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The State vs. the Corporate: Winners and losers of failed Pfizer-Allergan merger

April 11, 2016
Editor(s): Yana Gourevitch
Writer(s): Erin Shen, Lang Qin, Adam Akmal Dzulkipi, Edwin Chaw

In November 2015 Pfizer announced a $220 billion merger with Allergan to create the worlds largest pharmaceutical company. The success of this merger would have highly undermined the taxing capabilities of the US government, with Pfizer being subject to the far lower tax rates of its new state of domicile, Ireland.

On Monday 4th of April 2016, the US Treasury fired back, announcing a significant tightening of the legislation that had allowed for the offshoring of profit to occur. These changes significantly impacted the feasibility of the merger, and on the 6th of April, Pfizer announced the termination of the deal.

 

Who is Pfizer?

Pfizer is a company that is widely regarded as being at the forefront of the pharmaceutical industry. Founded in 1849, Pfizer developed into the multibillion dollar pharma juggernaut that it is today through countless acquisitions, the largest deals being with Warner-Lambert in 2000, Pharmacia in 2003 and Wyeth in 2009. Some of the notable drugs that Pfizer has been credited with for introducing into the market include Zoloft (depression), Glucotrol (diabetes) and Viagra (erectile dysfunction).

 

‘The deal that could have been’

The merger deal, which was expected to be completed in the first quarter of 2016, was valued at $US160 billion and was to become one of the biggest corporate mergers in history.

The merger was packaged and marketed by the company as an opportunity for “two great companies to come together to create a new global biopharmaceutical leader.” (Read, 2015)

Many press releases issued by the company, similar to the one shown above, aimed to highlight the strong presence of Pfizer in the US and its commitment to continue growing within the continent. However, there was a reason that Barack Obama, Hillary Clinton, Bernie Sanders, and Donald Trump – the most unlikely quartet to ever agree on something – all came out in opposition of the merger.

 

Tax.

More specifically, the term ‘tax inversion’ has been branded as the motive behind Pfizer’s actions. Tax inversion is a scheme that many companies employ to take advantage of discrepancies in corporate tax rates between countries. It works when one company acquires a competitor whose operations are based in a country with a less demanding tax system. In doing so, the company is able to shift its headquarters to that country, thereby avoiding the higher tax rates in its country of origin, as it is now legally bound to the country with the lighter tax burden. The majority of the company’s business operations, including manufacturing, marketing and sales, do not need to change for tax inversion to work, which is one reason why such schemes are so lucrative.

However, Pfizer has been fighting back against allegations that the merger will cause capital to funnel out of the USA, with Pfizer CEO, Read claiming:

“The combination will allow us to invest a combined $9 billion in research and development, the bulk of it here in the U.S., making us one of the largest single R&D investors in America and expanding our ability to invest in the U.S.”

Pfizer has also taken a defensive stance against tax inversion allegations:

“There is a myth that we are skirting U.S. taxes. Not true. All companies must pay taxes on U.S. income regardless of where they are incorporated. The proposed combination will not affect the tax rate Pfizer pays on U.S.-based income, reflecting our two companies’ earnings and 30 R&D and manufacturing locations in the U.S. It also allows us to maintain a strong base of 40,000 high-skill, high-wage jobs in the U.S.”

Despite such company statements, media reports have claimed that a successful merger was projected to save Pfizer approximately US$1.2 billion in tax in 2017 alone, due to the reduced corporate tax rate of 17% in Ireland as opposed to the 25% rate in the US. The merger was also expected to achieve $US2.8 billion in operational savings. Such cost cuts would have come at a time of need for Pfizer, as the company has reported a 15.2% dip in earnings over the past year.

 

Regardless of Pfizer’s true motives for the merger, a successful deal would have spelt bad news for the US government, which is projected to expand its deficit by almost 40%, from US$438 billion in FY 2015 to US$616 billion in FY 2016. It is evident that the merger was set to divide clear winners and losers, with the US government and Pfizer pitted against one another.

 

Tax Inversion Trend

Interestingly, the Pfizer-Allergan case is not the first example of a company fleeing their state of domicile in order to find more attractive tax rates for their bottom line. There have been findings of notable companies such as Google, Apple and Microsoft ‘offshoring’ their profits. The image below demonstrates the states that many US corporates have shifted their headquarters to.

The graph above demonstrates where US corporates have shifted their state of domicile in the past 33 years.

(Bloomberg)

 

Tax evasion tensions have been brewing for decades between states and international corporations. For example, Apple only paid $85 million in Australian income tax while it was making almost $8 billion in local revenue last year. The company is currently under audit by the ATO, with Treasurer Scott Morrison stating that the government is committed to “shutting down tax avoidance used by multinationals.” Apple has managed to pay such a low tax rate by routing their profits through Ireland. That is, Apple Australia buys products such as iPads and iPhones from overseas operations, and resells them. It then gets taxed on local profit earned. A report from the AFR has indicated that Apple had an effective rate of 1.9% on US$36 billion in international earnings in 2012.

