Canada’s pharma sector can benefit from America’s terrible corporate tax code
Unfortunately, the Canadian pharmaceutical company most discussed these days is Valeant Pharmaceuticals International, Inc., headquartered in the Montreal suburbs. Criticized for eye-popping price hikes for it's medicines, and embroiled in boardroom drama, Valeant is not really a poster child for Canadian medicines.
Nevertheless, innovative Canadian drug-makers should be able to exploit a competitive advantage dropped into their laps by the U.S. Treasury’s 300 page-plus batch of regulations that blew up the merger between Pfizer and Allergan in early April. The deal was a so-called “inversion,” a deal whereby a U.S.-domiciled company reverses itself into a foreign firm for the purpose of reducing its U.S. tax burden.
In a recent op-ed in the Wall Street Journal, Pfizer’s CEO, Ian Read noted:
Surely we benefit from world-class academic institutions, a highly skilled labor force and other attractions of doing business in the U.S. But the key point is so do our foreign competitors. And they pay significantly less for the privilege. So we compete in a global marketplace at a real disadvantage. The U.S. tax code has among the highest rates in the Western world and forces its multinationals to pay U.S. tax on income earned abroad if they want to bring it back to this country.
The real-world consequences are significant. In Cambridge, Mass., where Pfizer has a state-of-the-art research lab, we are surrounded by foreign-owned competitors’ facilities. When those companies invest in their facilities, it is often as much as 25%-30% cheaper than every dollar we put into research and jobs. Why? Because our competitors don’t have to pay the penalty imposed on U.S. corporations bringing earnings back to America. We can invest less—because of a broken tax system.
Pfizer’s friendly deal with Irish-based Allergan was confirmed on Nov. 23. I will leave better minds to wrangle with whether the new regulations are legal or not. To me, dropping these new rules into a merger that has been disclosed for more than four months looks perilously close to a violation of the U.S. Constitution’s prohibition on ex post facto laws; or even a bill of attainder, because it so clearly targets Allergan. The rules target “serial inversions,” and Allergan is the world champion serial inverter. The key to inversion is that the foreign parent can lend money to its U.S. subsidiary. The interest on that debt is a deductible expense (like all interest expense), thus reducing the company’s U.S. tax burden.
The new rule significantly reduces this advantage.
Treasury now proposes to ignore U.S. assets acquired by inverters over the previous three years. This rule is clearly aimed at Allergan, which is the result of a number of inversions, starting with the 2013 inversion of a New Jersey drug-maker into an Irish one.
Here’s the worst of it: There’s no saying how much of Pfizer’s and Allergan’s valuable management time has been chewed up trying to figure out this inversion. Under a low U.S. corporate tax rate and a tax code that was easy to navigate, pharmaceutical executives could seek merger partners based only on acquiring and developing sustainable competitive advantage in medical innovation.
The U.S. Treasury’s new rules signal that will not happen soon. These self-defeating rules favour foreign pharmaceutical companies, which can invest in U.S. R&D and commercial operations, while U.S. pharmaceutical companies are strangled by a punitive tax code.
It’s a benefit Canadian pharmaceutical companies can exploit.
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