Column: Pfizer’s creative merger plan revives concerns about tax-avoiding ‘inversions’

Protesters dumped fake currency outside Pfizer's New York headquarters in 2015 to protest high drug prices
(Spencer Platt / Getty Images)

A corporate tax dodge known as “inversions” had a moment in the spotlight about a year ago, when a number of such high-profile mergers got U.S. Treasury officials, politicians and voters steaming.

Inversions are mergers in which a big U.S. company buys a smaller foreign company and reincorporates in the foreign land to take advantage of its lower corporate tax rate. Following the public uproar and a tightening of Treasury rules--and a public denunciation from President Obama--inversions ebbed, for a bit. (We reported on the inversion craze here, here and here.)

The shareholders of Pfizer expect us to maximize the return.

— Pfizer Chairman Ian Read


But a huge merger being discussed by Pfizer and Ireland-based Allergan has revived the specter of these tax-advantaged flights of corporate assets from U.S. shores. The deal, which the companies say is under “preliminary” discussion, would create the world’s largest drugmaker, valued at more than $300 billion.

It also would lower Pfizer’s effective U.S. tax rate--though by how much isn’t clear, since many critics think the company’s declared effective rate of 25.5% in 2014 is vastly overstated. The key may be that the deal would relieve Pfizer of the potential tax burden of as much as $148 billion in overseas earnings it has stashed overseas. That money would be subject to U.S. taxes if brought home, but might be permanently sheltered under the terms of an inversion merger.

Pfizer has been among the nation’s most aggressive exploiters of U.S. tax breaks by booking business expenses in the U.S. and shifting income abroad, according to critics such as Americans for Tax Fairness. In a report issued this month, the organization asserted that Pfizer’s effective tax rate last year actually was only 7.5%, not 25.5%. The discrepancy was due to “accounting fiction,” including the reporting of “deferred taxes” that the company is unlikely to pay in the future.

Pfizer maintains that its income policies and tax reporting comply with all government rules and regulations. No one has shown they don’t.

What’s unclear is why Pfizer would aggressively overstate its tax bite, since that means understating its earnings. Among the possibilities, experts say, is that the company fears that revealing its inordinately low real tax rate might attract unwelcome attention from pharmaceutical and tax regulators. Or it might be building up a reserve of deferred taxes to apply to any overseas earnings it eventually repatriates to the U.S., whether under orders from U.S. tax authorities or voluntarily, as part of a partial amnesty.

Inversions aren’t illegal, though they have been politically touchy. Pfizer Chairman Ian Read acknowledged as much during a conference call with securities analysts Oct. 27, but said the “political ramifications” wouldn’t stop him from taking any step he judged to be in his shareholders’ and employees’ interests. “The shareholders of Pfizer expect us to maximize the return,” he said, “and the employees of Pfizer want to have a robust, successful company.”

The political issues can’t be dismissed so lightly, however. Obama took aim last year at companies he called “corporate deserters--a small but growing group of big corporations that are fleeing the country to get out of paying taxes.... They’re declaring they’re based someplace else even though most of their operations are here.”

A tightening of regulations by the Treasury Department last year succeeded in quashing several large inversion deals. Among other things, tax officials are certain to be on the lookout for any merger-related maneuvers that seem aimed at reducing the percentage of Pfizer shareholders still holding interests in the merged companies. That’s a key metric followed by the Treasury. These steps could include spinoffs of existing businesses or stock buybacks that pay off shareholders with cash.

A Pfizer deal might also spur Congress and the White House to finally make a permanent deal on corporate taxes--which could be good or bad for companies like Pfizer, depending on the terms.

That effort should start with a two-year moratorium on all inversions “to reduce the hemorrhaging,” suggests Edward D. Kleinbard, a USC law professor whose role as a former chief of staff to the Congressional Joint Committee on Taxation certifies him as one of our leading experts on the corporate tax.

Kleinbard argues that the elements of a new corporate tax structure have long been clear on both sides of the partisan aisle. “The scope of disagreement between [House Speaker Paul] Ryan and President Obama is so small that they could work out the bullet points in the course of a weekend,” he says.

The points would include reducing the corporate tax rate, which tops out at 35%, to somewhere around 25% while eliminating a host of corporate tax rates and taxing earnings on a territorial basis--that is, levying U.S. tax chiefly on income earned within the U.S., perhaps with a lower but minimum tax on foreign earnings. That would encourage companies to bring foreign earnings back to the U.S., where they could be invested in the U.S. economy.

Such changes might not quell the incessant whining by American companies about our high corporate tax rate--although, as Pfizer shows, they rarely pay anything approaching the statutory rate. But in practical terms it might quell their appetite for merger deals that make sense largely as tax maneuvers. American business ingenuity is almost limitless, and it might do everyone good for it to be applied to developing useful new drugs and other products, instead of tax schemes.

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