Burger King merger: Do 'tax inversions' really make sense?

Burger King’s buyout of Canadian coffee-and-doughnut chain Tim Hortons – and shift of its legal address and corporate tax payments to Canada – isn’t necessarily a winning strategy, some business gurus say.

Burger King’s buyout of Canadian coffee-and-doughnut chain Tim Hortons is drawing heightened attention to the trend of companies using a merger to change their corporate citizenship.

In this case, Burger King will follow a host of other firms recently in moving its domicile outside the United States. It’s called a “tax inversion” because a company is changing its legal home to the nation where a smaller acquired firm is based – and where tax policies are more favorable.

But is this rush to the exit door really a good idea for US companies?

The question is a hot one because, for one thing, the US stands to lose substantial tax revenue if more and more companies move overseas – not to mention lost prestige for the economy that has long been the world’s symbolic capital of corporate dynamism.

Some business gurus say it makes good financial sense for companies to move their legal address outside the US, until Congress reforms the corporate tax code to make it less onerous.

But, even as President Obama weighs executive action to stem the trend, some evidence suggests that inversion isn’t automatically a winning strategy.

First, America’s official top tax rate of 35 percent shouldn’t be confused with the effective tax rate that corporations actually pay. Depending on a firm’s profitability and various tax breaks built into the US code, the real tax rate is often considerably lower.

Burger King, for example, plans to become a “Canadian” company with the Tim Hortons deal. But the hamburger chain is saying it doesn’t expect “meaningful” tax savings. Instead, it emphasizes that the merger makes sense mainly because of the strategic opportunity for global expansion and greater to become more of a player in breakfast-food sales.for global expansion and greater breakfast-food sales.

Public relations spin? Maybe a bit, but AFP quotes Burger King executive chairman Alex Behring saying Tuesday that the firm’s effective tax rate "is currently in the mid- to high twenties, which is pretty much in line with the current effective rate in Canada."

Some other data points suggest CEOs might want to take at least a doughnut break before seeking an inversion partner.

According to a recent Reuters analysis, companies that have done inversions over the past three decades haven’t shown any edge in stock-market performance.

Of 52 transactions Reuters found, 19 of the companies subsequently outperformed the Standard & Poor's 500 index, but an equal number underperformed. Of the rest, 10 were bought by rivals, three went out of business, and one inverted its own inversion by incorporating in the US again.

Even if an inversion looks successful on paper, moreover, there may be another important caveat. Although business experts generally point to corporations’ fiduciary duty to shareholders as a prime motivator of inversions, some analysts question whether shareholders come out ahead.

“An inversion, in effect, is the sale of a U.S. firm to a foreign company. Stockholders in the U.S. firm are deemed to have sold their shares in the U.S. firm in exchange for shares in the new foreign-based entity,” explains an online commentary by Roberton Williams of the nonpartisan Tax Policy Center in Washington.

“They get no cash, just a stake in the new company,” he says, but they can end up owing substantial capital-gains taxes if they had made their original purchase of stock long ago.

So, for at least some shareholders, it could take quite awhile before any financial gains from the inversion outweigh the taxes they owe as a result of the transaction.

Still, many corporate executives may calculate that, under the current US tax code, the grass is greener for the firm and its shareholders in the long run under an overseas address.