Can Anything Stop Drug Companies From Fleeing The U.S. Tax System?

Can Anything Stop Drug Companies From Fleeing The U.S. Tax System?


Friday morning, after five spurned bids, AbbVie , the North Chicago-based pharmaceutical giant finally closed in on a deal to buy Irish drugmaker Shire for $54 billion. One key consequence of the deal: AbbVie will change its tax domicile from Illinois to the U.K., reducing its tax rate.

The deal, the largest so called “tax inversion” ever, caps off what feels like an epidemic of acquisitions to escape U.S. taxes in the health care industry. Pfizer ’s failed attempt to acquire rival AstraZeneca was driven in part by the tax benefits. In June Medtronic , the biggest standalone medical device company, pledged $43 billion to purchase medical product maker Covidien, which itself moved its tax domicile from Bermuda to Ireland in 2009. In perhaps the strangest deal, Chicago-based Abbott, which is AbbVie’s former parent company, sold a generic drugs business to Mylan Pharmaceuticals, based in Pennsylvania. This will allow Mylan to move its tax domicile to the Netherlands.

And then there is the pending deal that gets U.S. politicians especially upset: Walgreen, long known as America’s drugstore because of its own advertising, may move its tax domicile to Switzerland as part of its merger with drug chain Boots. Illinois Senator Richard Durbin, a Democrat, has accused the company of “giving up on America.”

These changes in tax domicile often don’t involve significant changes in a company’s business. Executive headquarters and manufacturing locations, for instance, remain where they are.

“Congress ought to take its head out of the sand,” says Ron Cohen, the chief executive of U.S.-based biotech Acorda Therapeutics. He advocates lowering U.S. corporate taxes to match those in the rest of the world. “

Can Anything Stop Drug Companies From Fleeing The U.S. Tax System?

Source: Ron Graziano, Credit Suisse, March 14, 2014


What is driving the exodus? The U.S. corporate tax rate is now one of the highest in the world, above that of Japan, France, or Germany, and it has not kept pace tax rates in the rest of the world as they have fallen. Unlike other countries, the U.S. taxes revenues made outside its borders, and money held in overseas accounts is taxed if companies want to make use of it in the U.S. Companies like General Electric, Microsoft, Pfizer, and Apple each have more than $50 billion “trapped” overseas as a result of U.S. tax laws that would force them to pay taxes on the money if they spent it in their home country.

Health care companies are not the only ones fleeing for lower-tax regions. Chiquita Brands’ purchase of Fyffes will likely move its domicile to Ireland; Applied Materials moved its domicile to the Netherlands via the purchase of Electron; and Pentair moved to Switzerland. But many of the deals have been in healthcare, including the moves of drugmakers Actavis, Perrigo, Jazz, Alkermes and Endo Health, all to Ireland.

It may be that pharmaceutical and biotech companies are more prone to tax inversions than those in other industries because of the way their intellectual property works. “They can move their IP around quite easily so it is domiciled outside of the US but then, in turn, end up having a lot of cash ‘trapped’ overseas in these low-tax jurisdictions,” says Vamil Divan, who follows the pharmaceutical industry for investment bank Credit Suisse. “Doing an inversion allows them to access the cash that is trapped.”

But another possibility is just that this is an idea that has become de riguer, and that the fear among pharmaceutical executives that the U.S. might move to make tax inversions even harder to accomplish is pushing companies to act even faster. “Everyone’s doing it, so everyone has to do it, like any momentum market,” says Mark Schoenebaum, the lead pharmaceuticals analyst at ISI Group.

Can Anything Stop Drug Companies From Fleeing The U.S. Tax System?

Source: Ron Graziano, Credit Suisse, March 14, 2014Source: Ron Graziano, Credit Suisse, March 14, 2014

In 2010, Valeant Pharmaceuticals purchased Biovail, a failing generic drug company, and moved its tax domicile to Canada. Its lower tax rate allowed it to make a string of increasingly big acquisitions (lower taxes mean higher earnings, which in turn allow for a higher deal price.) That’s helped shares in Valeant, which is currently bidding for Botox maker Allergan, increase 386% since the deal closed.

In September 2011, Jazz Pharmaceuticals, the maker of a drug to treat patients with the sleep disorder narcolepsy, announced plans to purchase Azur Pharma and move its tax domicile to Ireland. Then it made big acquisitions, buying Eusa Pharma for $650 million in 2012 and Gentium in 2014. Shares have tripled since the deal closed.

The success of smaller companies like Valeant and Jazz (and then Actavis and Perrigo, which makes store brands for big drug stores) led to a general sense among health care investors and analysts that tax inversions, which had seemed difficult to pull off, could work. Then, when Pfizer made its bid for AstraZeneca, it may have catalyzed the whole sector.

“It is like any fad that you ever see anywhere, but also in the business world,” says Cohen, the biotech CEO. “There are certain fads that take root, managerial fads, restructuring, Six Sigma. An idea takes root, some people see other companies doing it, and they say, ‘we should be doing it too.’ Inevitably, these sort of things play to a crescendo, it plays out, and it peters out.”

But Cohen doesn’t see the deals stopping quickly unless Congress and President Obama can reduce the U.S. tax rate to be more competitive with other countries. Can Congress move fast enough to make that happen?
They should. This should be a bipartisan issue. Some of these deals would happen regardless – AbbVie’s purchase of Shire makes sense for more than just tax reasons. The company has long been held hostage by investor fears about what will happen when it faces the patent expiration of its massively successful rheumatoid arthritis drug, Humira, which has annual sales of $10.7 billion, more than half the company’s total revenue. Buying Shire gives it a profitable rare disease business.

But it’s hard to see how Medtronic would be buying Covidien or Mylan would be purchasing specialty drugs from Abbott without big tax advantages. Democrats may require some new penalties for companies trying for inversions in order to be OK with lowering the tax rate; Republicans should acquiesce. This is a time to get a deal done, before even more healthcare firms try to get out of even more U.S. taxes. After all, as Cohen points out, if companies could be encouraged to bring the money they have locked up overseas to the U.S., it would probably only be good for the U.S. economy.



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