Behind Shire PLC's $30B Baxalta Bid: Hopeful Foreign Buyers Court US Pharmaceutical Companies After Regulators Halt Tax Inversions

If Shire plc's (LON:SHP) $30 billion unsolicited proposal to acquire Baxalta Inc. (BXLT) is accepted, the deal would be a pairing of two drug companies that manufacture treatments for rare diseases. It would also be a marriage of tax convenience. In a letter pitching the deal, Shire’s Chief Executive Officer, Flemming Ornskov, wrote that Baxalta would gain a valuable asset: a new area code. Baxalta is currently based in Deerfield, Illinois, and Shire is located in Dublin. If the deal were completed, Baxalta could assume the enviable tax status of its rival.

The U.S. has the highest corporate tax rate of any industrialized country, but Irish companies pay taxes at a rate of just 12.5 percent, according to the Tax Foundation. In contrast, American companies based in New York or New Jersey may pay up to 40 percent in federal and state corporate taxes.

As part of the bid announced Tuesday, Shire estimates that the combined Shire and Baxalta would produce $20 billion in sales by 2020. And although Ludwig Hantson, Baxalta’s chief executive officer, has repeatedly rebuffed Shire’s advances, the tax advantages are a strong incentive to say yes to a deal.

“Typically the growth rate for pharmaceutical companies is somewhere around 6 or 7 percent on an annual basis,” Milos Todorovic, a lead analyst in medical technologies at Lux Research Inc, says. “Anytime you can get a savings of 10 to 15 percent on taxes -- that's basically a ‘Bingo’ for pharmaceutical executives.”

What Is A Tax Inversion?

Regulators have recently scolded U.S. companies for striking deals known as tax inversions, transactions in which large American companies purchase foreign businesses and claim the acquiree's homeland as their new corporate headquarters--all in pursuit of more favorable corporate tax rates. Shire itself moved to Ireland from the U.K. in 2008 in search of an "optimum" tax rate.

Across all industries, at least 41 tax inversion deals were struck between the 1980s and mid-2014, according to the law firm Chadbourne & Parke LLP. Ireland was the most popular destination for these dealmakers -- 11 out of 21 firms that have completed or proposed transactions since 2010 planned to move there, while three wanted to relocate to the U.K.

Critics have long said this practice steals jobs and tax revenue from the U.S. Often, companies keep their executive team in place and maintained operations that relied heavily on U.S. infrastructure, research funds and security.

“Obviously there are public policy implications because if you're not paying taxes in the country where your headquarters are technically domiciled, you're not paying into social support systems, you're not paying for infrastructure, and you're not paying for all those things that taxes are collected for,” Lea Prevel Katsanis , a pharmaceutical marketing expert at Concordia University, says. “ Tax inversions can be a political hot potato.”

A decade ago, several companies including Tyco International Inc. moved their corporate headquarters to Bermuda amid a wave of tax inversion deals. The Internal Revenue Service responded by making it more difficult for companies to execute tax inversions by forbidding the owners of a former U.S-based company from holding more than 80 percent of the new company and still qualifying for foreign tax status in the U.S. tax code.

Consolidation in the healthcare industry may have spurred the most recent wave of tax inversions -- “The bigger you are, the more you stand to save,” Prevel Katsanis says -- which was frenetic enough to capture the attention of 14 U.S. senators who signed a letter last year pleading with Congress to act.

Last fall, the U.S. Treasury announced further measures that it said would “significantly diminish the ability of inverted companies to escape U.S. taxation” which included limiting the ability of American companies to extract money from offshore accounts at a lower tax rate through these deals and preventing U.S. owners from padding their reported ownership by counting assets unrelated to the company’s day-to-day business in order to meet the 80 percent requirement.

That announcement did halt several deals that were already in progress – including New York.-based Pfizer’s attempt to takeover Britain’s AstraZeneca as well as a proposed merger between Shire and AbbVie.

But opponents of the Treasury’s measures are pointing to a slew of recent deals as evidence of the need to loosen these requirements – and the proposed Shire-Baxalta deal could become their latest case study.

Foreign Buyers

In this latest trend, companies already based overseas seek out American companies that they perceive to be crippled by high taxation. Critics say in these deals, the foreign buyer may have the upper hand because the domestic company’s tax rates are so high. If successful, these bids stand to place more U.S. assets under foreign ownership – an unintended consequence of the Treasury’s efforts to keep U.S. companies on American soil.

“The U.S. concern has overwhelmingly been with tax revenue. It's not really a matter of companies really moving with these inversions,” Michael Knoll, co-director of the Center for Tax Law and Policy at University of Pennsylvania, says. “The counter argument is that you could end up with provision meant to discourage inversions, encouraging foreign firms to buy up U.S. firms and really move them offshore.”

Earlier this year, Canada-based Valeant Pharmaceuticals International Inc. bought Salix Pharmaceuticals, which was headquartered in Raleigh, N.C. A recent Senate investigation pointed to Valeant’s activities as emblematic of this newest trend which some say has replaced tax inversions.

“What we're seeing now is almost the flip of that, in overseas companies taking advantage of their tax status,” says Laura Vitez, principal biotech analyst at Thomas Reuters.

However, Reuven Aviyonah, director of the international tax program at the University of Michigan’s law school, says there are plenty of reasons why American pharmaceutical and biotech companies will likely remain in the U.S., no matter who owns them. Public funding for research and development in the U.S. is higher than in many countries, and the talent scientific talent pool is deeper, too.

Loopholes And Deterrents

Regardless of whether foreign buyers will continue to pursue American companies, others say tax inversions are here to stay -- companies will inevitably find loopholes to exploit even the latest regulations.

“Most likely, companies will find loopholes to figure out ways to relocate and take advantage of lower taxes in other counties,” Todorovic says.

He suggests a better solution might be to simply do what these companies have pleaded for all along.

"You can always enact punishment but long-term, I think the only solution is to figure out how to somehow lower some of these corporate taxes to make them not even have to think about these deals," he says.

Knoll at University of Pennsylvania says further efforts to restrict the ability of foreign companies to earn lower taxes on money held by American companies by funneling it through offshore accounts will lighten pressure for these deals, but also says that any regulations are unlikely to halt all such transactions.

“Companies have very sophisticated advisors looking at these issues. It’s kind of this cat-and-mouse game – the government takes a step and the parties take a step and it’s tough for the government to keep up, ” he says.

Aviyonah adds that requiring companies to physically move their headquarters overseas in order to escape domestic corporate tax rates might be another solution since these companies are hesitant to uproot their executive teams and research facilities. If the expense or hassle of doing so outweighs the benefit of a lower tax rate, more companies would remain stateside.