Why the Tax 'Inversion' Controversy Doesn't Matter

NEW YORK (TheStreet) -- Of all the things Congress and President Barack Obama might do to hurt the stock market, closing tax loopholes on corporate tax "inversion" mergers isn't one of them.

All summer, Washington has been in a tizzy over mergers between U.S. companies and offshore rivals where the merged company incorporates outside the U.S. to avoid corporate income taxes. The U.S. taxes corporate profits at a top 35% rate while Ireland, to pick one popular destination, charges only 12.5%.

To the left, these kinds of mergers are the latest sign of the 1% cashing in on the rest of us. To the right, they're a sign U.S. tax rates are too high, although effective U.S. corporate taxes are close to the developed-nation average because of more generous deductions.

Let's take the politics out of it for a moment. What investors need to know is that inversion deals are a tiny share of the merger market -- a whopping total of 10 inversions have been completed since 2011, according to Thomson Reuters. Only seven involved companies worth $1 billion or more -- and only 16 inversion deals that large have even been proposed.

If the rules are tightened by Congress, the likeliest proposals will affect even fewer deals because some will still qualify. For most companies driving the merger boom, the strategic and business rationales for the deals were the point before and will be the point after any change in policy.

In other words, if you're inclined to place merger bets, bet away.

In the first half of 2014, the dollar volume of mergers hit a seven-year high, driven by a relatively small number of very large deals. Thomson Reuters reports $1.46 trillion worth of U.S. deal announcements through Sept. 9, with deals like the $48.5 billion AT&T (T) -DirecTV (DTV) merger, Time Warner Cable (TWC) -Comcast (CMCSA)  and Facebook's (FB)  acquisition of WhatsApp near the top of the list. In all, there have been 49 deals U.S. worth $5 billion or more. For much of the year, the low end of the market has slowed down slightly, with more than 18,000 deals overall.

None of this happened because taxes were cut on inversion deals -- they've been the same since 2004. Neither was there any big movement to raise them before the announcement of a half-dozen deals this year kicked off Washington's furor.

There are three big reasons why the legislationTreasury Secretary Jack Lew is urging will change little.

1. The "inversion loophole" doesn't apply if both companies are based in the U.S.

It's been illegal since 2004 to move headquarters outside the U.S. for tax purposes alone, as companies like Tyco used to do, all while their operations and execs stayed here. So in looking at this year's mergers, deals like AT&T-DirecTV would be left intact. So would Facebook-WhatsApp, Comcast-Time Warner Cable, and Family Dollar (FDO) and Dollar Tree  (DLTR) .

2. The likeliest proposal would protect the tax status of still more deals.

Democrats have proposed a standard that mergers be denied inversion tax status unless the owners of the non-U.S. partner own at least half of the merged company, up from 20% now. This would make companies like the proposed merger of Covidien (COV) and Medtronic (MDT) pay U.S. taxes. But the controversial Burger King (BKW) -Tim Hortons  (THI) merger -- which fed the brouhaha because conservatives felt obliged to tweak Warren Buffett for financing a deal that evades taxes although Buffett favors higher tax rates for the rich -- would be just fine. Tim Horton holders will own 73% of the company. 

3. Many of the remaining mergers make perfect sense for non-tax reasons.

This explanation can be simple, or difficult. I can explain the stagnation of the medical device business and how it's been affected by Obamacare, which would have led Minneapolis-based Medtronic to buy something like its smaller rival Covidien, which is based outside of Boston but pays taxes in Ireland. Similarly, we can parse the state of Pfizer's drug pipeline.

 Or I can invite you to have a perfectly crappy breakfast at Burger King.

You can argue over whether Burger King's tax bill will decline (management says it's about the same), but you can't dispute that the pending deal marries a U.S. fast-food chain that does a terrible job at breakfast, which rival McDonald's (MCD) has dominated for years, with a chain that makes its living in the morning. Deals that make sense for non-tax reasons like these will still get done.

Factor it all out, and you come up with maybe three to five deals a year that will likely go away if the inversion rules are reformed. They'll be mergers of unequals between U.S. and non-U.S. partners that make little strategic sense. If the only idea a management team has to boost profits is to pretend to be based in Ireland, the economy loses even less from forcing their boards to replace them. 

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.


TheStreet Ratings team rates BURGER KING WORLDWIDE INC as a Buy with a ratings score of B-. TheStreet Ratings Team has this to say about their recommendation:

"We rate BURGER KING WORLDWIDE INC (BKW) a BUY. This is driven by multiple strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its solid stock price performance, impressive record of earnings per share growth, compelling growth in net income, expanding profit margins and good cash flow from operations. Although the company may harbor some minor weaknesses, we feel they are unlikely to have a significant impact on results." You can view the full analysis from the report here: BKW Ratings Report

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