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The fast food chain Burger King made waves in the corporate world two weeks ago when it announced an agreement to merge with Tim Hortons, a Canadian doughnut and coffee chain, and relocate to Toronto. Financial analysts argued that the move – called a tax inversion – may help Burger King reduce its corporate tax burden since Canada has a lower corporate tax rate than the United States. President Obama and Democratic lawmakers criticized Burger King for joining the list of “corporate deserters,” a term applied to companies that have relocated their corporate headquarters outside of America’s borders to reduce their tax burden. Ohio Senator Sherrod Brown and leftist groups have called for a national boycott of Burger King as well. If the merger is approved by American and Canadian regulators, the new company will become the third-largest fast food chain in the world.
This topic brief will provide an overview of the Burger King-Tim Hortons merger and explain what tax inversions are, weigh the potential benefits and drawbacks of the merger for both brands, and evaluate how lawmakers might respond to Burger King’s tax inversion.
Readers are also encouraged to use the links below and in the related R&D to bolster their files about this topic.
An Overview of the Merger
The merger of Burger King and Tim Hortons is worth an estimated $11.2 billion. Burger King was acquired by 3G Capital Management, a private equity group, in 2010. The New Yorker on August 27 reports that when 3G acquired the fast food chain it took the company private and then made it public again in 2012. MacLeans, a Canadian magazine, reports on August 29 that Burger King has had substantial problems since it was founded in 1953. It has struggled to advertise as well as Subway and McDonald’s and its attempt at creating healthier products backfired when its Satisfries were dropped by two-thirds of its chains due to poor sales. Advertising is something the company has struggled with as well, with the Burger King mascot deemed “creepy.” The Wall Street Journal notes on September 3 that the company has been sold several times over the last fifteen years and is $3 billion in debt. Burger King hopes that by merging with Tim Hortons, a revered Canadian brand, that it will improve some of its marketability in Canada, and this could potentially lead to it improving its breakfast offerings. To learn additional knowledge about the merger, check out this brief two minute video on Forbes.
The Wall Street Journal article previously cited breaks down the finances behind the merger of the two brands. To acquire Hortons, 3G is putting up $1.2 billion of its own money and a collection of banking firms such as J.P. Morgan Chase & Company and Wells Fargo & Company are helping 3G raise over $9 billion for the sale. 3G also turned to the Warren Buffett, the so-called “Oracle of Omaha”, and his Berkshire Hathaway operation to finance some of the deal as well. Buffett, a friend of President Obama who is on record supporting higher taxes for wealthier Americans, is contributing $3 billion for the sale in return for preferred shares in the new corporation – called 1011773 B.C. Unlimited Liability Company – that will exist in Toronto. Buffett’s group will enjoy the ability to purchase up to 1.75% of the new company.
So what is so controversial about the merger? Well, to start with, it appears that Burger King might be merging with Tim Hortons and then relocating the headquarters of the new firm out of the United States to avoid paying some American taxes. This type of maneuver is called a tax inversion. The Huffington Post on August 25 writes that a tax inversion is “where a bigger U.S. company buys a smaller foreign firm in a country with a lower tax rate, renounces its U.S. corporate citizenship, and reincorporates in the new nation.” So in this case, Burger King is merging with Tim Hortons, which is a smaller fast food chain located in a country with a lower corporate tax rate than the United States, and it is creating a new corporation based in Toronto. Bloomberg on September 3 explains that the number of American corporations participating in tax inversions has increased significantly since 1982. Forty-three companies have moved outside of the United States since 1982 and thirteen of those moves took place since 2012. The United States Treasury Department, according to Bloomberg, estimates that nearly $20 billion in tax revenue will be lost as a result of these tax inversions.
Some argue that Burger King is making a wise choice participating in a tax inversion for two reasons. First, it is completely legal under American law. And second, the U.S. currently has the highest corporate tax rate (35%) of any developed nation in the world. By comparison, Canada’s rate is 15%, which The Washington Examiner on August 28 writes is the lowest among the nations in the G7. CNN on August 27 writes that U.S. corporate taxes appear prohibitive to some corporations because, unlike other nations in the Organization for Economic Cooperation and Development (OECD), it taxes a corporation’s profits made abroad and domestically. Most nations simply tax corporate profits that are earned within its territorial jurisdiction. However, one has to be careful when comparing the corporate tax rates of various nations because corporations often pay lower than the official rate as the result of deductions that they can take in the tax code. This is especially true for corporations that carry a substantial debt burden such as Burger King. And indeed, The Business Insider on September 2 reveals that Burger King’s American corporate tax rate over the last three years has been 26%. Nevertheless, the corporate tax rate provided by the United States does not include state and local taxes that corporations pay and The Washington Examiner article cited earlier notes that when those taxes are included, the U.S. corporate tax rate is actually close to 40%. Those Americans who favor a substantial reduction of the corporate tax rate are using Burger King’s tax inversion as evidence to state their case for far-reaching tax reform.
