Wednesday, December 29, 2010

Excellent Bloomberg Analysis: Of The Legacy Schering-Plough/New Merck Tax Avoidance Contortions

Writing for Bloomberg tonight, Jesse Drucker has an excellent analysis of the astonishing level of "sub-rosa corporate welfare" underway -- via trivially miniscule US tax payments made on transfer-priced income made by multinational pharma concerns, in tax havens like Puerto Rico, Ireland and Costa Rica. Do go read it. It did not escape the notice of Bloomberg that thus far, Schering-Plough has been the only large pharma to lose a "haven repatriation" restructuring/transactional case to the IRS. It should not excape the readers' notice here, either -- as was plainly true on several fronts, Schering's lawyers had pushed to the very edge of the enforcement envelope -- and then pushed, just a little bit beyond it. Last year, a federal judge hit the company with a nearly $500 million judgment for playing far too much tax-avoidance footsie.

Here is the background on that Schering-Plough loss, as I had previously reported back in August of 2009. [Note that Schering-Plough's then General Counsel, Tom Sabatino, was also then in favor of the idea of distorting the attorney client privilege doctrine, for certain kinds of corporate work product, well beyond the existing state of the law. And, why?

Well, because the various schemes and slides drawn up under his supervision in Kennilworth had likely cost him the case, against the IRS (to the tune of nearly a half-billion dollars). In the able federal judge's entirely non-novel view, schemes to avoid taxes (as opposed to simply minimizing them) are plans to overtly violate the law. As such, the judge had ruled that the Schering-Plough slides and schemes could not fall under attorney client protections. Mr. Sabatino has since also resigned from his most-recent employer, United Airlines.]

In any event, below is a bit of the long and well-sourced Bloomberg article -- do go read it all:

. . . .Merck. . . the second-largest drugmaker in the U.S., last year brought more than $9 billion from abroad without paying any U.S. tax to help finance its acquisition of Schering- Plough Corp., securities filings show. Merck is also appealing a federal judge’s 2009 finding that Schering-Plough owed taxes on $690 million it had earlier brought home from overseas tax-free. . . .

With the exception of the Schering-Plough case, no authority has accused Merck. . . of paying less tax than [it] should have. . . .

Last year, Merck, based in Whitehouse Station, New Jersey, tapped its offshore cash, tax-free, to pay for just over half the cash portion of its $51 billion merger with Schering-Plough, according to company filings.

At the deal’s closing, Merck’s foreign subsidiaries lent $9.4 billion to a pair of Schering-Plough Dutch units. Then the Dutch companies used those funds to repay a pre-existing loan from their U.S. parent, securities filings show. The $9.4 billion ended up with Schering-Plough shareholders as part of the cash owed under the merger, according to the company’s disclosure.

No Tax Hit

Bottom line: Merck used its overseas cash to pay the former Schering-Plough shareholders -- with no U.S. tax hit. In considering whether companies owe taxes in such cases, the IRS often asks whether payments from an offshore unit constitute a dividend, which would be taxable.

In Merck’s case, it arguably could be, said Robert Willens, who runs an independent firm that advises investors on tax issues.

“Merck was obligated to pay Schering-Plough shareholders and they tapped into the funds of their overseas subsidiaries to do it,” he said. “You’d have to be concerned about a constructive dividend there. . . .”

In the Schering-Plough case decided last year, the drugmaker brought home $690 million tax-free as a result of assigning its rights to income from a complex interest-rate swap to a foreign subsidiary in the 1990s. A judge found the company “failed to establish a genuine purpose for the transactions other than tax avoidance” and said Schering-Plough was not entitled to $473 million in back taxes in dispute. Merck is appealing the judgment. . . .

So, the next time you hear a Republican politician, or a red-faced CEO complaining about the level of cost for health care as any form of "socialist" medicine, please remind yourself that these very same multinational corporations are, and have been for decades, among the largest beneficiaries of one of America's most "socialist" of policies -- essentially free-passes, on corporate income taxes -- for the unimaginably wealthy ficticious persons we've chartered as corporations in the US. These non-people generate between $10 and $15 billion in net profits quarterly, year after year (among just the top 20!), and pay almost no tax on these profits -- decade after decade. And no one even mentions this.

If that's not wrong -- then I don't know what is. These corporations enjoy all the benefits of the most-liquid capital markets on the planet, the most-developed infrastructure on the planet, the highest standards of living (for their key executive officers, and boards of directors) -- but simply will not pay their fair share for roads, bridges and schools -- to say nothing of national defense, or humane health care, for all. And that, my friends, is simply appalling.


Anonymous said...

The tric is easy, The Netherlands have a minor tax on income from foreign sales. You situate a HQ in The netherlands, an office with a secretary. After you pay 1 or 2% tax in The Netherlands about money transferred from other countries to The Netherlands you transfer the money to the USA with the statement you already paid taxes about the money you transfer to the USA. Ireland has a same construction.

condor said...

While I hear you, when the numbers grow into the hundreds of millions, and billions -- the United States tax law side fo the equasion becomes more complex.

US companies must prove that -- in your example -- the second "transfer of money FROM the Netherlands", back to the US -- is NOT a "constructive dividend".

Under US tax laws, constructive dividends are a assessed a tax at almost the rate that original income on operations would be assessed.

Thus this whole multi-billion dollar industry -- made up of firms of tax lawyers, M&A lawyers, accountants, financiers and MBAs -- has evolved to create structures and strategies like "Killer B" and "Deadly D".

So -- I hear you, but almost all this torturing of what would be ordinary dividend payments -- happens here, stateside.

Namaste, and thanks for the info on the Dutch havens!

Florida Tax Professionals said...

Indeed countries like Netherlands, Monaco, Switzerland are tax heavens.