Tax-driven merger?

Now that American burger royalty is about to reach into the treasury and acquire Canada’s much-loved coffee icon, the question is, why does a Florida-based, Brazil-owned fast food giant want to enter into a partnership with a Canadian competitor? And, what’s more, why it would choose to headquarter itself in Hamilton?

The $12.5 billion deal between Tim Hortons and Burger King, and its Brazilian owners, came down the pipes this week, with the assumption coming out immediately that the American burger joint was looking to take advantage of the Great White North’s lower tax rates.

The process is known as a tax inversion, and it’s been the scourge of American tax collectors for decades.

A tax inversion is, more or less, a tax avoidance scheme that involves picking up shop and moving to a more tax-friendly jurisdiction by picking a company located there and becoming either a subsidiary or entering a partnership with that company. It’s a crafty move that has become du jour in the United States, as companies balk at their corporate tax rates, which can reach as high as 40 per cent. Ontario’s combined federal and provincial corporate tax rate stand at 26.5 per cent,

U.S. drug store chain Walgreens is in the process of buying Swiss company Alliance Boots in order to take advantage of their advantageous tax rate. In the 90s, security company Tyco became a subsidiary of Bermuda-based ADT Limited and saved themselves millions. Other companies have sought out Ireland, Panama, and even the United Kingdom.

However, there are safeguards to discourage tax inversion deals. Twice the U.S. Congress has slapped rules on these partnerships to prevent situations where the target company is just a bit player in the new arrangement, in which case Washington would continue to tax the newly formed entity as an American company.

The more onerous rules forbid the American company from owning more than 50 per cent of the partnership, bar the shareholders of the American company from owning more than 80 per cent stock in the new company, and require that the new American company have “substantial business activities” in the host country.

The Tim Hortons deal passes all those metrics. Brazilian investment group 3G will own 51 per cent of the company, Tim Hortons shareholders will be given ample stock options in the new company, and the merged company would obviously have substantial operations in Canada.

That doesn’t mean they’re out of the woods.

President Barack Obama has proposed legislation that would crack down on tax inversions, and it would be retroactive to May 2014. While that legislation’s fate seems doomed, it does pose a risk for the deal.

Even still, the inversion angle may only be half the story.

The executives of the two betrothed companies deny this deal is driven primarily by tax considerations. Burger King has maintained that Tim Hortons fits in with its plans for international expansion.

“Their goal was not necessarily about tax, but about growth,” says Mindi Banach.

“This might be ‘inversion-lite,’” adds Robert Kepes.

The two tax lawyers specialize in cross-border tax issues at Morris Kepes Winters — Banach is an associate who focuses on the American side, Kepes is a partner who deals primarily with Canadian tax law.

They point out that this inversion isn’t quite the same beast as some of the more transparent ploys orchestrated by companies looking for a tax shelter.

There’s the simple reality that Burger King is likely paying nothing near Florida’s 38 per cent corporate tax rate, where its corporate headquarters are located. Between loopholes, grants, and refunds, the home of the Whopper was probably shelling out something much closer to Ontario’s tax rate.

And labour is significantly cheaper in the U.S. Moving any sort of operations to Canada involves high minimum wages, higher payrolls taxes, and so on. Which is probably why Burger King isn’t moving their headquarters at all. So why bother?

There’s one compelling theory: that, in applying the net benefit test required under the Canada Investment Act, Stephen Harper — once dubbed the Tim Hortons Prime Minister — would never allowed the acquisition.

Of course, making Burger King a Canadian company is an easy way around that.

“It could be strategic,” says Robert Korne, a partner at Spiegel Sohmer in Montreal. “Obviously, we have sensitivities.”

Indeed, if sabre-rattling form the NDP is an any indication, Burger King may have been smart to sidestep the issue.

“Any foreign takeover needs to pass a net benefit test and not just a Conservative government rubber stamp,” industry critic Peggy Nash told QMI.

That said, it wouldn’t be the first time that Tim Hortons has been the target of a fast-food takeover. In 1995, it merged with another big burger joint: Wendy’s. That partnership dissolved a decade later, and the Canadian staple repatriated in 2009.

But there’s another compelling reason for Burger King’s move to Canada: if it really is looking to expand abroad, headquartering in Ontario means it won’t be slapped with American corporate tax for its international earnings. Canada’s territorial tax system would be very helpful.

For its operations in America, Burger King will actually be paying the same 38 per cent rate (give or take) that it pays now. But it also means that the new company will pay the domestic rate in any country where it has operations and a market.

“There are going to be tax savings on a global basis once Burger King and Tim Hortons fall under the same holding company,” says Kepes.

“Though, admittedly, not as high as some may think,” adds Banach. “We’re not talking the Cayman Islands.”

Nevertheless, Korne says it’s a good business plan — and, given that Burger King’s corporate overlords aren’t even American, patriotic allegiance may be less of a factor.

“Potentially what you’re looking at is your tax cost could be more significant with these future expansion plans if the company would stay in the U.S.,” he says.

And as more companies realize that they’re being hobbled by those punitive tax practices, the Obama Administration is sending out some pretty jingoist messaging about the trend.

“The U.S. Government is making it very burdensome for both individuals and corporations to comply and pay taxes,” says Banach. And, she adds, the reaction from the president has been less than understanding. “There’s a lot of political rift and political sensitivity in this area. They’re using words like ‘corporate deserters’ and ‘exploiting an unpatriotic tax loophole’ those are strong statements coming from the U.S. Government.”

But it’s not just corporations. American citizens have been facing the wrath of the taxman, since Washington passed the Foreign Account Tax Compliance Act (FATCA) and began forcing the world to help enforce their nearly unique practice of taxing based on citizenship.

There’s one big catch for the inversion, however.

While news of the deal sent stocks for both companies skyrocketing, American shareholders might be less than thrilled to learn about the details of the acquisition.

When the deal goes down, Tim Hortons shareholders will get $65.50 in cash, and their shares converted to shares in the new company at a rate of about 80 per cent. They have the option of receiving just cash, or just shares.

Burger King shareholders will have their shares more-or-less converted to the new company.

While cash might sound like a nice thing, any American shareholders taking those dividends will get slapped with Canada’s withholding tax, which amounts to some 15 per cent. That goes for any dividends paid out by the new company going forward.

“So there’s a bit of an upside to Canada, because they’re getting a withholding tax that they weren’t getting before,” says Kepes.