Benefits and Detriments of the Merger
As stated above, Burger King is looking to expand its place in the international market. The Business Insider article previously cited from September 2 reports that Burger King’s largest market outside of the United States is in Germany. Between 2011-2012, Burger King made over $500 million there, but it is still looking to expand market share elsewhere. By partnering with one of Canada’s biggest national brands, Burger King is prime for a breakout in the Canadian market, but some question whether Burger King can actually do that. USA Today on August 27 writes that although Tim Hortons could give Burger King great advice on breakfast and might boost Burger King’s coffee sales, the new corporate entity plans to keep each brand separate. In other words, it does not appear that the brands will sell each other’s products, so the potential benefits that might come to both sides in the merger are questionable.
Tim Hortons stockholders, who have to approve of the merger, are being told that the deal will help the company establish a stronger foothold in the American market. The Huffington Post on August 26 writes that Hortons is experiencing growing sales in the United States, but it must be said that this growth is not as robust as some investors would like. The MacLeans article cited earlier notes that over the last twenty years Hortons has invested more than $650 million into the U.S. market, but its market share has not cracked 10%. MacLeans argues that this might be due to a lack of brand awareness and the fact that Canadian companies tend to be more risk-averse than their American counterparts. The hope of Hortons executives is that the merger will allow them to use the Burger King brand to raise awareness about their products, hook customers, and thereby grow their market position in the United States. However, this may not happen if Burger King remains an independent entity in the new corporation and does not carry Hortons doughnuts or coffee.
Burger King argues that the move to Canada is simply to assist in its outreach to new markets and to improve innovation. It rejects the notion that it is moving to escape American taxes and Time on September 3 concedes that Burger King’s tax savings from the move are only $3.4 million. Burger King will also continue paying American taxes on its sales within the United States and its territories. However, the CNN article cited earlier points out that there are other ways for the company to save money in the future beyond paying taxes on its foreign generated profits. For example, Burger King could engage in “earning stripping” whereby the new Toronto-based corporation could issue a loan to American-based operations of Burger King or Hortons and those operations, in turn, could take a tax deduction based on the interest they are paying on the loan. Sometimes this has the effect of completely eliminating the taxes that these corporations would have to pay the American government. That said, the tax inversion may not be as profitable for investors as some expect it to be. The Business Insider, reprinting an article from The Christian Science Monitor, reports on August 27 that companies that participated in tax inversions over the last thirty years have a mixed record. Although nineteen companies outperformed the Standard & Poor’s 500 stock index, nineteen other companies underperformed. Three of the companies that participated in tax inversions actually went out of business. Stockholders, who will receive stock in the new entity, may also face high capital gains taxes if they have held Hortons or Burger King stock for an extended period of time. Therefore, investors are the ones that might take a more significant tax hit, at least in the short-term.
Extempers should realize – and incorporate into their speeches – that this is not Tim Hortons first appearance at the merger rodeo. In 1995, Hortons merged with the American fast-food company Wendy’s. That deal was made with the same justifications as the Burger King deal: help both companies acquire a higher standing in the other’s country and allow more innovation to take place. Hortons actually moved to Delaware as a part of the merger, thereby participating in an inversion of its own! The agreement broke down by 2006, though, as activist shareholders spun Hortons off as its own entity again and it returned to Canada in 2009. The Washington Post on August 27 writes that although some Canadians have misgivings about the merger, namely that it will harm Hortons ability to create new food products (the company is known for experimenting with a host of new menu items each year), other Canadians remind them that the failed agreement with Wendy’s did not kill the company off. It has to be somewhat disconcerting to Burger King, though, that they are merging with a brand that one fast food chain failed to do anything with and, it must be said, Burger King has a poor record in terms of advertising, innovating, and coming up with ways to beat its competitors in recent years.
