Time for a new home?
15 July 2014
The high number of companies, mostly U.S., eyeing acquisitions or ventures that will allow them to redomicile their business in the UK and Ireland is a major theme of Allen & Overy’s M&A Index (H1 2014). Mostly, it is about tax. But there is quite a bit more to it than that.
Flick through the pages of the report and a recurrent theme will immediately leap out at you – the growing number of U.S. companies trying to buy UK or Irish competitors so that they can achieve a so-called inversion, cutting their corporate tax bills significantly.
The last 18 months has seen a growing stream of businesses, across a variety of sectors, trying to redomicile their operations to take advantage of lower tax rates.
Liberty Global’s USD23bn merger with Virgin Media last year had a clear commercial logic, but tax planning was also reportedly at the heart of it. The deal allowed it to set up a new corporate structure, with a ‘topco’ based in the UK (although its headquarters remain in the U.S.), and enabled it to take advantage of a raft of recent, targeted, UK tax reforms.
Life sciences companies have been at the forefront of the trend. Inversion is a manoeuvre that suits companies with large stockpiles of foreign earnings, as many global pharma businesses have.
So it is not surprising that, in the last few months, this sort of tax planning was a fundamental part of a large number of life sciences deals, including Pfizer’s attempted USD69bn takeover of AstraZeneca, AbbVie’s unsuccessful approach to Shire, and Medtronic’s current USD43bn bid for Ireland’s Covidien.
But relocations of this sort appeal to non-U.S. companies, too. Fiat – the Italian carmaker that now controls Chrysler – has courted controversy at home and in the U.S. by announcing that it will headquarter its operations in the UK, for example.
Four or five years ago, it was unthinkable that the UK would become the destination of choice for corporations looking for tax efficiencies.
At that time, we were witnessing the process in reverse. Think, for instance, of advertising giant WPP moving its tax domicile to Ireland in 2008, if only temporarily – it was back in the UK by 2013 once those tax reforms had been introduced.
Making sense of the trend – the U.S. angle
On the surface, it is easy to see why this trend has developed. The U.S. corporate tax rate, at 35%, is one of the highest in the industrialised world. By contrast, the UK rate – now set at 21% and soon to fall to 20% – is the lowest in the G20; Ireland’s rate is much lower still.
By accident rather than design, the U.S. system is facilitating the trend in two ways.
It encourages businesses to raise money at home for foreign acquisitions, with interest costs fully deductible against domestic profits. At the same time, it encourages companies to keep overseas earnings offshore – they are only taxed when repatriated (and then, as we have noted, at punitive rates). This is further compounded by accounting provisions, which mean profits built up abroad can boost the earnings per share of the U.S. parent company without taking account of the tax costs involved if the profits were actually paid back to shareholders.
It is reported that trillions of dollars are held offshore by U.S. companies – because they are caught in a kind of tax-deferral treadmill.
But there comes a time when storing cash up in this way no longer makes sense. It needs to be put to use, or shareholders will certainly start to demand it is brought back onshore and used to fund better dividends or share buybacks.
Given that background, it may seem surprising that more U.S. companies have not simply relocated abroad, as UK companies have done in the past. The reason is that U.S. tax rules make that quite difficult to do – U.S. law does not have a concept of ‘residence’ that can be moved to a different jurisdiction, and companies organised under U.S. law will always be regarded as U.S. taxpayers.
But mergers offer a way out. Done in the right way, a merger can remove the U.S. company as the parent of the combined group, without adverse tax consequences – although to avoid other penalties, the new holding company may need to be based in a jurisdiction where the combined group books a substantial amount of business.
This gives the group an opportunity to repatriate overseas profits to shareholders without incurring significant tax cost.
A wide range of substantial merger partners and a relatively benign tax environment for holding companies, are, therefore, key attractions of the UK to U.S. companies looking to achieve an inversion.
The UK – why else?
Raw tax advantage is very rarely a justification in itself for an M&A transaction, especially one of the scale and complexity of recently attempted megadeals. Inversion is only part of the strategy. And inversions are not the only situation where the UK is an attractive option for a holding company location. For example, it is used as a (sometimes neutral) jurisdiction for joint venture companies or even for regional holding companies within a group structure.
The UK has one of the largest double tax treaty networks, covering more than 100 countries. There is no dividend withholding tax on outbound dividends, wherever shareholders are located, and inbound dividends will usually qualify for exemption from corporation tax. A new territorial controlled foreign companies (CFC) regime is also a spur, making it easier, among other things, to do intra-group financing. Furthermore, a new system of tax reliefs on profits from exploiting intellectual property, the so-called Patent Box, also applies. The list goes on.
But other cultural and legal issues also hold sway. It matters that the UK is part of the EU and a founder member of the OECD; that it is English-speaking; that London is a leading financial centre sitting in a central time zone between the U.S. and Asia, with good global transport links.
It is important, too, that the UK has an established, common law legal system with an efficient Companies Court; that there are no restrictions on where shareholder meetings are held; and that executive remuneration requirements are flexible (a tightening of Swiss rules here has led to several global companies relocating their parent company recently – once again, to the UK and Ireland).
Lifestyle issues might also play a role. The UK in general and London in particular are attractive to company executives who need to relocate or travel here.
A loophole closed?
The U.S. inversion rules are already something of a minefield, and there is widespread speculation that the U.S. may soon seek to tighten the rules on inversion still further.
Certainly, some businesses expect the inversion window to be relatively narrow, which might explain the growing rush of recent transactions even in the face of continuing public disquiet about corporate tax avoidance.
It may be a short-lived phenomenon. But while it lasts, it is proof once again of another important fact.
Governments, looking to create tax environments that will attract investment, can be as competitive as business. Despite public disquiet, they are likely to remain so.