American Dollars To Canadian Doughnuts

Tim Hortons (THI) has long been a regular stop whenever I visit Canada.

For one thing, I couldn’t avoid Tim Hortons outlets if I wanted to; they’re everywhere. I do genuinely like their doughnuts, however. The chain is the biggest coffee and doughnut seller in Canada and marked its 50th anniversary this spring.

Given Tim Hortons’ ubiquity and popularity, it is no surprise that American dollars are chasing Canadian doughnuts.

News broke over the weekend that Burger King Worldwide Inc. (BKW) is engaged in talks to buy Tim Hortons. Should the deal succeed, the combined businesses would together have about $22 billion in sales, making the new fast-food company the world’s third-largest.

Burger King wouldn’t only be securing a Canadian institution with habit-forming baked goods, though. It would also pick up a more favorable tax situation, courtesy of a move north of the border. In the proposed version of the merger, Burger King would create a new, Canadian-based parent company, housing both independently operating chains. This structure would give Burger King domicile in Canada and preserve Tim Hortons’ domicile there.

While unnamed sources briefed in the deal told The New York Times that taxes were not the primary motivation behind the talks, Burger King is obviously aware of the tax implications. Canada cut its national corporate tax rate to its current level of 15 percent several years ago. (Companies there must also pay provincial taxes, meaning Ontario-based corporations such as Tim Hortons currently pay 26.5 percent total.) Meanwhile, the U.S. insists not only on a 35 percent federal corporate tax rate, plus state taxes in most places, but also on taxing corporations on earnings worldwide. Burger King doesn’t currently hold much cash outside the country, the Times reported, but it may certainly have an eye on expansion in the future, both in Canada and elsewhere.

Although Burger King is an American company, it is controlled by a Brazilian investment firm, 3G Capital, which owns about 70 percent of the company’s shares. Why would Brazilians want to continue to pay U.S. tax on profits from burgers they sell in Buenos Aires or Hong Kong? There is no reason they would. Under the tax systems in place almost everywhere outside the United States, there is no reason they should, either.

As for Burger King’s American shareholders, like all corporate shareholders here, they are taxed twice: once on corporate profits and again when the corporation pays out dividends. This makes tax inversion – relocating a company’s headquarters to a lower-tax nation, as Burger King may – an attractive prospect, even for American shareholders. It’s worth noting, too, that those who criticize inversion most vehemently are almost always people whose income is only taxed once – and often, that income is a salary paid by taxpayers.

The current president has made no secret of his displeasure with the practice. Before, and especially since, I last wrote about American companies fleeing to less hostile tax climates, Obama and the Democrats have bleated about unpatriotic U.S. corporations, as if there were an inherent patriotic duty to have income earned abroad taxed back in the U.S at least once. In the wake of at least five large U.S. companies that have announced plans for inversions between mid-June and late July, Obama criticized a “herd mentality” at play in the decisions, calling the companies “corporate deserters who renounce their citizenship to shield profits.” This characterization imagines corporations are owned by nobody, or by Martians, who otherwise lack citizenship elsewhere on Earth.

The administration is said to be looking for a way to make inversions difficult or impossible in the future. Treasury Secretary Jacob Lew has acknowledged that his agency is seeking ways to hinder or stop inversions without the need for legislative support from Congress.

However, unlike government-regulated banks, which under pressure have forked over billions of dollars in penalties for real and imagined offenses, most private corporations have legal teams that are well used to challenging rulings from the Internal Revenue Service. We have an active and independent Tax Court in this country. The IRS is a frequent litigant and a not-infrequent loser, especially when it faces adversaries with technical knowledge and financial resources, such as are available to major corporations. If the administration wants to challenge inversions using, shall we say, novel interpretations of the tax law, it should not expect most of corporate America to roll over the way that the banks have.

Even if the government succeeds in making inversions impractical for U.S.-based companies, it is unlikely to be pleased with the result. Blocking inversions here will only turn American companies into takeover targets for foreign businesses. Acquirers will simply buy U.S. companies and relocate the headquarters, or their assets, once the deal is complete. In the process, even more American jobs will be lost.

When Canada lowered its corporate tax rate, critics warned that the move would be disastrous for Canadian federal government revenues. If the Burger King inversion is any indication, an attractive tax structure can more than make up for a lower rate by drawing new and existing businesses to establish headquarters in Canada.

The sensible thing is to recognize once again that neither Martians nor corporations pay taxes. Shareholders and customers – in other words, people – do. If those people have no connection to the U.S. other than a corporation’s legal domicile, they will find ways to sever their ties rather than fund a foreign government at exorbitant rates.

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