Among the more valuable assets Medtronic acquired with its $42.9 billion purchase of Covidien PLC:
Covidien’s Irish address.
Medtronic, the acquirer in this deal, is based in Minneapolis. Covidien has its US headquarters in Mansfield, where most of its corporate staff is based, but is technically based in Dublin for tax purposes. About 1,500 of Covidien’s 38,000 employees work in Ireland, compared to 1,800 in Massachusetts.
Normally, when a US-based company buys a smaller foreign one, the foreign company becomes a part of the American entity that acquired it. Profits generated by the foreign business of the American company would be sent back to the United States and taxed at the US corporate tax rate of 35 percent.
But Medtronic’s purchase is what’s known as an inversion, a particular type of corporate buyout deal that is attracting much scrutiny in Washington.
In an inversion, the process is flipped: Although the American company is doing the acquiring, it is reincorporated in whatever low-tax or no-tax country its target is located in, subject to a few requirements.
“If I did this thing straightforward, then Covidien would live in Minneapolis, but we don’t want that. So we do it the other way around, so we have the small fish eating the big fish,” said Richard Ainsworth, the director of the graduate tax program at Boston University.
“It doesn’t make a whole lot of sense.”
But it does make a whole lot of money. Earlier this year, the pharmaceutical giant Pfizer attempted to buy the London-based drug maker AstraZeneca for $100 billion. Although the deal fell apart, British financier Barclays estimated that could have saved the new company over $1 billion a year by taking advantage of an effective tax rate that was six points lower in the United Kingdom.
Medtronic executives have denied that their primary goal with the acquisition was to gain the tax benefit that comes with inversion, characterizing it as a “slight benefit” in a conference call on Monday morning.
“The first thing we looked at was, from a strategic perspective, what kind of opportunities are there,” Medtronic chief executive Omar Ishrak said during the call.
Ireland’s baseline corporate tax rate is 12.5 percent, compared to 35 percent in the United States. Although the taxes levied on Medtronic and Covidien weren’t very far apart after various other taxes and write-offs were factored in — Medtronic’s effective tax rate was 18.4 percent in its most recent fiscal year, and Covidien, which faced an inflated tax bill in 2013 owing to ongoing disputes with the IRS, paid an effective tax rate of 14.7 percent in 2012 — shaving just a few percentage points off its tax bill could save billions of dollars in the long run for Medtronic.
The company recorded a profit of $12.5 billion in its last fiscal year.
Inversions were “initially something that people weren’t too worried about, from a tax policy perspective,” said Daniel Berman, a principal at the Boston offices of McGladney LLP and a former Treasury official. But regulators in the United States and Europe are looking into changing the laws to curtail their tax losses, he said, as “people start to wonder what the tax law is allowing that it shouldn’t allow in order to make this so popular.”
No estimates have been made of how much Medtronic stands to save on its taxes after reincorporating itself in Ireland, but the larger issue of tax losses from corporate inversions has gotten the attention of the federal government.
Under changes passed in 2004 that sought to crack down on the kind of inversion that prevailed in the 1990s, the foreign company in an inversion must control at least 20 percent of the combined company for the American company to change its address.
But a bill submitted by Senator Carl Levin, a Democrat from Michigan, would make shareholders in the foreign company own at least half the shares in the combined company.
The bill would be retroactive to May 2014, which would prevent Medtronic and many other companies from getting a tax benefit. According to its press release, Covidien shareholders will control about 30 percent of the new company.
The Levin bill, called the Stop Corporate Inversions Act of 2014, has 20 cosponsors. A report by the Senate Banking Committee has estimated the bill would generate an additional $19.5 billion in tax revenue over the next 10 years.