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Walgreens Proposes Move to Europe to Take Advantage of ‘Tax Inversion’

Are American Companies Ethically Obligated to Pay Taxes in the U.S?

U.S. corporations are not legally obligated to pay taxes in the U.S. if they can shift net sales revenue to an overseas subsidiary in a country with a lower tax rate than in the U.S. The question is whether a company such as Walgreens has an ethical responsibility derived from its corporate social responsibility to pay its ‘fair share’ of taxes in the U.S. Perhaps I am naïve on this point. However, the way I look at it is: What would happen if every U.S. corporation shifted its revenue-generating activities overseas to limit global net taxes and maximize global net profits? The answer is the U.S. government would lose a major source of tax revenue that is essential to fund government activities. The ethical principle is based on Rights Theory that posits a decision-maker should act only in a way s/he would want others to act in a similar situation for similar reasons. Thus, would we want all U.S. companies to act this way? If the answer is no, which it is for obvious reasons, then any one company (Walgreens) should not act in this way.

Perhaps you have heard that an investor group wants to persuade Walgreen to relocate to Europe as a way to reduce its corporate tax burden. Three hedge funds and a Goldman Sachs investment fund want the 113-year-old pharmacy chain, based in suburban Chicago, to consider a tax “inversion” and move to Europe. Walgreen Chief Executive Greg Wasson and the company’s chief financial officer met in Paris last week with a hedge fund group that wants the company to leave Illinois for what would most likely be Switzerland, which has lower tax rates.

Walgreen already owns 45 percent of Alliance Boots, the dominant pharmacy retailer in the United Kingdom, and is scheduled to acquire the rest next year for a total of $16.2 billion—giving the company a larger overseas presence. Boots made this same move in 2008 and has saved an estimated 100 million pounds ($167 million) in taxes per year, drawing public protests outside some of its London-area stores.

Walgreen officials will not say the company is pondering a relocation—or planning to stay put in the U.S. “Our focus is always on analyzing and doing what is in the best long-term interest of our company and its shareholders, and when we have something more definitive to announce about our future structure and strategies, we will do so,” the company said in a statement in April.

Two analysts said they don’t believe Walgreen would leave the U.S. for Europe to cut its tax bill, due to the potential political and public hurdles it could create, as well as probable operating inefficiencies. Even with the Boots acquisition, Walgreen’s revenue will derive mostly from the U.S., where it has a store in every state.

 “I struggle with sort of the political and social ramifications and how this would play,” said Ross Muker, a senior managing director at consulting firm ISI Group. “There’s nothing in retail more American than the drug stores. So the perception that you would be shifting to Switzerland to evade taxes when there’s a competitive dynamic” could send some of Walgreen’s revenue to rivals, such as Wal-Mart Stores, CVS Caremark and Target.

Here's how it works. Say you have a US company and it sets up a subsidiary in Ireland. Let's assume the US company ships raw materials or semi-finished (even finished) goods to Ireland. The subsidiary operates as a separate entity so a price has to be established for the shipment. Ireland has one of the lowest income tax rates on corporations in the world (12.5%) whereas the maximum rate is 35.0% in the US. The goal of the US parent company is to minimize worldwide taxes thereby maximizing global profits. Let's assume the raw materials cost $1 million. The US company charges the Irish subsidiary $1.1 million even though it could sell the materials for as much as $2 million in the US had the raw materials or semi-finished product been kept at home. The US company earns $100,000 in profit, pays the US government $35,000 in taxes ($100,000 x .35), and nets $65,000.  Now, the Irish subsidiary sells the product it received from the US company at a cost of $1.1 million to customers in Ireland and elsewhere for what the product is really worth -- $2 million. The subsidiary earns $900,000 in profit, pays the Irish government $112,500 in taxes ($900,000 x.125), and nets $787,500. The total worldwide profits are $852,500 ($65,000 + $787,500).

However, had the US company not set up the Irish subsidiary and simply made and sold the product in the US, its profits would have been $1 million ($2m-$1m) and paid $350,000 taxes to the US government ($1 million x .35) thereby netting $650,000 or $202,500 less than in the transfer situation ($852,500-$650,000). The US government is "cheated" out of $315,000 in taxes: $350,000 it should have received less the $35,000 it did receive. If we add some zeroes to the total value of such transferred goods in our hypothetical company and add to it the same effect that is occurring in hundreds of US companies, then we have our estimated $100 billion in tax revenue lost by the US Treasury. Let me summarize the data.

                    US Profit w/o Transfer     US Profit w/Transfer  &   Irish Sub Profit    

Sales                     $2,000,000                      $1,100,000                        $2,000,000               

Cost                       (1,000,000)                      (1,000,000)                       (1,100,000)   

Profit                    $1,000,000                     $    100,000                        $   900,000

Taxes               (.35)  $350,000          (.35)  $       35,000               (.125)   $  112,500

                                                                                                                  (paid to Irish gov't)

Americans for Tax Fairness and Change to Win Retail Initiatives issued a report in April alleging that Walgreen’s headquarters move could cost U.S. taxpayers $4 billion in lost revenue over five years.

A rally of a few dozen representatives from these organizations and other Chicago-based “community, labor and tax groups” was held outside of Walgreen’s flagship Chicago in April. “If Walgreens relinquished its Illinois roots by becoming a Swiss company, it would not only be a betrayal of the people of our great state, but it would undermine critical taxpayer-funded services that we all rely on,” said William McNary, Co-Director of Citizen Action/Illinois.

Companies are legally allowed to participate in tax inversion when at least 20% of their stock is owned outside of the U.S. Walgreen would likely meet that criteria upon the closing of its purchase of European pharmacy giant Alliance Boots, slated for early 2015.

As noted in an article in the “Fiscal Times,” the bottom line is Walgreens may soon be able to change its tagline from "At the Corner of Happy & Healthy" to "Take This Tax and Shove It" if a group of powerful shareholders has its way.

Blog posted by Steven Mintz, aka Ethics Sage, on July 15, 2014 . Dr. Mintz is a professor in the Orfalea College of Business at Cal Poly, San Luis Obispo. He also blogs at: www.workplaceethicsadvice.com.

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