August 27, 2014

Burger King the Latest to Jump on the Corporate Tax Inversion Bandwagon

A number of corporations have engaged in corporate tax “inversions” this year, which typically involves a large U.S. company merging with a smaller counterpart in a lower-tax country abroad, then moving the corporate billing address to the lower-tax country to reduce the overall tax burden. The actual headquarters and the executives go nowhere, but the nominal address changes so the company can avoid U.S. tax rates. A number of corporations in the pharmaceutical space have pulled this off in 2014, but it took the drugstore giant Walgreen to flirt with the idea (through a merger with the Swiss company Alliance Boots) for the non-financial press and the public to really catch on. Outcry actually stopped Walgreen from going through with the inversion; they merged with Alliance Boots, but kept their headquarters in the U.S. Clearly, it was easier to rally public scrutiny to a consumer-facing brand attempting to skip out on America while still using the public resources afforded any company selling their wares here.

Now, the same coalition that stopped the Walgreen inversion will get another chance with Burger King:
Burger King Worldwide Inc. is in talks to buy Canadian coffee-and-doughnut chain Tim Hortons Inc., a deal that would be structured as a so-called tax inversion and move the hamburger seller’s base to Canada. 
The two sides are working on a deal that would create a new company, they said in a statement, confirming a report on the talks by The Wall Street Journal. The takeover would create the third-largest quick-service restaurant provider in the world, they said.
Inversion deals have been on the rise lately, and are facing stiff opposition in Washington given that they threaten to deplete U.S. government coffers. A move by Burger King to seal one is sure to intensify criticism of them, since it is such a well-known and distinctly American brand.
Tim Hortons actually has a pretty big following in America as well, particularly in the northeast and upper Midwest. They have over 850 U.S. locations (compared to 3,500 in Canada), with over $500 million in annual U.S. sales. They have 100 co-branded stores in America with Cold Stone Creamery, the ice cream shop owned by Kahala Management.

So this is at one level a merger between two American brands (which would apparently continue to operate stand-alone). Only Tim Hortons has a corporate structure and a history and a foothold in Canada, so Burger King wants to jump across the border and take advantage of their newly minted 15% nominal corporate tax rate.

Oddly enough, this would be the second burger joint pairing for Tim Hortons. In 1995, Wendy’s bought them out, and owned them for 11 years. After Bill Ackman and some other activist investors bought significant shares in Wendy’s in 2006, Tim Hortons spun back off through an IPO (traded on the NYSE), and by 2009 had organized themselves as a Canadian public company. (Hilariously, Ackman today has a big stake in Burger King.) As far as I can tell, Wendy’s never considered moving to Canada in 1995 to lower their tax rate. But it’s a different world now.

Interestingly, Scout Capital Management and Highfields Capital Management just bought a bunch of Tim Hortons stock in what seemed like a prelude to a private equity deal. They requested that Tim Hortons curtail U.S. expansion plans and take on more debt. So Burger King may save Tim Hortons from a private equity nightmare, in addition to saving themselves a big chunk of change. Of course, Burger King itself is both public but also controlled (through 70% of the shares) by private equity company 3G. If you find any company these days not touched in some way by private equity, let me know.

Burger King will certainly face some pressure to back down on the corporate restructuring aspect. The President has given a number of public statements against inversions, and the Treasury Department is in the midst of putting together rules on the subject to try and discourage them. Democrats seem to think that railing against companies deserting America will play well in the midterms, and they’re painting Republicans as indifferent to the practice. For their part, Republicans pay lip service to wanting to address inversions, but only in the context of overall tax reform that lowers corporate rates as it also closes loopholes (or at least pretends to do so). This is rooted in the noble lie that American corporations pay the highest tax rates in the world, which simply isn’t true when you look at the effective rates rather than the nominal ones. Corporate tax collection as a percentage of GDP was 17th out of 27 wealthy countries in 2011, per the OECD.

Long before the President and the Dem machine got involved, consumer and anti-corporate groups have been calling attention to inversions, which certainly serve to satisfy the drive for higher corporate profits, but carry a heavy aura of unseemliness with them. Especially as this one involves a fast-food chain that’s already in the sights of activists for their low wages, I think it’s ripe for a public campaign. I asked Frank Clemente, executive director of Americans for Tax Fairness, to comment about the rumored inversion:
Burger King’s announcement is one big whopper. If the company goes through with an inversion and deserts America, its customers are likely to bring their business down the street to the nearest McDonald’s or Wendy’s. Walgreens got the message that its inversion would be very damaging to its brand, and it walked away from a deal. Hopefully, Burger King will do the same. While changing its address to Canada rather than a tax haven country may not appear on the surface to be so objectionable, if the intent is to dodge paying its fair share of taxes the American people are likely to be no less sympathetic to Burger King.
With the 15% nominal rate in Canada, this is absolutely a move about taxes. As WSJ points out, a 2010 merger between Valeant Pharmaceuticals International and Biovail Corp, which led to a redomiciling in Canada, produced a company that “now has a tax rate less than 5%.” So this move would clearly save Burger King billions of dollars.

Once one of these brands successfully breaks through and moves their headquarters overseas, without significant blowback that hurts sales, it’ll be a run for the exits. Capital mobility has a long and storied history, and it’s even easier when you don’t have to move anything, just simply change the address on the corporate letterhead.

The bigger issue here is how the concept of shareholder value highlights the profit-at-all-costs mentality that has permanently changed the worldview inside corporations and the pools of private capital that increasingly run them. And I don’t know exactly how that changes. Maybe inversions are just a tipping point into some activism that gets at the fundamental root cause.

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