Note: Ron recognized this type of tax evasion as a potential problem long before recent news began bringing it into the headlines. Although mentioned in many earlier articles, he featured the problem in an Aug 25, 2012 article Tax evaders of the S&P 500. The list of companies in the S&P 500 that evade US taxes has grown considerably since. This includes the addition of Transocean Inc. (RIG), headquartered in Zug, Switzerland on Oct 28, 2013 and mentioned in that article as a possible future inclusion.
As Congress struggles with a rising national debt, US corporations continue to execute exit strategies to reduce US tax burdens called inversions. Inversions allow merging companies to domesticate to foreign countries and avoid paying US taxes.
In a letter to Congress Treasury Secretary Jacob Lew requested that Congress take immediate action to stem the flow of inversions. Hoping to instill a sense of urgency in Congress, he called for “a new sense of economic patriotism” in that letter.
Congress is not likely to act on this request due to Republican Party members taking a hard stand against stopping this practice. Many have vowed to vote down legislation they support if it includes riders dealing with the problem.
There are some, like the Wall Street Journey, that believe there is no economic benefit in stopping the flow of companies leaving this country. The Wall Street Journal stated in a recent rebuttal to the secretary’s letter that, “Mr. Lew doesn’t know much about economics”
That is an interesting stance considering the source, but not a very rational one. It seems the Wall Street Journal believes a rising national debt without the ability to pay it off has nothing to do with the economy. Eventually Congress will have to act, or break the Constitution and allow a US debt default. Just waiting until that point will cause economic harm as companies could wait, as they have in the past, until the ruckus is settled to make important decisions like hiring or to go ahead with expansion plans. Time is money and delays are expensive.
Others argue that CEO’s are making these moves in the best interests of shareholders. They argue that these moves are maximizing shareholder value by increasing profits.
One of the larger recent announcements was by Mylan, Inc. (MYL), who plans to buy Abbot Labs (ABT) developed markets business and use inversion to domesticate in the Netherlands. Heather Bresch, CEO stated that Mylan currently pays a 25% rate that will be reduced to 21% with the move. It is a shame that a mere 4% tax savings could cause, in Heather’s words “a proud US company”, to run for another shore.
Who’s left holding the bag when these companies leave? The deficit won’t disappear, so those that are left will likely see larger and larger tax burdens. Most that left for inversion will still have operations in the US, using our roads, airports, police and fire departments, etc. to move their product and protect their investments, but will not share equally in the cost of these amenities.
Several companies are currently trying to beat law changes that would prevent these moves, thinking the widow of opportunity is closing.
Was the window every really open? There is another possibility; these companies may escape minor tax burdens, only to dump large burdens their US shareholders.
Current laws tax investors in certain types of investments on the corporate earnings of these investments, while these companies pay no US taxes. For instance those that have investments in S-Corporations or Limited Partnerships pay the taxes for the company they invest in. The same type of tax strategy could be used for investors in the companies involved in current and past inversions or re-domestications.
The companies may have evaded the tax collector, but there is no Grandfather Clause protecting US shareholders. A similar tax is already in use, just not currently applied to companies that re-domesticated to avoid US taxes. It could be uniformly applied to all inversion companies at any time, forcing US investors in these companies to pay the US taxes due for these companies regardless of when the inversion took place.
To make matter worse, since the inversions are no longer US companies, Congress could limit or eliminate tax breaks that are allowed to US companies. So investors could end up paying a higher rate than the fleeing company would have if they had stayed.
Much like the recent crackdown on tax evasion in foreign banking, which required foreign banks to supply information on US account holders, these companies could easily be forced to supply tax information to the IRS including a list of US investors, or be delisted from US exchanges and denied access to bulletin boards if they refused.
The law change would likely allow investors a grace period to vote to re-domesticate these investments back to the US. The problem is many domesticated in countries that won’t allow them to just pick up and leave like Bermuda or the Cayman Islands did.
The process could reduce the value of these companies to pennies on the dollar, allowing companies in the US that stayed and paid their fair share of taxes, to gobble them up very cheaply. Everybody that is TRULY a patriot wins in this scenario.
That doesn’t include Healther Bresch, CEO Mylan, Inc. and former “Patriot of the Year”. She is oblivious to the fact that it is likely most of the people that work for Mylan in the US pay a higher rate on their income than the company does. Individual taxpayers can’t deduct many of the expenses businesses can and as a result their incomes are taxed much more in line with Mylan’s revenue basis.
Considering a tax rate on even basis to its workers, Mylan pays little in taxes. According to Mylan’s 2013 annual report (the Edgar 10-K filling of Feb 27, 2014):
In 2013 Mylan had total revenues of $6,909,143,000 and paid $120,808,000 in income tax provisions equating to a tax rate on revenue of 1.75%. They had earnings from operations of $1,135,530,000 for a 10.63% operating earnings tax rate.
In 2012 Mylan had total revenues of $6,796,110,000 and paid $161,145,000 in income tax provisions for a tax rate of 2.37%. They had earnings from operations of $1,109,349,000 for a 14.53% tax rate.
In 2011 Mylan had total revenues of $6,129,825,000 and paid $115,833,000 in income tax provisions for a tax rate of 1.89%. They had earnings from operations of $1,005,449,000 for an 11.52% tax rate.
In 2010 Mylan had total revenues of $5,450,522,000 and paid $10,402,000 in income tax provisions for a tax rate of 0.19%. They had earnings from operations of $721,584,000 for a 14.42% tax rate.
In 2009 Mylan had total revenues of $5,092,785,000 and received a refund on income taxes of $20,773,000 for a tax rate of -0.41%. They had earnings from operations of $523,352,000 for a -3.97% tax rate. It is not a typo; with operating income of over a half billion dollars they got over a $20 million tax refund.
Based on total revenue, which is much closer to how individuals are taxed, on average Mylan pays taxes at a rate lower than those with an adjusted gross income (AGI) from $1 to $5000. According to statistics derived from those supplied by the IRS for 2011, these taxpayers had a tax rate of 2.5%.
Based on earnings from operations, Mylan’s average tax burden over the 2009 to 2013 time period was 8.62%. The 2011 IRS data shows this rate was about equal to the 8.52% those with an AGI from $50,000 to $75,000 paid. Those with an AGI between $25,000 and $30,000, the income bracket that is quickly becoming the new poverty level, had a total AGI of $145,680,579,000 and paid total income taxes of $8,916,366,000, for a 6.12% tax rate.
The 25% tax rate that Mylan claims it pays is arrived at once even more income is stripped away from earnings that the average tax payer is not allowed to claim. US companies do have the highest corporate tax rates in the world, although few large companies actually pay at the 35% US corporate rate. US companies pay much less than the average US tax payer when comparing income on a more level basis, and many have income in the billions, not thousands.
One last thing to consider before voting yes on an inversion: Most of the countries that charge these low corporate tax rates have economies that are falling apart. The last downturn uncovered a few of those with flaky finances and many of them saw civil unrest and riots that caused billions in damages. Many US companies have flocked to these countries as tax havens since. Bad news Ms. Bresch, the Netherlands might be a tax haven, but it is not a safe tax haven.
Many of these sources of information were used in this article.
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Disclosure: Ron currently has investments in ABT. Ron currently has no investments in MY ro RIG. Ron divests in all companies that re-domesticate or invert and has since sold postions in XL and ETN mentioned in the earlier article. Ron is currently about 76% invested long in stocks in his trading accounts.
Disclaimer: This article is intended to provoke thought about investment possibilities. Acting on the information provided is at your own risk. You are urged to do your own research, and where appropriate, seek professional investment advice before acting on any information contained in these articles.