The global headquarters of Endo International is so new that, apart from a few desktop computers, the most visible purchase to date is the Nespresso machine in the kitchen. Located in the basement of a Georgian house in central Dublin, the company, which makes branded and generic medicines, does not even have a brass plate on the door.
“We are just getting started,” says Blaine Davis, senior vice-president for corporate affairs, who will run the office with a skeleton staff on behalf of a group with annual sales of $2.6bn.
Endo’s arrival in Fitzwilliam Square is part of one of the biggest trends in global mergers and acquisitions – a practice known as inversion. By moving their headquarters to another country, US companies are able to slash their tax rate.
This week’s announcement by Pfizer that it wanted to take over AstraZeneca in a £60bn deal that would move its tax domicile to the UK is the latest and largest example of a pattern which is sweeping the pharmaceutical sector and beyond.
Dozens of US multinationals have moved their tax base outside the country to escape the high tax rate, global reach and perverse incentives of a system that has encouraged companies to build up a $1tn cash pile trapped overseas.
Yet inversions are increasingly contentious, focusing attention on corporate ploys when governments around the world are intent on cracking down on tax avoidance.
For the US, the trend threatens billion of dollars of tax revenues and raises “significant policy concerns”, in the words of the US Treasury. In March, President Barack Obama announced plans to slam the door on inversions by the end of this year, a move the US Treasury said would raise $17bn over the coming decade.
Inversions also shine a spotlight on the policies of the countries being chosen as the new tax base for businesses wanting to cut their tax bills. The UK led calls for an international crackdown on avoidance. But a series of business-friendly reforms in the UK have made it a desirable tax base for companies that are headquartered elsewhere. This is politically sensitive, as suggested by the delay in winning tax approvals reported by Omnicom and Publicis last week, threatening the $35bn merger to create the world’s largest advertising company.
The popularity of inversions is starting to worry the Irish authorities. They fret that the country’s 12.5 per cent corporate tax rate – a pillar of Irish development policy – is being used for purposes for which it was not intended. That undermines Ireland’s insistence that it is not a tax haven, making it more difficult to defend its system in an international climate that is turning sharply against tax avoidance.
Ireland began to adopt an active tax policy to lure foreign direct investment in the 1950s. In 1980 it introduced a 10 per cent tax on manufacturing, later changed to an across-the-board 12.5 per cent. This incentive, together with the flexibility of the tax regime, helped attract many pharmaceutical companies. Nine of the top 10 global pharmaceutical companies now have operations in Ireland as well as leading technology companies including Google, Facebook and Twitter.
Apart from tax, Ireland appeals as a hub for pharma and tech companies because many of their peers are already present. Its legal infrastructure is similar to the UK and the US, and it turned out graduates in record numbers in the 1980s and 1990s.
Endo is one of the latest companies to be drawn to Ireland. Six months ago the Pennsylvania-based group, which employs 4,100 people, had no connection with Ireland. Now its global headquarters has arrived in Dublin following its purchase last November of Paladin Labs, a Canadian drugmaker with equally tentative links to Ireland.
Besides Endo, recent similar inversion examples include Perrigo, Horizon Pharma, Actavis, Alkermes, Jazz Pharmaceuticals, Covidien and Forest Laboratories.
For shareholders, the process is attractive. Cian McCourt, a partner and head of the New York office of A & L Goodbody, an Irish law firm, says inversions provide “a real boost” to earnings per share, retained earnings and cash flow. That has a big bearing on acquisition premiums. “It is bridging valuation gaps for sellers and sometimes exceeding sellers’ expectations,” he says.
Endo, for example, is eyeing $75m of annual after-tax savings from “operational and tax synergies” arising from its rebirth as an Irish company.
One driver of the deals is the trapped overseas cash of US multinationals, which makes foreign acquisitions attractive even if they do not subsequently relocate their businesses abroad. General Electric’s cash hoard of $57bn is one reason behind its bid to acquire Alstom of France.
But inversions offer additional advantages by making it easier for companies to escape US tax on their offshore intellectual property, cutting US tax bills by loading their domestic businesses with debt, and making low foreign tax rates permanent. They halt the build-up of offshore cash. The cash pile is larger for healthcare companies than any sector except technology, accounting for 15 per cent of the $947bn total, according to a recent report by Moody’s.
Ireland’s finance ministry argues that many of the factors driving the trend of inversions are “push rather than pull” – that the high rate of US tax rather than the low rate of Irish tax is behind the trend of US companies inverting into Ireland.
Many US observers agree. Max Baucus, who chaired the Senate tax committee and is now ambassador to China, said last year: “It would be easy for us to attack these companies by calling them immoral and unpatriotic. But it’s more constructive to step back and ask, ‘what’s motivating these companies to move their headquarters abroad?’”
Both Mr Obama and congressional Republicans have proposed cutting the US corporate tax rate from 35 per cent to 28 per cent and 25 per cent respectively, and changing the tax treatment of foreign income to cut gaming by multinationals.
But the bill has stalled because the White House and Congress disagree over the details. There is little political appetite for slashing business tax breaks and deductions that would help pay for a lower tax rate. Moreover, any reform would likely have to include changing the rates paid by individuals and small businesses as well, adding to the political challenge. The chances of tax reform advancing this year are slim to none, and it may be very difficult to reach a deal during Mr Obama’s administration.
