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Pfizer-Allergan Deal Puts Focus on Inversions

The trend has been growing for the tax-saving move.
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Pfizer (PFE) inked a record deal today to buy Allergan (AGN) for $155 billion. The deal was primarily to help Pfizer save billions of dollars every year in taxes (a.k.a. tax inversion). Pfizer is the latest in a series of high-profile companies moving their headquarters overseas to take advantage of a corporate tax loophole that allows them to pay lower taxes on income generated aboard. Let's take a closer look at tax inversions and a list of companies that have inverted recently. (Allergan is part of TheStreet's Action Alerts PLUS portfolio.)

What is a tax inversion? The most common definition is when a company becomes a subsidiary of a new parent company located in another country for the purpose of lowering its tax rates.

Why invert? The simple reason is to save money by paying less taxes. In the U.S., the 2015 corporate tax rate is 35%, one of the highest in the developed world. Meanwhile, Ireland's corporate tax rate of only 12.5% translates into billions of dollars saved per year.

The loophole(s): In addition to the 35% corporate tax rate, the U.S. is also one of the few countries that taxes its companies on their worldwide income. The current U.S. tax code allows domestic companies to defer the taxes owed on profits generated overseas until they bring the money back to the U.S. Meanwhile, other countries, like the U.K. or Canada, only tax domestic profits. This means a company based in the U.S. can end up paying more taxes than an identical U.S. company owned by a foreign entity. The loophole allows U.S. companies to buy a foreign parent, which lets them escape paying Uncle Sam on their worldwide income. Another important loophole is that once a company inverts, it can take advantage of the U.S. tax deduction on interest for payments to their own affiliates abroad. These deductions are only available with a foreign parent company and add up to serious dollars.

Tax inversions -- see the data: The following data courtesy of Bloomberg show which companies have inverted recently and that the pace of inversions has grown rapidly in recent years.

The following data are from the middle of 2015:

Corporate Expatriates -- Chart 1

Bloomberg

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Corporate Expatriates -- Chart 2

Bloomberg

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Corporate Expatriates -- Chart 3

Bloomberg

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Corporate Expatriates -- Chart 4

Bloomberg

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Notations: 1 (in chart 1) -- For companies that have changed incorporation more than once, indicates latest place of incorporation.

2 (in chart 4) -- Xoma reincorporated from Bermuda to the United States in 2011.

At the time of publication, Sarhan had no positions in the stocks mentioned.