Comprehensive tax reform needed for more competitive system
In September, I had some business trips outside the United States. Business travel overseas is more prevalent given free trade and new market opportunities. International business is a reality most businesses need to deal with each day. There really aren’t many closed markets anymore for international trade and commerce — businesses can’t hide from this reality.
Isolationism isn’t really a viable alternative in our world. There was a point in our country’s history when calls for isolation were common. We only need to recall Grand Rapids’ own Sen. Arthur Vandenberg once called for isolationism and changed his views to being in favor of joining the United Nations and the U.S. taking a more active role in the world. For many years, U.S. businesses have led the way in international trade, and the result is the marketspace is a global one.
The changing face of international business is evidenced from the merger and acquisition activity taking place in the past few years. No longer is it a U.S. acquirer targeting a foreign company. It is more often a foreign acquirer targeting a U.S. company. This trend has changed the impact and results of merger and acquisition transactions for companies, their shareholders and their employees.
In recent years, much of the hype has been with respect to merger and acquisition transactions that were structured as inversions. Many headlines in the financial and mainstream press covered these transactions and the outcry in Washington and the obtained tax benefits. Despite the media coverage, the reality is most foreign acquisitions of U.S. targets are not inversions.
Many of the recent large merger and acquisition deals often include a U.S. target being sought by a foreign acquirer. In recent weeks, this is a trend evidenced by two deals in the chemical industry. Bayer AG (Germany) agreed to acquire Monsanto, and Potash Corporation (Canada) acquired Agrium. The former deal is an all-cash deal and the latter a stock deal. Earlier this year, we saw a large pharma deal with Shire PLC acquiring the Baxter spin-off Baxalta.
These and other cross border merger and acquisition transactions have various commercial reasons for combining, including research pipelines, expanded product offerings, cost-savings synergies, revenue enhancement and geographic footprint, among others. In many cases, shareholders and financial markets favorably respond to such transactions.
Some pundits predicted in the past year, when the corporate inversion debate was hot and heavy, putting limitations on inversions (mergers and acquisitions that resulted in U.S. shareholders remaining in control of the combined entity and its management remaining generally U.S. based) would result in many U.S. companies becoming the pursued rather than the pursuer. Some may wonder whether the latest announced deals start the first wave of that trend. Some more time is needed to make any analysis or conclusion in this regard.
The inversion regulations announced by the Treasury Department and the Internal Revenue Service earlier this year certainly have reduced the number of announced merger and acquisition deals that are structured as inversion transactions. However, the regulations didn’t address the issues in the U.S. tax code that were creating the landscape for structuring certain merger and acquisition transactions as inversions.
Those same issues with respect to the U.S. tax code may be, in part, why foreign acquirers (rather than U.S. acquirers) are acquiring some large U.S. businesses. These issues include a high U.S. corporate income tax rate and the ability to deduct interest incurred related to acquisitions of U.S. targets. Thus, the after-tax cost of debt financing is enhanced by the U.S. corporate tax rate that hovers around 40 percent when Federal and state income taxes are considered. In addition, the low interest rate environment also has likely made debt, rather than equity, the choice many have made in financing merger and acquisition transactions.
Then, of course, there is the fact the U.S. taxes worldwide income and, thus, taxes dividends from foreign subsidiaries. Most of our large trading partners, including the United Kingdom, Germany, Canada and Japan, exempt from taxation most, if not all, foreign subsidiary earnings from active business operations. In addition, most of our trading partners also have reduced their corporate tax rates significantly over the past 10 to 20 years, while the U.S. federal corporate income tax rate has remained at its current level for more than 25 years. There has been some speculation the Brexit aftermath of the UK leaving the European Union may allow the UK to continue to drop its corporate income tax rate and offer other incentives for businesses to locate and conduct activities in the UK. As a result of these factors, it doesn’t take a rocket scientist to determine foreign acquirers often may have an advantage over U.S. acquirers in evaluating the after-tax return in evaluating U.S. target companies in their merger and acquisition strategy
The recent Base Erosion and Profit Shifting (BEPS) initiative put forward by the Organisation for Economic Cooperation and Development (OECD) likely will impact some tax planning strategies used by many businesses engaged in cross border transactions. Many of the OECD countries have, or are considering, implementing new tax legislation to reflect the recommendation of the Action Plans arising from the BEPS initiatives. Some countries have gone beyond the recommendations in an effort to minimize the impact of certain tax planning strategies.
The BEPS initiatives being implemented by many of our trading partners don’t change the fact U.S. corporate income tax rates are higher than the rest of its major trading partners; its taxation of earnings of foreign subsidiaries is the exception, rather than the rule, among major trading partners and many of its other rules regarding foreign subsidiaries, foreign tax credits, etc., need a significant overhaul. Comprehensive tax reform to make the U.S. tax system more competitive may result in the key contribution the U.S. makes to the BEPS imitative.
Only time will tell what will happen in the U.S. with respect to comprehensive tax reform. Once the results of the upcoming U.S. elections have had time to settle, there may be an opportunity for genuine and constructive discussion on comprehensive tax reform legislation.
William Roth is a tax partner with the local office of international accounting firm BDO USA LLP. The views expressed above are the author’s and not necessarily those of BDO. The comments are general and not to be considered specific tax or accounting advice or relied upon for the purpose of avoiding penalties. Readers are urged to consult their professional advisers.