Still, Mr Obama and other lawmakers have tried to lay down some markers, including high-profile hearings in the Senate lambasting companies such as Apple and Caterpillar for tax avoidance strategies. Mr Obama sought to make it much more difficult to execute deals involving inversions by raising the threshold of shares needed to be transferred to foreign owners from 20 per cent to 50 per cent when a company moves abroad.
That measure is unlikely to pass soon, but even so William McBride, chief economist of the Tax Foundation, a think-tank in Washington, described it as a “Berlin Wall technique” which would do nothing to solve the fundamental problem of an uncompetitive tax system.
He predicted that big companies could end up spinning off divisions to get around anti-inversion rules which stop the largest companies from moving. “It is very likely we will see an acceleration of inversions.”
Ireland’s finance ministry is becoming worried about the growing criticism. “In relation to transactions that may not involve real substance in terms of jobs and investment in the Irish economy, the [ministry] has concerns and is examining ways to discourage such transactions without damaging legitimate business activity,” says a ministry spokesman.
Barry O’Leary, chief executive of IDA Ireland, the inward investment agency, says: “Transactions that rely solely on tax benefits, with no substance behind them, will not bring economic benefits to Ireland.”
Deciding which transactions have “substance” could prove tricky, however. Mr Davis says Endo could have re-domiciled to any country because of the way it structured its purchase of Paladin. “We chose Ireland because a lot of pharma companies are based here, there is a big talent pool, and the skill set is very strong.”
The demand for “substance” also raises tricky questions about how much of the Irish pharma industry’s profits are actually earned by its Irish operations. The industry has an undeniably big presence in Ireland. It pays more than €3bn of taxes in the country each year and has invested over €7bn in the past decade, according to the Irish Pharmaceutical Healthcare Association. But its profitability is out of proportion to its scale, a sign of tax planning that has allowed companies to route profits to tax havens such as Bermuda.
The sector employs less than 2 per cent of Ireland’s workforce, yet data published by the US commerce department suggest that Ireland generated profits in 2011 of $21.8bn for US chemical and pharma companies. That is a third of all foreign profits for US companies in the sector, and about 40 per cent of all Irish corporate profits.
US pharma companies paid a tax rate of less than 6 per cent on over $100bn of Irish profits over the past decade, according to an FT analysis. It showed that the Irish subsidiaries of US chemical companies have cut their tax rates far below the statutory rate, from an average of 8 per cent in the seven years to 2004 to 4.5 per cent in the following seven years.
The Irish government disputes the relevance of the data. But it faces criticism for facilitating the tax planning that results in very low tax rates for Irish subsidiaries.
One tactic is the so-called “double Irish” structure that exploits different definitions of residence in the US and Irish tax codes to move profits from Ireland to Bermuda. This structure allows royalties paid by the Irish manufacturing subsidiary to end up in a company that is not taxable under either Irish or US rules.
Tax arrangements of this sort are powerful attractions for US suitors. But they could be under threat. The Paris-based Organisation for Economic Co-operation and Development is considering an overhaul of international tax rules to boost the taxing powers of countries where consumers are based. That would reduce Ireland’s lucrative role as the cornerstone of multinationals’ tax structures.
In the US, despite the political deadlock over tax reform, bipartisan support is growing for moves to tax offshore intellectual property, which could erode Ireland’s appeal to US multinationals.
Endo’s Mr Davis remains untroubled. “We’re looking to build leadership positions here,” he says over a coffee, stressing that the company will be relocating key personnel in research and development, finance, supply chain management, and support services. Looking around his cramped new global headquarters in Dublin, he adds: “Fitzwilliam Square is just our temporary space … But we are [in Ireland] to stay. This is now our global headquarters.”
Corporate tax rates: Flower pots and double Irishes
Call it the ceramic flower pot dilemma. The headline rate of Irish corporation tax is 12.5 per cent, and calculations by PwC and the World Bank show the effective rate of tax levied on foreign company profits in Ireland is about 11.9 per cent.
Yet a recent study by Jim Stewart, associate professor of finance at Trinity College Dublin, shows some US multinational subsidiaries operating in Ireland paid an effective rate of tax of just 2.2 per cent on their Irish activities in 2011.
Prof Stewart argued that, in order for PwC and the World Bank to compare tax rates across the world, they created a hypothetical company that does not engage in tax planning, and was “small, domestically owned, has no imports or exports and produces and sells ceramic flower pots”. Such a company bears no resemblance to the US multinationals that operate in Ireland, ranging from big pharma (Pfizer, Alexion) to big tech (Intel, Google, Apple, Facebook). One of the big attractions is Ireland’s headline 12.5 per cent corporation tax rate. As recent examples show, that provides a basis for further cutting their global tax bills.
Many US technology companies have taken advantage of a contentious loophole in Irish corporate law, known as the “double Irish”, which allowed them to be registered in Ireland without being tax-resident there. For example, Google holds its intellectual property in an Irish company that is tax-resident in Bermuda, which has a zero rate of corporate tax.
However, Ireland is starting to yield to pressure to close especially egregious corporate tax loopholes. In the last budget, the government moved to ensure that companies incorporated in Ireland that were in effect “stateless” for tax purposes had to declare a tax residency in another jurisdiction or become liable for the Irish 12.5 per cent rate.
In the global debate about corporate tax avoidance, Ireland is anxious to retain its competitive fiscal regime while not being branded as a tax haven. As Prof Stewart says: “Ireland is not a tax haven for individuals. But it does have the features of a corporate tax haven – a low nominal tax rate, light-touch regulation and a very responsive state that is highly sensitive to international tax law.”