A proposed takeover of Canada's beloved Tim Hortons Inc. has put the iconic coffee chain directly in the line of fire of United States lawmakers who are worried about corporate taxes and whether American companies are using foreign takeovers as a way to avoid paying their fair share.
Tim Hortons is already feeling heat from an announcement late Sunday that it plans to merge with Burger King Worldwide Inc. and suggestions the American fast-food chain might relocate to Canada for tax purposes. On Monday, Sherrod Brown, a U.S. senator from Ohio, urged Americans to boycott Burger King in favour of other restaurant outlets that "haven't abandoned their country or customers."
The tax plan that is expected to be included in the merger is known as "tax inversion." If the takeover goes through, Burger King and Tim Hortons will be controlled by a Canadian holding company, bound by Canadian "territorial" tax laws and rates which are generally lower than in the U.S.
U.S. tax rules require corporate revenue to be taxed at a 35-per-cent federal rate, one of the highest in the developed world, regardless of whether the money is made at home or abroad.
In Canada, companies are taxed at around 26 per cent on income earned domestically.
Any revenue earned outside Canada is taxed according to the tax code in the country where the income was generated.
Because Burger King and Tim Hortons are keeping mum on their plans, other than confirming they are in talks, it is difficult to determine precisely how much they will benefit from the inversion.
About 48 per cent of Burger King's revenue came from outside the U.S. in 2013, and it is this income that could benefit from Canada's territorial tax regime. But for now, the mere optics of avoiding taxes looks unpatriotic. "It's much more symbolic than anything else," said James Hines, a professor at the University of Michigan and one of the few academic experts on tax inversions. "There's a doomsday tendency in these settings to think that everything's going to come apart."
Many U.S. lawmakers argue they have good reason to employ their rhetoric. At least 15 American companies have proposed inversions in 2014 alone, and large, iconic brands are joining the fold, helping to catch the average American's attention. Drug giant Pfizer Inc.'s recent proposed $126.3-billion takeover of Britain's AstraZeneca PLC "was a lightning rod because it's such a big company," said Mihir Desai, a professor at Harvard Business School and a widely respected voice on inversions. AstraZeneca has since rebuffed the bid.
U.S. retailer Walgreen Co. also flirted with the idea, but ultimately decided against buying the remaining portion of of Switzerland-based drug store chain Alliance Boots GmbH it did not own because the deal proved to be too complicated. Washington also put Walgreen in the political hot seat over its proposal.
The political uproar largely owes to an outdated tax code. "Many countries looked like the U.S. 30 years ago," Mr. Desai said. In the years since, large developed countries started opting for territorial tax regimes like Canada's, particularly in the past five years when both Britain and Japan updated their tax policies. "The U.S. has been the slowest to change," he added.
The difficult thing now is determining the best way to deal with the issue of inversions. After a flurry of deals in the late 1990s and early 2000s, that saw companies such as Tyco International move their headquarters abroad, U.S. lawmakers cracked down by raising the bar to qualify for such a deal. After new laws were passed in 2004, companies could no longer simply relocate on paper – they had to find a partner and merge. And even then, at least 20 per cent of the merged companies' shareholders had to be foreign, a threshold Burger King would meet with Tim Hortons.
But the latest flurry of inversions proves that it only takes time to ultimately skirt any rules. Companies such as Tim Hortons are willing to step up to the plate – sometimes for the right reasons, others simply for tax purposes. If the federal government wants to crack down again, President Obama must now decide if he should opt for a short-term "Band-Aid," as Mr. Desai put it, or push for structural, sweeping reforms to the federal tax code.
The clock is ticking. Bill George once ran medical device maker Medtronic, and his former company now has plans to merge with Dublin-based Covidien in a $43-billion (U.S.) inversion. While Mr. George supports this particular transaction because he believes there is solid strategic rationale for it, he acknowledges that it is hard for CEOs to sit back and watch rivals merge.
Too often, chief executives will think, "I've got to go find [an inversion] because my competitors did," Mr. George said. These mergers only make sense if they offer synergies, the two companies have a good strategic fit and employees will be treated well. "If you can't pass all those tests, don't do it."