The largest-ever corporate merger to skip out on American tax obligations is now kaput.
Drug giant Pfizer is giving up on its corporate marriage to Ireland-based Allergan after an Obama administration policy change designed to prevent U.S. companies from fleeing taxes by moving their mailing address abroad. The $160 billion merger cemented last fall would have produced significant tax savings for Pfizer, at the expense of the American public.
The sudden collapse of the deal comes as news organizations the world over comb through the huge Panama Papers leak that exposes how individuals take similar advantage of the cracks in international tax law to conceal their personal holdings and business dealings with offshore shell companies. The leaks are bringing a burst of fresh attention to a long-standing problem: It’s very easy, and often legal, to slip out of the taxman’s grasp by way of clever accounting.
Founded in Brooklyn in 1849, Pfizer is one of the longest-running corporate success stories in the American economy. It has benefited from U.S. taxpayers’ investments in roads, education, scientific research, and global stability for almost 160 years, growing from $2,500 in seed money from Charles Pfizer’s father into the top-selling drugmaker in the world.
But for the past several years, Pfizer’s executives have tried desperately to move away. The company sought what’s called an inversion merger, in which two corporations combine and use accounting schemes to shift almost all of their profits into a country with low tax rates.
Pfizer tried to buy British drug titan AstraZeneca in 2014, hoping to slice a billion dollars per year off its U.S. tax bill. But it wouldn’t meet AstraZeneca’s asking price, and the would-be inversion fell apart.
A year and a half later, Pfizer and Allergan announced the largest inversion deal in history. The merger didn’t have the same flashy annual tax savings as the failed AstraZeneca bid would have delivered, but it would have allowed Pfizer to permanently avoid U.S. taxes on huge cash reserves it currently holds offshore.
But the Pfizer-Allergan announcement came after inversions had become a hot topic in the political press rather than just the financial pages. A series of high-profile corporate expatriations to duck American taxes had prompted a populist backlash, and the White House had begun explicitly shaming inverters as unpatriotic.
To put force to those words, the Obama administration began taking a series of independent steps to discourage inversions. The highly technical steps chipped away at the financial incentives that lead companies to invert in the first place.
The most recent of those came this week, leading Pfizer to abandon its latest inversion. The government didn’t act to block the merger, but rather to negate the tax benefits that were Pfizer’s primary reason for trying to shift its official headquarters abroad while continuing to operate in the United States.
One change blocks a corporate practice called “earnings stripping,” whereby inverted companies shift their corporate debts into the American tax jurisdiction at the same time that they shift their profits out of the country. Because interest payments on such debts are tax-deductible, earnings stripping effectively doubles down on the tax-avoidance at the core of inversion mergers.
And for “serial inverters” that have repeatedly used these mergers to minimize their American tax obligations, Treasury officials announced this week, some key tax and accounting questions will now work a little differently. Allergan itself is the product of multiple inversion mergers between U.S. and international drugmakers down the years.
The new rules meant that if Pfizer went ahead with the deal, Allergan would be considered by Treasury to hold a much smaller share of the total ownership of the merged firm. So small, in fact, that the merged firm would still count as U.S.-based for tax purposes.
If Pfizer believed that combining with Allergan were in its best interests in fundamental business terms — production, research and development, all the work of actually creating, manufacturing, and selling medicine — then it would have gone ahead with the deal.
But instead, after learning the merger wouldn’t shave its tax bill down, Pfizer decided to walk away — even though doing so means paying Allergan a $150 million “break-up fee.”