Closure of Window for Tax Inversion Might Not Deter Pharma Giants from Acquiring Peers

American pharmaceutical and medical device players are proactively seeking to acquire their global competitors. However, with recent deals pending, the American government is planning to implement controversial corporate tax reform. Changing domicile to save on taxes is the primary motivator, but there are also other advantages to rebasing, so that merger and acquisition activity might therefore be more muted, but not killed in the years to come.

Encouraged by a reluctance to pay high corporate taxes in the US market, tax inversion is the hottest financial savings instrument of the moment. The recent acquisition of Shire by AbbVie, labelled as the biggest tax inversion deal ever, and seven more deals this year, are pending as the US government seeks to curb the relocation mania.

Presently, the rule holds that inversion is possible if at least 20% of the consolidated (the new) company is owned by foreign shareholders, which makes targets pretty big companies themselves. In its 2015 budget plans, the US administration is proposing to increase the threshold to 50%, which would make the inversions nearly impossible. The new regulation is being hurried in due to an initiative seeking to introduce the law retroactively – from May 2014 – threatening the eight deals this year.

Despite the rather drastic measures and estimated savings of almost US$20 billion over the forthcoming decade, the likely success of the proposed reform is debatable since it addresses the consequences rather than the cause. Opponents therefore suggest changing the rigid corporate tax code, which is one of the highest in the developed world. The American corporate tax rate is 35%, significantly higher than the UK’s 21% or the figure of just 13% in Ireland. However, acquisitions and changing domiciles have other advantages than just tax savings, as proved by the most recent deals made by AbbVie and Mylan Laboratories.

AbbVie’s chairman and chief executive Richard Gonzalez stressed that, in addition to the tax savings, no less important reasons for acquiring Shire were research and development capabilities and enhancements in the pipeline. After all, it is easier to make an acquisition than go through the whole research and development process. With the company’s patent for Humira, its star drug for arthritis, expiring in 2016, Shire provides it with the chance to exploit the expansion opportunities in rare diseases, neuroscience or immunology as well as take advantage of drugs for attention deficit hyperactivity disorder, which are on the rise at present. Diversification of the business into generics is a reason (in addition to tax inversion) that might be highlighted by Mylan Laboratories in its acquisition of the generics operations of Abbot Laboratories.

2014 will definitely be a boom year for mergers and acquisitions – and not only in the pharmaceuticals and medical devices businesses – and tax inversion will be cited as costing Americans billions. However, since the healthcare industry is predisposed to merger and acquisition activity not just because of financial reasons, acquisitions are forecast to continue to be seen.