Should Companies Use Acquisitions and Financial Engineering to Reduce Corporate Taxes?

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Perrigo (NYSE: PRGO), an American company best known for selling generic medication, baby formula and nutritional supplements, recently acquired Irish drugmaker in Elan (NYSE: ELN) for $8.6 billion in an unexpected deal that initially left investors puzzled. After all, what would Perrigo gain by acquiring Elan, a biotech primarily focused on experimental treatments for neurodegenerative and autoimmune diseases? The answer was simple - lower tax rates.

A big buy for even bigger savings

Through the acquisition, Perrigo joined Apple (NASDAQ: AAPL) and several other major companies in using Ireland as a tax haven. After the purchase, Perrigo is moving its bank accounts to Dublin, Ireland, where the corporate tax rate is a mere 12.5%, compared to the 35% it was paying in the United States. Yet in terms of complementary businesses or cost-saving synergies between Perrigo and Elan, there are none.

Prior to Perrigo’s takeover, Elan fought off three hostile bids by investment firm Royalty Pharma, which resulted in numerous injunctions, court hearings and widely publicized PR battles. Allergan, Mylan International and Endo Health Solutions were also rumored to be interested in acquiring Elan. Perrigo’s offer came in at a 10.5% premium over Elan’s previous closing price.

In February, Elan sold its 50% interest in its blockbuster multiple sclerosis treatment, Tsybari, to its partner Biogen, but retains royalty rights to the drug, which generated $1.6 billion in revenue last year. Elan’s royalty payments amount to 25% of future sales of the drug, which could either continue generating revenue for Perrigo, or be sold to another interested buyer, such as Royalty Pharma.

A controversial but unoriginal move

Perrigo’s acquisition of Elan has revived the controversial debate that the Senate’s hearing on Apple in May started - are companies right to take advantage of tax loopholes to maximize their profits to avoid overzealous taxation, or should the American government be worried that this bad behavior from larger companies is setting a dangerous precedent in international business?

Back in May, fellow generic drugmaker Actavis (NYSE: ACT) also made a similar purchase, buying Dublin-based Warner Chilcott (NASDAQ: WCRX) for $5 billion to lower its corporate tax rate from 28% to 17%. Unlike Perrigo, however, Actavis’ primary reason for purchasing Warner Chilcott was its diverse portfolio of drugs, which includes branded medications for women’s healthcare, dermatology and urology. Actavis CEO Paul Bisaro referred to the tax reduction as “icing on the cake.”

Actavis, which is already the largest maker of generic medications in the world, has grown from a primarily domestic company to a multinational one with a portfolio that is diversified through brand-name treatments. Just like Apple, Actavis feels justified in the reduction of its corporate tax rate, since it now generates a large portion of its revenue overseas, especially after its $5.5 billion acquisition of Swiss generics maker Zug last year. Actavis’ sales of generics, sold through its Pharma segment, reported a 58% year-on-year gain in revenue to $1.6 billion last quarter, accounting for 80.4% of the company’s top-line. 40.6% of those generic sales, or $649.8 million, came from international markets, which reported 209% year-on-year growth.

In addition to Actavis, pharma giants Pfizer, Amgen and Eli Lilly have all shifted significant parts of their businesses to countries with lower corporate tax rates.

Big Pharma still can’t match Big Tech’s tax rates

Although the tax rate reductions that Perrigo and Actavis have reported are certainly impressive, they pale in comparison to Apple and Microsoft’s accounting skills.

Apple’s foreign tax rate sits at 2%, based on a clever organizational shift that uses an Irish company to purchase its assembled iPhones and iPads from China, and then sell them to distributors across the world. Since those sales aren’t considered Irish transactions, they aren’t taxed by the Irish government, yet Apple’s Irish subsidiary still receives the international profits. Only sales of iPhones and iPads within Ireland are taxed at a normal corporate rate.

Microsoft, on the other hand, went for a far more complicated system by using tax havens like Ireland, Puerto Rico and Singapore. Microsoft sold the intellectual property rights of its retail businesses to various companies in tax haven countries, and reportedly dodged $2.4 billion in U.S. corporate taxes in 2011 as a result.

The Foolish Bottom Line

In conclusion, big companies aren’t waiting around for the U.S. government to fulfill its vague promises of lowering the corporate tax rate from 35% to 28%. Big companies which started in the United States have discovered that it’s much easier to simply shift their operations overseas instead, and this trend will likely accelerate in the future, since the 28% proposed by President Obama is still hefty compared to the much lower tax rates that companies that Perrigo, Actavis, Apple and Microsoft have cleverly engineered.

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Leo Sun owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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