The hunt for a lower corporate tax rate is a major factor driving this week's international deal to merge Minneapolis-based Medtronic Inc. and Dublin device maker Covidien plc.
Medtronic — already the world's largest stand-alone medical device maker — announced plans June 15 to buy Covidien for $42.9 billion in cash and stock.
The result will be a new company, called Medtronic plc and based in Ireland, but with operational headquarters in Minneapolis. The new company will have a broader scope and more than 87,000 employees in more than 150 countries — and a much lower U.S. tax bill thanks to the so-called tax inversion move.
In such inversion deals, acquirers buy companies domiciled in countries with lower corporate tax rates than their own as way to reduce their overall tax rate.
Covidien, though it has a U.S. base in Mansfield, Mass., is headquartered in Ireland which is known for its relatively low corporate tax rate of 12.5 percent. The U.S. corporate tax rate, 35 percent, is one of the world's highest.
Rather than just purchasing an overseas company the U.S. company actually creates a new company overseas, which then buys both companies to form the new, internationally based one. As long as a significant percentage — at least 20 percent — of the new company is owned by the shareholders from the original foreign company, that is enough to move the original U.S. company out of U.S. domicile for tax purposes, explained New York-based independent corporate tax expert Robert Willens.
“What then happens is that the companies are in a position to reduce their tax rate by shifting income from the U.S., in this case to Ireland, through inter-company transactions — loans, license agreements, among other things,” Willens said. “It allows the companies to get access to the unremitted foreign earnings that have been built up over the years that, in their current state, can only be accessed at the cost of U.S. taxes being paid on the earnings accrued. An inversion allows the U.S. company to get at the earnings without having to pay U.S. tax on the repatriation.”
The new Medtronic, however, is making amends for its international tax inversion by pledging to invest $10 billion in additional technologies in the United States over the next 10 years, which will cover venture capital investments, research and development and additional acquisitions.
“The medical technology industry is critical to the U.S. economy and we will continue to innovate and create well-paying jobs,” said Omar Ishrak, Medtronic chairman and CEO, in a statement. “This combination will allow us to accelerate [our] investments.”
Combining the two businesses will provide greater global reach and a wider portfolio of products and services, the companies said. The joint company will also have greater access to emerging markets, where it will have $3.7 billion in sales. Covidien has extensive capabilities in emerging market R&D and manufacturing, while Medtronic has established business in a broader product range that it can bring to those regions.
Tax relief and inversions aside, a Medtronic/Covidien merger makes strategic sense in the churning medical device market. It will open the door to accelerate Medtronic's growth in vascular therapies with Covidien's market-leading peripheral vascular and neurovascular therapies. The new Medtronic will also be a leader in gastro-intestinal, respiratory and advanced surgery devices and with $27 billion in global sales, be on par in size, scope and sales with global medtech leader Johnson & Johnson.
The exploding global medical device market is seeing a lot of merger and acquisition churn in 2014. Orthopedic device giant Zimmer Holdings Inc. announced in April that it is buying cross-town rival Biomet Inc. in a $13.35 billion cash and stock deal. Kalamazoo, Mich.-based device maker Stryker Corp. last month told the Financial Times it had been considering a bid for United Kingdom competitor Smith & Nephew plc, but had decided against the move for the time being. Privately held Philips-Medisize Corp. changed hands in early May and Baxter International Inc. opted to break off its medical device division into a separate company in April.
Washington has been less than enthusiastic about U.S. companies overseas tax moves, voicing particular outrage at Pfizer Inc.'s abandoned attempt at a $119 billion inversion deal with AstraZeneca plc.
President Obama's most recently proposed budget includes language meant to crack down down on the corporate tax maneuver. Sen. Carl Levin (D-Mich.) introduced the Stop Corporate Inversions Act of 2014, which would require foreign shareholders to own 50 percent of the new company and halt inversions if the company or 25 percent of its sales, assets or employees remain in the United States — either of which would be deal killers for Medtronic and Covidien. But the bill has not yet seen much traction in Congress.
There is more desire to end inversions as part of a more sweeping, comprehensive U.S. tax code reform, Willens said. But such legislation has also been slow-to-immovable in Congress as well.
In the absence of tax reform from Congress, “companies have to take the bull by the horns and do the next best thing,” Willens said. “Inversions allow them to be taxed like a U.K. company or an EU company or an Irish company, getting the same benefits if the U.S. tax system were reformed. Companies are creating their own changes”
