversions are worried about the seeming ease that companies can go to avoid paying taxes in the US. By foregoing these taxes, the country can potentially lose billions of dollars.

On the Republican side of the debate, many Republicans do believe this process needs to be overhauled, but as part of the overall reform of the tax system, which they would want to have in order to lower that high 35 percent tax rate, as opposed to laws directly addressing corporate inversions.

Successful Inversions

Despite the raised eyebrows around corporate inversions, there have been plenty of success stories involving this process. In fact, around 50 US companies have inverted over the last ten years alone (which, as you might recall, has been since Congress passed tighter regulations on corporate inversion laws), with more considering it.

It should be noted, though, that while there have been many such deals, White House spokesman Josh Earnest told reporters that prior administrative actions designed to discourage tax inversions has slowed down the pace of these deals.

So which companies exactly have taken advantage of the inversion process? Here are some of the bigger deals that have taken place over the last decade:

  • In 2010, Global Indemnity reorganized into an Irish company, bringing with it its $319 billion revenue.
  • In 2012, power management company Eaton/Cooper took its $22 billion revenue to Ireland.
  • In 2013, the cable company Liberty Global Plc moved to the United Kingdom with its $17.3 billion.
  • In 2014, another pharmaceutical company, Medtronic, took its $16.5 billion to Ireland.
  • In 2011, TE Connectivity, an industrial manufacturer with a revenue of $13.3, reorganized to become a Swiss company.

The Final Takeaway

What happens to corporate inversions in the future is yet to be seen. However, what is clear is that right now, despite the controversy, it is legal. And that means that Pfizer Plc will probably be an Irish company soon.

What do you think? Is it time to make corporate inversions illegal, or at least more regulated? Or should businesses have the freedom to incorporate in the country that they chose?

Ashley Shaw

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Ashley Shaw is an experienced Legal Writer with years of experience. After receiving her JD, she worked for years in a corporate environment writing on business and employment law topics

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