When companies flee U.S. tax system, investors often don’t reap big returns

August 18

Establishing a tax domicile abroad to avoid U.S. taxes is a hot strategy in corporate America, but many companies that have done such “inversion” deals have failed to produce above-average returns for investors, a Reuters analysis has found.

Looking back three decades at 52 completed transactions, the review showed 19 of the companies have subsequently outperformed the Standard & Poor’s 500-stock index, while 19 have underperformed. Another 10 have been bought by rivals, three have gone out of business and one has reincorporated in the United States.

Among the poorest performers in the review were oilfield services and engineering firms, all from Texas. One, McDermott International, was the first of these companies to invert, and it moved its home tax base to Panama in 1983.

Drugmakers are dominating the latest wave of inversions, and most of them have outperformed the benchmark index. In 2014, five U.S. pharmaceutical firms have agreed to redomicile to Ireland, Canada or the Netherlands. Deals that have not been completed were excluded from the review.

It is impossible to know how the companies might have fared in the market had they not inverted. But the analysis makes one thing clear: Inversions, on their own, despite largely providing the tax savings that companies seek, are no guarantee of superior returns for investors.


U.S. Sen. Dick Durbin, D-Ill. speaks during a news conference outside a Walgreen's drugstore Wednesday, Aug. 6, 2014, in Chicago. Durbin praised Walgreen, the nation's largest drugstore chain, for declining to pursue an overseas reorganization to trim its U.S. taxes. (M. Spencer Green/AP)

The deals basically involve a U.S. company initially forming or buying a foreign company. Then the U.S. company shifts its tax domicile out of the United States and into the foreign company’s home country. The name “inversion” comes from the idea of turning the company upside down, making a smaller offshore unit the new head and the larger U.S. business the body.

Companies that do these deals typically promise that shareholders will benefit. But aside from stock price underperformance by many, inversions also can impose substantial up-front tax costs. When a deal occurs, investors must recognize any taxable capital gains on their stock holdings. These costs are not taken into account in the study, as they differ for each shareholder and don’t apply in some cases.

Corporations that invert say they are seeking only to pay the lowest tax rate they can get, noting that this is what shareholders would expect them to do.

Inversion was pioneered as a strategy by oilfield companies that reincorporated chiefly in the Cayman Islands, Bermuda and Britain. Most have lagged the S&P 500 since their inversions were completed: McDermott by 85 percent, Rowan Cos. by 35 percent and Transocean by 18 percent, among others.

Beyond oilfield services, the inversion strategy has been used by a half-dozen U.S. insurance firms, with half of them outperforming and the rest either acquired or out of business. White Mountains Insurance Group, managed from Hanover, N.H., has outpaced the S&P 500 by 248 per-
cent since reorganizing in 1999 as a Bermuda corporation, for example.

The analysis, using Reuters data and analytics, measured simple share price performance against the S&P 500 index using two benchmarks — the date each company completed its inversion deal and the date each deal was announced.

With only four exceptions, the inverted companies that were still in business since completing their deals uniformly underperformed or outperformed on both benchmarks.

Concern is growing in Washington about inversions. President Obama has criticized a “herd mentality” by companies seeking deals to escape U.S. corporate taxes. Of the 52 inversions and similar redomiciling deals done since 1983, 22 have occurred since 2008, with 10 more being finalized and many more said to be in the works.

Following recent deals by major companies such as Medtronic, bankers and analysts have said another burst of deals is waiting to be unveiled in September.

Congressional action this year is unlikely, with Republicans opposing Democrats’ proposals, analysts said, although the Obama administration has been weighing executive actions. The White House might, for instance, announce tighter restrictions on federal government contracting with inverted companies, Chris Krueger, an analyst at Guggenheim Securities in Washington, said in a research note last week.

Inversions have a firm legal basis. The government has been writing rules on them for 30 years. But they are complex and risky, and some major proposed deals have recently unraveled.

On Aug. 6, for example, after months of internal debate and public criticism from politicians, U.S. retailer Walgreen said it would not reincorporate in Europe. Drugmaker Pfizer and advertising firm Omnicom Group, which are U.S. leaders in their industries, also have walked away from planned inversions recently because they couldn’t reach deals with their targets.

No two inversions are identical, and they have changed shape along with evolving Internal Revenue Service rules.

One appeal of inversions is putting foreign profits out of the IRS’s reach. Another is “earnings stripping,” in which a foreign parent lends to a U.S. unit, which deducts the interest to shrink its U.S. income for tax purposes, while the foreign parent books the interest at its home country’s lower tax rate.

Inversion destinations have lower corporate tax rates than the United States. The top U.S. rate of 35 percent is among the world’s highest. Still, many U.S. companies pay far below that headline rate because of abundant loopholes that give businesses, especially big ones, a lower effective tax rate.

— Reuters

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