For anyone who can’t tell the difference between EBITDA and NOPAT or simply isn’t bothered about accounting terms like these, corporate inversions are actually pretty boring.
However, inversions are pretty simple to understand. Say you own a media company in the United States and have been running this firm for many years. In the past, most of your profits were made in America, so you paid your taxes and moved on. But recently you’ve been using the internet a lot and now have clients from all over the world, paying you in ten different currencies.
You probably don’t want to pay American taxes on this non-American income, so you find a company in a country where the tax rate is low, buy it and convert your company into a foreign company. That’s an inversion.
Corporate inversions were not very common before the 1980s simply because the world wasn’t as connected then as it is now. Multinationals were rare and money was mostly generated within one’s own country. But this is no longer the case. Now, even small companies can set up shop abroad and avoiding taxes isn’t just a thing rich people do anymore, everyone is involved.
The Panama Papers leak goes to show that big companies and wealthy individuals can store their wealth away on a nice little island with no taxes. Payments that come to Google or Apple or Netflix from India, for example, go into a subsidiary in Ireland, Singapore or the Netherlands. It’s pretty much an open secret how the big corporation cut taxes. It’s all very clever, but completely legal.
But inversions go one step further and change the location of a corporation. These inversions are now in the spotlight, since the Allergan/Pfizer merger issue started. The fact that these were big pharma companies (which are controversial for their pricing strategies anyway) helped the issue attract even more attention. And since it’s an election year, such a major deal and large amount of money not going into the government’s pocket becomes an even bigger issue. But the new anti-inversion rules from the US treasury have some far reaching effects.
The new rules discourage US companies from inverting abroad and cutting down taxes, but they have also disrupted the Allergan Pfizer deal, which is the biggest deal in history to fall apart. Critics are arguing that this does harm to the economy and it’s easy to see why- foreign corporation may be wary of using debt to fund a US plant if they don’t think the debt will actually be treated as such. Pfizer’s chairman argued that the new rules mean foreign acquisitions of local companies will increase, which will cut local jobs.
But the US Treasury has made it’s decision, Hillary Clinton has made it firmly part of her campaign and the public’s opinion on the issue is unlikely to change any time soon. So, in short, that is how a boring merger strategy became front-page news.