Monthly Article

October 2014 Monthly Article – Tax Inversion and Competition

By Jerry Pacheco

Burger King buys Canada’s largest fast food chain, Tim Hortons, and a wave of new controversy is unleashed in terms of how to perceive and deal with U.S. companies that move their headquarters to foreign countries in order to avoid U.S. corporate taxes. It is common for U.S. companies to conduct mergers with foreign counterparts. However, it seems to be a current trend for them to seek foreign tax shelters in reaction to what are perceived to be high U.S. corporate taxes.

It is not unusual that Burger King merged with Tim Hortons. By doing so, the new company will account for more than $23 billion in worldwide sales and more than 18,000 locations in approximately 100 countries. It will become the third largest fast-food chain in the world. By establishing the headquarters in Toronto, the new merger is following a popular strategy called tax inversion, which simply means that a company (in this case Burger King) relocates its headquarters to a country with lower taxes, while still maintaining the bulk of its operations in its home country.

For Burger King’s case, the implementation of a tax aversion strategy is telling. In the U.S., the company is subject to a 35 percent corporate tax rate. In Canada, the company will have to pay a 15 percent corporate tax rate, along with an 11.5 percent tax rate that is applied in Toronto, for a combined rate of 26.5 percent. This results in an 8.5 percent difference, which will allow the Burger King portion of the company’s profits to be subject to a lower tax rate, and thus millions of dollars in savings. These savings can be used in market development or to attract new investors.

The latest wave of companies adopting the tax inversion strategy has set off finger pointing between Democrats and Republicans in the U.S., each side accusing the other of adopting counterproductive positions or ignoring the problem while U.S. companies move their headquarters to foreign countries. President Obama has accused these companies of taking advantage of an “unpatriotic loophole” and leaving hardworking U.S. families to pick up the slack. Republicans accuse the president of being a “tax and spend” liberal and providing no leadership on this issue.

Solutions being proposed to fix the loophole range from lowering U.S. corporate income taxes to penalizing tax aversion practitioners. However, the tax aversion issue, much like immigration reform, seems destined to end up in a Congress that is stuck in political quagmire when it comes to solving critical issues.

Business environments are not static – they need to constantly be tweaked and improved based upon what the competition is doing. Countries cannot exist without facing competition for attracting new investment and creating jobs by other countries that are desperate for the same things – unless of course we take an extreme example such as North Korea, whose citizens routinely are at the bottom of most socio-economic charts.

Nor do countries only compete in their own region. On the contrary, countries in regions such as North America have formed trading blocs to compete against other regions of the world. The irony in the Burger King case is that the U.S.’s most important trading partner, Canada, is benefiting at the expense of the U.S.

The bottom line is that countries compete in a global market, and they have to make themselves as attractive as possible to successfully land business investment, which leads to a multiplier effect of supplier bases and new employment. The other cold-hard fact is that the number one goal of corporate boards of directors is to maximize the value of the shareholders’ stock. This often puts a local company in a position of being caught between patriotism for its home country, making money for its stockholders and being able to compete globally.

The solution to the tax aversion problem is not an easy one. For countries, there is a fine line between attracting businesses to boost the economy versus giving the farm away in order to attract investment. Attracting and retaining investment depends on a myriad of factors including a skilled workforce, supplier bases, good infrastructure, minimal red tape, job creation incentives and a favorable tax base. Some of these factors will take years to improve, and all of them need to be tended to in the long term. As the competition fine tunes its approach, the U.S. must do the same. In the meantime, unless we are content as a nation to stand by while companies relocate their headquarters to countries with more favorable tax environments, President Obama and Congress need to come up with a solution to the tax aversion issue as soon as possible.