A growing number of U.S. companies are looking to trim their tax bills by combining operations with foreign businesses. It's a trend that might eventually cost the federal government billions of dollars in revenue.
Generic drugmaker Mylan said Monday that it will become part of a new company organized in the Netherlands in a $5.3 billion deal to acquire some of Abbott Laboratories' generic-drugs business. The deal is expected to lower Mylan's tax rate to about 20 to 21 percent in the first full year and to the high teens after that.
The Canonsburg, Pa., company's deal follows a path explored by several other U.S. drugmakers in recent months. AbbVie has entered talks with Shire over a $53.68 billion deal that would lead to a lower tax rate and a company organized on the British island of Jersey.
But drugmakers aren't the only companies looking overseas for better tax deals.
Last month, U.S. medical device maker Medtronic said it had agreed to buy Ireland-based competitor Covidien for $42.9 billion in cash and stock. The combined company would have executive offices in Ireland, which has a 12.5 percent corporate income tax rate. And drugstore chain Walgreens, which bills itself as "America's premier pharmacy," is also considering a similar move with Swiss health and beauty retailer Alliance Boots.
These tax-lowering overseas deals, called inversions, have raised concerns among some U.S. lawmakers over the potential for lost tax revenue. But business experts say U.S. companies that find the right deal have to consider inversions because of the heavy tax burden they face back home.
At 35 percent, the United States offers the highest corporate income tax rate in the industrialized world. By contrast, the European Union has an average tax rate of 21 percent, said Donald Goldman, a professor at Arizona State University's W.P. Carey School of Business.
In addition to the higher rate, the United States also taxes the income companies earn overseas once they bring it back home. The tax is the difference between the rate the company paid where it earned the income and the U.S. rate.
"We tax income wherever it is earned around the world once you bring it back home, and almost nobody else does that," Goldman said.
In addition to lowering a company's tax rate, inversions can also help a company reduce its U.S. tax liability through a process known as earnings stripping. Essentially, the U.S. business takes on debt to fund a dividend for its foreign operations and deducts interest payments on that debt.
Inversions can happen if a U.S. company combines with a foreign business and shareholders of the foreign entity own at least 20 percent of the newly merged business. Legally, the foreign company might acquire the U.S. business or the two would create a new entity overseas. But the U.S. company often maintains both its corporate headquarters and control of the company.
President Barack Obama has proposed raising the threshold for inversions on foreign entity ownership to 50 percent, with the goal of making them less attractive.
In the meantime, experts say companies will continue to consider inversions.
Walgreens is among those considering it now. The drugstore chain acquired a 45 percent stake in the Swiss health and beauty retailer Alliance Boots in 2012, and it has an option to buy the rest of the company next year.
A Walgreens inversion could have a deeper impact than the drug and medical device makers that have already forged ahead because the drugstore chain's business deals directly with consumers.
The company will have to guard against any customer backlash, "since consumers have many choices when it comes to purchasing pharmaceutical and convenience goods," said Vishnu Lekraj, an analyst who covers the industry for Morningstar.