There are also some concerns about the patience of 3G Capital. 3G will have a 51% share of the new corporation and it has a record of not waiting long for returns on its investments. The Toronto Star reports on August 29 that 3G is controlled by Jorge Paulo Lemann, a Brazilian business tycoon and former tennis champion who has a net worth in excess of $24 billion. 3G has a history of trying to make companies profitable by stripping their workforces, thereby acquiring profits through a reduction in the bottom line. Critics allege that this strategy is does little for the businesses affected because it does not leave enough stores or staff to turn business around. Examples of 3G’s ruthless behavior according to the Star are the loss of 8,000 jobs in Europe when 3G acquired Anheuser-Busch InBev in 2010 and the slicing of several top corporate jobs when it took over Burger King. Canadian critics of the deal argue that Hortons will suffer the same fate unless it can quickly improve its profitability and that could leave the brand in awful shape.
Political Impact of Burger King’s Tax Inversion
It is hard to foresee American or Canadian regulators not approving the merger. It is similarly tough to see Hortons shareholders opting not to participate in the deal, especially in light of the fact that Hortons stock price rose significantly after 3G announced the terms of the merger. That does not mean that the move will not provoke a significant discussion in American policy circles about tax inversions, though. President Obama and Democrats view Burger King’s maneuver as a betrayal of America and the President said Burger King is avoiding “paying its fair share” of taxes. Critics of Burger King’s move north allege that if corporations continue participating in tax inversions that the U.S. government will lose substantial tax revenue and the burden will have to borne by American workers. Socialist Senator Bernie Sanders of Vermont warns that inversions are drying up much needed government revenue that is earmarked for education and infrastructure projects. For their part, Republicans agree that Burger King’s move is regrettable, but they argue that moves like Burger King’s will continue until the United States slashes its corporate tax rate and reduces onerous regulations.
So will Burger King’s tax deal promote significant reform in the near future? Most would say any chance of a large-scale tax deal between President Obama, Senate Democrats, and House Republicans is unlikely in the near future for several reasons. First, as Politico writes on August 26, Republicans believe that they will take control of the Senate after the 2014 midterms. This means that they will be unwilling to pass any legislation reining in tax inversions by corporations since they believe they can acquire more leverage in future negotiations if they take over the Senate. Second, Democrats are unlikely to significantly compromise with Republicans in the run up to the midterms because they would rather use Burger King as an example of corporate greed. In a year when Democratic losses are expected in the Senate, leftist strategists see tax inversions as a potentially winning issue. Whether that issue is enough to trump American unhappiness with President Obama’s foreign policy, frustrations over job growth, and illegal immigration is yet to be seen, though. A third reason not to expect reform is that those spearheading the legislation are far apart from each other. Again, Politico writes that the chances for significant tax reform collapsed after Montana Senator Max Baucus (D) left his post to become the U.S. Ambassador to China and House Republicans pushed aside the proposals of House Ways and Means Committee Chairman Dave Camp (R-MI). If the U.S. moves to reduce its corporate tax rate and enact any other reforms, they might have to await the outcome of the midterms and, failing that, the arrival of a new president in 2017.
Could President Obama or the Treasury Department take unilateral action regarding tax inversions? The answer to this question is yes and the Obama administration has signaled that is looking into what it could do to restrict the practice. According to Politico, President Obama issued an executive order in 2012 requiring companies to place 25% or more of their employees, property, and income in the foreign nation they reincorporated in. The problem, though, is that corporate lawyers exploited loopholes in the order and inversions continued. The administration could look into new orders to raise that percentage and could look into taking away interest deductions for corporations that have relocated abroad. Inc. Magazine on August 27 writes that $1.95 trillion in corporate assets now exist abroad, so the United States must find a way to get corporations to bring some of this taxable income back home. Otherwise, the United States will find itself at a significant disadvantage in the global marketplace.
On the activist side of things, some are calling for a nationwide boycott of Burger King. Ohio Senator Sherrod Brown (D) has reminded voters that they should frequent other fast food establishments in an attempt to pressure the company to remain in the United States. Protests by activists caused Walgreens to avoid a tax inversion in July (it planned to reincorporate in Switzerland), so left-wing interests hope that a boycott would lead to similar outcome with Burger King. However, boycotting Burger King might affect people who have nothing to do with the decision. USA Today on August 27 explains that most of Burger King’s businesses are local franchises, so a boycott would just hurt small business owners and not the corporate giant. In fact, battles between Burger King’s leadership and its franchises have given the company a black eye for years, as franchises have chafed at corporate-level decisions regarding menu items and pricing. Therefore, a boycott would probably not cause 3G to call off the merger and some smaller franchise owners might go out of business.
Burger King will not be the last U.S. corporation to participate in a tax inversion. Members of both political parties agree that tax reform is necessary, but until they can agree on what corporations and individuals should pay in taxes, the chances of significant reform are small. This is unfortunate because in a globalized era, where companies find it easy to relocate their operations abroad, the United States risks falling behind the rest of the world.