S&P warns of downside to corporate tax inversions: lower credit ratings

American companies shifting their headquarters overseas to reduce taxes face a potential downside -- lower credit ratings, Standard & Poor’s warned in a new report.

So-called inversions, which have been on the rise, involve a U.S. firm buying a smaller rival in a foreign country with a lower corporate tax rate and moving its headquarters there.

But the attraction of reducing tax bills through the maneuver leads to “more aggressive financial policies” that raise credit risks for companies. according to S&P, one of the three top credit rating companies.

For several reasons, S&P said firms considering an offshore tax shift should be guided by the Latin phrase caveat emptor, or let the buyer beware.

“An effective inversion strategy should make sense for business fundamentals and not just for tax reasons,” the report said.

Firms take on higher debt to pay for the foreign acquisition, which also reduces their ability to make other strategic purchases to improve their business, S&P said.

Inversions also give companies easier access to foreign earnings, which can lead to “more aggressive share buybacks and dividend payments” that also can damage credit ratings.

And with the Obama administration sharply criticizing tax inversions recently, raising the profile of the issue, companies face “the potential for public, political, media and customer backlash,” S&P said.

Burger King Worldwide Inc. faced such a backlash, including calls for customer boycotts, when it announced last month it would buy Canadian coffee-and-doughnut chain Tim Hortons and put the combined firm’s headquarters north of the border.

Canada has a lower corporate tax rate than the U.S., which has the highest of any developed economy, although Burger King said that was not the main reason for the deal.

A recent wave of inversions, largely focused in the pharmaceutical industry, has drawn attention to the tactic.

The White House has called for new limits on the maneuver, with Treasury Secretary Jacob J. Lew saying U.S. companies should show “economic patriotism” instead of trying to avoid paying their fair share of taxes.

S&P said that companies seeking inversions could end up facing higher tax bills than they are anticipating if the Obama administration and its congressional allies are successful in enacting retroactive limits on the practice.

All those factors add up to the potential for credit ratings downgrades, the report said.

It noted that some recent inversions announced by pharmaceutical companies, including AbbVie Inc’s purchase of Shire and Medtronic Inc.’s acquisition of Covidien have led S&P to place the firms’ ratings on negative watch.

“In our view, Big Pharma companies may be utilizing their financial capacity to execute what is essentially a predominantly tax-focused transaction, rather than one that adds promising new products and prospects to their portfolios,” the report said.

“With increased potential exposure to legislative action against companies considering inversion tactics, inversions can be a net negative from a credit perspective,” it said.

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