Google, now part of Alphabet, has acted in a similar manner in regards to tax payments. Following the release of tax transparency information in 2015, it was revealed that Google paid A$9.2 million in taxes, which accounts for 2.6% of its $357 million income in 2013-2014. However, Google has recently agreed to pay US$264 million in back taxes to Britain. The agreement comes after a multi-year investigation in Britain, which examined Google’s tax operations and concluded that the company illegally avoided paying required taxes in 2014.

 

Despite the fact that governments are trying to fight the trend of offshoring profits, it seems that corporates continue to find loopholes in new legislation.

(Bloomberg)

For example, the diagram above shows that despite the suspension of inversions in the US following new legislation, exceptions in the law were soon found and the rate of companies offshoring their operations has picked up. Despite this, the US government continues to fight back with new legislation.

 

The bitter end of the Pfizer-Allergan deal

On the 6th of April 2016, Pfizer announced the termination of the merger with Allergan after a “mutual decision” between the two companies. This decision comes after the US Treasury Department announced new rules on the 4th of April 2016 to discourage mergers between US and foreign businesses. The new rules tightened the restrictions around ‘inversion deals’ in a way that would have made it difficult for Pfizer to assume headquarters in Ireland.

 

The laws set in 2002, which ceased inversions for several years (as demonstrated by the graph), “required the foreign company to be at least one-fourth the size of the US one for offshore headquarters to be established.” Monday’s proposed rule tightens that restriction by saying that if a foreign company has “bulked up through mergers with other US companies in the last three years, as Allergan has, that additional bulk isn’t counted toward its size.”

 

The termination of the deal represents a victory for the Obama administration, which has pledged to take a tougher stance against the offshoring of profits by corporates.

 

Implications of the offshoring trend

While it appears that the US Treasury has won this round in the boxing ring, how long before the next loophole can be found in the new legislation? Are governments fighting a losing battle?  More importantly, what are the implications for Australia?

A recent article in the AFR highlighted the greater implications of corporates assuming overseas bases for tax purposes. Writer John Kehoe suggested that the recent merger of Pfizer and Allergan should be taken as a lesson for Australia to remain competitive within the international tax system.

Especially as the mining boom winds down, Kehoe claims that Australia needs to retain and attract new sources of foreign capital into other sectors of the economy. That is, rather than fighting to prevent corporates from fleeing their headquarters to a tax-haven, Australia needs to find a reason for corporates to keep their operations in the country.

While the offshoring of profits may seem as an injustice served against the company’s original state of domicile, corporations such as Pfizer are seeking to relocate to where they can bring the most value to shareholders. In a globalised world economy, it may be time to accept such changes and instead take action to be more competitive internationally in order to retain profits.

As corporates continue to expand internationally, the extent of state authority and control subtly blurs. The future balance of power between the two players remains unknown and will continue to be contested. Will the state and the corporate learn to cooperate?

 

References

Bradshaw, J. (2016). Pfizer could split after its merger with Allergan fails. Sydney Morning Herald. Retrieved from http://www.smh.com.au/business/world-business/pfizer-could-split-after-its-merger-with-allergan-fails-20160406-go0b2r.html. Retrieved on 6/04/2016.

Cassidy, J. (2015). The Pfizer–Allergan Merger Is a Disgrace. The New Yorker. Retrieved from http://www.newyorker.com/news/john-cassidy/the-pfizer-allergan-merger-is-a-disgrace. Retrieved on 1/04/2016.

Fisher, N., & Liebmand, S. (2016). Forbes. Retrieved from http://www.forbes.com/sites/nicolefisher/2015/04/22/are-ma-replacing-rd-in-pharma/#4409c0e4cb57.

Khadem, N. (2016). Apple’s $85 million tax bill is a fraction of its almost $8 billion revenue. Sydney Morning Herald. Retrieved from http://www.smh.com.au/business/the-economy/apples-85-million-tax-bill-is-a-fraction-of-its-almost-8-billion-revenue-20160126-gmej0z.html. Retrieved on 3/04/2016.

PICCHI, A. (2016). 5 things to know about the biggest ever drug merger. CBS. Retrieved from http://www.cbsnews.com/news/5-things-to-know-about-the-biggest-drug-merger-ever/http://www.abc.net.au/news/2016-04-06/drugmakers-pfizer-and-allergan-to-terminate-merger/7305798. Retrieved on 6/04/2016.

Mider, Z., & Drucker, J. (2016). Tax Inversion. Bloomberg View. Retrieved 7 April 2016, from http://www.bloombergview.com/quicktake/tax-inversion. Retrieved on 6/04/2016.

Steele, A. (2016). FTC Seeks More Information on Pfizer-Allergan Merger. Retrieved from http://www.wsj.com/articles/ftc-seeks-more-information-on-pfizer-allergan-merger-1459357819. Retrieved on 3/04/2016.

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