Irish eyes are smiling in the world of mergers and acquisitions, with Milwaukee’s Johnson Controls (NYSE:JCI) becoming the latest U.S. company to capitalize on Ireland’s welcoming tax rates.
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Johnson Controls, which makes automotive parts such as batteries and HVAC equipment, announced on Monday that it will acquire Ireland-based Tyco International (NYSE:TYC) in a $16.5 billion merger. The deal will establish a new tax home for Johnson Controls in Ireland, a corporate tax inversion that allows Johnson Controls to benefit from lower rates.
Ireland is a popular destination for American companies seeking a tax break overseas. The U.S. has a federal tax rate of 35%, the highest of any developed country. Meanwhile, Ireland offers a much lower rate of 12.5%, and the country just slashed its corporate taxes to 6.25% for earnings derived from research and development projects.
“One should not forget that Ireland, notwithstanding their economic malaise of recent years, is called the Celtic Tiger for a reason,” said Anthony Michael Sabino, a law professor at St. John’s University’s Tobin College of Business. Celtic Tiger was a nickname for the Irish boom of the late 1990s. “Ireland has a highly educated workforce, speaks the English language and the cherry on top is their low tax rates.”
U.S. firms also see Ireland as a gateway to the rest of Europe, and Silicon Valley has been a big investor in Ireland.
Under U.S. rules, tax inversions are allowed if the American company’s shareholders will own less than 80% of the combined business, and certain restrictions kick in if ownership exceeds a 60% threshold set by the Treasury Department. Johnson Controls said its shareholders will hold approximately 56% of the new company, Johnson Controls Plc, upon completion of the merger.
Tax Inversions Gain Steam
The largest inversion deal on record was orchestrated by pharmaceutical titan Pfizer (NYSE:PFE), which announced in November that it would acquire Irish drug maker Allergan for $160 billion. Through the merger, Pfizer will move its primary headquarters from New York to Dublin. Burger King (NYSE:BKW) made headlines when it purchased Tim Hortons of Canada, which also has lower taxes than the U.S. Last summer, medical device maker Medtronic (NYSE:MDT) finalized its takeover of Irish rival Covidien, a former subsidiary of Tyco.
Tyco itself is familiar with tax inversions. Just last week, Tyco agreed to a settlement with the IRS in connection to the company’s 1997 inversion that established a tax domicile in Bermuda. Tyco has also split into three companies on two separate occasions over the last decade, spinning off businesses including ADT (NYSE:ADT). The slimmed-down Tyco moved its global headquarters to Ireland in 2014. Its U.S. base is located in Princeton, N.J.
“Tyco’s history is important here. Decades ago, they were one of biggest conglomerates in the country with business lines in hundreds of different sectors. They were one of the leaders in using a non-U.S. address for tax advantages,” Sabino said.
Pressure from D.C.
Inversions have drawn fire from Capitol Hill and the campaign trail. Democratic presidential candidate Hillary Clinton has proposed to create an “exit tax” to discourage the practice. President Barack Obama has called tax inversions “unpatriotic,” and the Treasury Department altered its rules that eliminated some of the tax benefits of corporate inversions. But since the rules were announced 16 months ago, a dozen inversion deals have been consummated.
Republicans are said to be working on legislation that would deal with tax inversions, but many lawmakers on the GOP side have argued that inversions are a product of a burdensome U.S. corporate tax structure.
Donald Trump, who leads the GOP field in the latest Fox News national poll, wants to lower the nation’s main corporate tax rate to 10%, thereby making inversions unnecessary. In the FOX Business debate earlier this month, New Jersey Gov. Chris Christie said the $2 trillion that U.S. firms are holding overseas should be taxed at 8.75%, while the corporate tax rate should be lowered to 25%.
More than Just Taxes
Sabino believes some level of concern over regulatory or legislative action always exists, but companies consider that risk before even considering a deal. Bankers will take into account how much changes to tax rules may cost in the long run. Meanwhile, analysts at J.P. Morgan Chase (NYSE:JPM) estimate that Johnson Controls currently pays roughly 19% in taxes, which is already well below the top U.S. rate.
“Anyone who does a deal solely for tax purposes is a fool,” he said, adding that Johnson Controls and Tyco appear to be a natural fit based on their product lines.
Johnson Controls and Tyco lauded other benefits of their combination aside from the tax break, saying only that they expect at least $150 million in annual tax synergies. On a conference call with analysts, executives said not much overlap exists between Johnson Controls and Tyco, which provides security and fire-protection systems for commercial buildings.
Johnson Controls, a $23 billion company, was already seeking ways to expand beyond the automotive business. A plan to spin off the firm’s automotive unit, which makes seats and other interior parts, remains on track to be completed early in the first fiscal quarter of 2017.