Tax Inversions: Maximizing Wealth by Going Abroad

Introduction In the fall of 2014, Alex Behring, CEO of Burger King (BK), faced a quandary on where to locate his firm's headquarters. BK had announced a merger with Tim Hortons of Canada to create a behemoth in the fast-food business. The merger was largely non-controversial as it offered improved economies of scale and new products to grow BK's breakfast offerings. Controversy, however, came in deciding where to locate the headquarters for the combined firm. Like other CEOs, Behring was tempted to relocate BK's headquarters (and tax residence) outside the U.S. in a corporate move to reduce the firm's tax bills and increase the firm's value. BK, however, faced an outpouring of negative social media when reports suggested the firm would move its tax residence to Canada. In fact, consumers generally viewed the merger and tax inversion as one action. In one thread, nearly 3,000 largely negative posts delivered messages like If you do an inversion deal, burger king will NEVER have me or anybody in my family as a customer ever again (Brody, 2014). Indeed, relocating one's tax residence to avoid taxes generated strong negative feelings among politicians and citizens with nationalistic feelings. Given tax and customer concerns, should Behring ask his board to keep a U.S. tax residence? Corporate Tax Inversions The United States had the highest corporate tax rate in the developed world: 40%. Regardless of the location of operations, firms were obligated to pay this rate on their profits. The rate a firm paid, however, was often lower due to deductions. This high rate motivated U.S. firms to merge with foreign firms in low tax countries, and subsequently move their tax residence. By 2014, several U.S. firms including Pfizer, Walgreens, and Medtronic pursued tax inversion strategies (Mider, 2014). In late 2014, BK joined these firms with a planned inversion of its own. BK acquired Tim Hortons, Inc., a Canadian fast-food restaurant, in a deal announced on August 26, 2014. Their combined 18,000 outlets would have $23 billion in sales. Both firms were to keep their headquarters in their original locations. However, the new global firm would move its tax residence to tax-friendlier Canada (BK Press Release, 2014). Tim Hortons was an iconic and beloved Canadian brand. Troubled as U.S. consumers were, Hortons' customers were even more outraged, and they expressed this in social media. Hsu and Lawrence (2012) pointed out that such social media outcries affected word of mouth (WOM) and can damage brand equity. In reality, the tax rate aspect of the deal was quite modest (Sahadi, 2014), as BK's U.S. effective rate was about 27.5% and Canada's was 26.5%. Experts pointed to another, far greater tax benefit, however. Profits repatriated to a Canada-based BK would not face double taxation as they would in the U.S. This amounted to a 40% tax on $500 million a year in foreign income. The market's response was clear: Hortons' stock price went up by 19%, a common response for targets of acquisitions. BK shares went up by 19.5%. Combined, these increases generated $5 billion in new market value. How much of this increase belonged to synergy benefits versus tax benefits was debatable, however. Before finalizing the deal, Behring had a notable example to consider. Walgreens had purchased 45% of Swiss firm Alliance Boots GmbH in 2012, with an option to buy the balance. When completed, this move would create the first global pharmacy enterprise with 11,000 stores in 10 countries, and a global wholesale distribution network (Walgreens Press Release, 2014). The merger held the potential for major cost efficiencies, just as BK hoped to achieve through its merger. Moreover, moving Walgreens' tax residence to Europe offered major tax advantages. U.S. investors reacted favorably over the summer of 2014 to the anticipated Walgreens move. Although Walgreens had sophisticated social media capabilities (Bruell, 2012), social media forces went to work in a significant effort to disrupt the merger (Carr, 2014). …

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