Friday, 4 December 2015

Inversions as a Tax Strategy - Implications of Ireland

Jim Stewart: The recent announcement by Pfizer that it is taking over Allergan and establishing their joint ‘headquarters’  in Ireland is another illustration of complex corporate tax strategies.  Moving headquarters to a low tax regime in order to minimize tax has become a well known phenomenon. Corporate inversions have a long history as a tax strategy.

A large international British manufacturer and processor of meat products, the Vestey Group moved “its headquarters to Argentina in 1915, to avoid being taxed at British wartime rates on its worldwide business” (Picciotto, 1992, p. 15).  More recently several UK firms have redomiciled to Ireland (See for example Julia Kollewe).

Most US firms have shifted their domicile within the US to the state of Delaware, and inversions over the last 30 years or so can be seen as an extension of this policy.  There are several examples of US insurance/reinsurance firms shifting their domicile to Bermuda, and then to Ireland, for example, Everest Reinsurance, and Willis. XL group moved their domicile from the  US to the Cayman Islands and then to Ireland.  Accenture is another example of a US to Bermuda and then to Ireland  transfer. Tyco international moved its domicile from the US to Bermuda, to  Switzerland and most recently to Ireland.

It is likely that tax and corporate law changes to facilitate the relocation of insurance groups to Ireland have facilitated the move of other firms and the more recent wave of  inversions in the pharmaceutical sector.

Will There be an Increase in Corporate Tax Payments ?
There has been some comment on the tax effects of the Pfizer inversion, arguing that this will result in increased corporate tax payments within Ireland (see Dominic Coyle, here).  But the main comment has been a comparison of the current US tax rate of Pfizer of 25.6% with that of the Allergan effective tax rate (Tax divided by Profit where both numbers are shown in the income statement) of 4.8%.

In making this comparison the components of Tax or Profit are never discussed.  The numerator is taken from the consolidated statement of operations for Allergan for 2014 and shows a tax benefit of $89 million, (shown as a negative payment).   The same statement shows a pre-tax loss of $1712 million (resulting from the write off of over $4.2 billion in charges that result in no cash outflows, for example depreciation allowances).

Thus as both the numerator and denominator are negative (-89/-1712) the tax rate is shown as positive at 4.8%. This is not a tax rate in any meaningful sense.  In fact Allergan paid $560 million in cash tax payments during this period.  It is not possible to estimate how much of these taxes were paid in Ireland or in the US or other countries.

The overall published tax rate (based on tax charge/pretax profits) of the Pfizer and Allergan merged firm is likely to fall because of a lower nominal tax rate, but cash tax payments may not fall.  The proportion of taxes paid in cash could change to the benefit of Ireland.  It is also likely that tax authorities in the US  and other countries will scrutinize intra-firm payments to a greater extent, with the effect of increasing tax payments in the U.S. and other countries (Bergin and Drawbaugh).

This increase in foreign tax payments may be offset against Irish corporate tax due, resulting in a reduction in current Irish tax payments.  Although tax payments by Pfizer in Ireland are likely to be large so that  Pfizer is one of the top 10 companies that account for more than 33% of corporate tax receipts (see written Parliamentary answer 40399/15).

Other Effects

Whether by accident  or design, Ireland has become  the country which is the largest recipient of inversions by value. This has considerable implications:-

  1. The stock of foreign direct investment (FDI) has increased dramatically from €391 billion in 2013 to €523 billion in 2014 largely as a result of inversions (see CSO Foreign Direct Investment 2014);
  2. GNP figures will be increased to the extent that retained profits are booked through Ireland;
  3. Some jobs will be created because of additional functions, but the US will remain the most important location for administrative functions, manufacturing, R and D facilities and sales;
  4. It is likely that the merged group will involve considerable reorganization and may split into two subsidiaries (see David Crow)  with consequent job losses on a world wide basis.  Some of these job losses are likely to occur in Ireland, if only because of rationalization of functions performed.

The Pfizer inversion is a high risk strategy with uncertain benefits, as indicated by the rather muted share price reaction of both firms. The main beneficiaries are likely to be the many financial and legal advisors involved, in the US and also in Ireland such as Arthur Cox  and A. and L. Goodbody.

Prof James Stewart is a member of TASC's Economists Network. 

This is Part 2 of a Series on Tax Inversions and Diversions. Read the first part here:

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