Medtronic Inc., the Minneapolis-based medical device maker is buying out Covidien Plc. for $42.9 billion, a 30% premium to Covidien’s market capitalization just prior to the merger. Due to its global sales by offshore subsidiaries, Medtronic has amassed $20.5 billion in foreign bank accounts that have avoided a 35% tax haircut by not being repatriated to the United States.
The United States is one of the few countries in the world that taxes foreign earnings of companies that have the misfortune of being domiciled in the U.S.
Currently, the only way of avoiding this taxation is by deferring bringing the money back in the United States or merging the American company with a foreign company and moving to a tax-friendly nation such as Ireland (where Covidien is legally domiciled).
In addition, foreign taxes are typically half of the U.S. corporate rate of 35%. Ireland’s corporate tax rate is even lower: a third or 12.5% of the U.S. corporate tax rate. Taxes can be lowered even further in companies such as biotechnology companies with strong intellectual assets such as patents by transferring those patent portfolios to foreign countries that have low or no taxes on patent-generated revenue.
When Tyco moved to Bermuda in 1997, (a country with no corporate taxes), it started a migration of companies fleeing the onerous tax policies of the IRS. Congress stopped the initial wave of corporate inversions by taking away the tax benefits unless the surviving company had at least 20% of its ownership retained by the takeover target’s shareholders. In Covidien’s case, its shareholders will retain over 30% of the merged company.
Unless Congress legislates new rules that Democatic Senator Carl Levin has submitted that raises the 20% threshold to 50%, a level that is so farcical that none of the 20 or so recent inversions carried out in the past ten years would have been eligible, it looks like Medtronic’s inversion will be successful.