On the surface, tax inversions seem like a great deal for investors. A U.S. company buys a foreign company, moves its headquarters abroad, and inherits a tax rate lower than what it paid at home.
Costs go down. Profits go up. What more could an investor want?
How about not getting a tax bill themselves, for starters.
Let me explain
Tax inversions -- such as Burger King's (NYSE:BKW) purchase of Canadian chain Tim Hortons (NYSE:THI), Medtronic's (NYSE:MDT) acquisition of Ireland-based Covidien (NYSE:COV), and AbbVie's (NYSE:ABBV) buyout of Shire (NASDAQ:SHPG) -- are classified by the IRS as a taxable event.
Investors are used to getting hit with a capital-gains tax bill when a company is bought out; it's the downside of owning a sought-after asset. Fortunately, the cash from the buyout can be used to pay the bill from Uncle Sam.
After a tax inversion, though, investors are typically hit with the same kind of capital-gains tax they pay when shares have appreciated since they were purchased. But they generally don't get any cash from the merger to pay the bill.
Tweaking the deal
As if these tax inversions weren't complicated enough, Burger King has set up its acquisition to allow investors the option of swapping their shares for partnership units.
Owning a unit in the newly formed Ontario limited partnership, which will be controlled by the new parent company, is apparently not a taxable event. After a year, the units can then be exchanged for shares of the new parent company.
More taxes for executives
In an effort to discourage companies from inverting, Congress set up an additional 15% tax on stock-based compensation of executives at companies that make this move.
Don't feel too bad for the executives at Medtronic and AbbVie, though. The boards of both companies agreed to pay the extra tax bills for their executives. For Medtronic CEO Omar Ishrak, the handout amounted to a whopping $24.8 million.
The argument for paying executives' tax bills sounds good in theory: You don't want executives making the decision not to invert simply for the benefit of their pocketbooks.
However, I'd argue that shareholders' tax burden should come into consideration. That's the definition of fiduciary duty: making decisions that are in the best interest of shareholders. Perhaps management teams should think twice about the tax implications before deciding to invert.
A couple of good guys
Biogen Idec's (NASDAQ:BIIB) management certainly has. After being asked during a recent conference call about the potential for the company to do a tax inversion, Biogen CFO Paul Clancy made it clear the management team is taking investors into consideration:
A major, major consideration for us, which is probably more acute than others, is for our long-term shareholders, it would result in a meaningful capital gains. ... We have shareholders that have been in this stock for a very long period of time, and with the capital appreciation in the stock, that's a major, major consideration that we think about.
Walgreeen (NASDAQ:WBA) also seems to have taken investors' best interests into account when it elected to stay stateside after the acquisition of European pharmacy and wholesaler Alliance Boots. Granted, the decision was based partly on legal considerations (it's not clear a merger with Alliance Boots would have qualified as a tax inversion, and who wants to be tied up in court for years?) and partly on public relations.
The Treasury Department recently announced new rules designed to make it harder for companies to invert.
Most of the new rules involve the treatment of cash abroad that companies typically use to make their foreign acquisitions. Because the cash wasn't earned in the U.S., it isn't subject to domestic taxation until it's brought into the U.S. The new rules will make it harder for companies to shelter that foreign cash to avoid U.S. tax.
Another rule strengthens the requirement that the former owners of the U.S. company own less than 80% of the new company. That's always been a rule to keep companies from buying small foreign companies simply in order to move abroad, but Treasury has plugged a few loopholes that companies have used to meet the less-than-80% rule.
Only time will tell if these new rules are enough to discourage companies from inverting. It might take an act of Congress to make new laws that have enough teeth to hamper the flight abroad that leaves investors with a tax bill.
Brian Orelli has no position in any stocks mentioned. The Motley Fool recommends Burger King and Covidien. The Motley Fool owns shares of Medtronic. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.