[Senate Hearing 114-88]
[From the U.S. Government Publishing Office]
S. Hrg. 114-88
IMPACT OF THE U.S. TAX CODE ON THE MARKET FOR CORPORATE CONTROL AND
JOBS
=======================================================================
HEARING
before the
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
__________
JULY 30, 2015
__________
Available via the World Wide Web: http://www.fdsys.gov
Printed for the use of the
Committee on Homeland Security and Governmental Affairs
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
U.S. GOVERNMENT PUBLISHING OFFICE
96-194 PDF WASHINGTON : 2015
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Publishing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
RON JOHNSON, Wisconsin, Chairman
JOHN McCAIN, Arizona THOMAS R. CARPER, Delaware
ROB PORTMAN, Ohio CLAIRE McCASKILL, Missouri
RAND PAUL, Kentucky JON TESTER, Montana
JAMES LANKFORD, Oklahoma TAMMY BALDWIN, Wisconsin
MICHAEL B. ENZI, Wyoming HEIDI HEITKAMP, North Dakota
KELLY AYOTTE, New Hampshire CORY A. BOOKER, New Jersey
JONI ERNST, Iowa GARY C. PETERS, Michigan
BEN SASSE, Nebraska
Keith B. Ashdown, Staff Director
Gabrielle A. Batkin, Minority Staff Director
John P. Kilvington, Minority Deputy Staff Director
Laura W. Kilbride, Chief Clerk
Lauren Corcoran, Hearing Clerk
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
ROB PORTMAN, Ohio Chairman
JOHN McCAIN, Arizona CLAIRE McCASKILL, Missouri
RAND PAUL, Kentucky JON TESTER, Montana
JAMES LANKFORD, Oklahoma TAMMY BALDWIN, Wisconsin
KELLY AYOTTE, New Hampshire HEIDI HEITKAMP, North Dakota
BEN SASSE, Nebraska
Brian Callanan, Staff Director
Margaret Daum, Minority Staff Director and Chief Counsel
Kelsey Stroud, Chief Clerk
C O N T E N T S
------
Opening statements:
Page
Senator Portman.............................................. 1
Senator McCaskill............................................ 4
Senator Johnson.............................................. 7
Senator Lankford............................................. 18
Senator Ayotte............................................... 24
WITNESSES
Thursday, July 30, 2015
Jim Koch, Founder and Chairman, Boston Beer Company.............. 8
David E.I. Pyott, Chairman and Chief Executive Officer, Allergan. 10
Walter J. Galvin, Vice Chairman, and Chief Financial Officer,
Emerson........................................................ 12
Howard B. Schiller, Chief Financial Officer, and Board of
Directors, Valeant Pharmaceuticals International, Inc.......... 31
Joshua Kobza, Chief Financial Officer, Restaurant Brands
International.................................................. 33
Alphabetical List of Witnesses
Galvin, Walter J.:
Testimony.................................................... 12
Prepared statement........................................... 54
Kobza, Joshua:
Testimony.................................................... 33
Prepared statement with attachment........................... 70
Koch, Jim:
Testimony.................................................... 8
Prepared statement........................................... 47
Pyott, David E.I.:
Testimony.................................................... 10
Prepared statement........................................... 49
Schiller, Howard B.:
Testimony.................................................... 31
Prepared statement........................................... 57
APPENDIX
Majority Staff Report............................................ 80
Organisation for International Investment statement submitted for
the Record 213
Responses to post-hearing questions for the Record from Mr.
Schiller....................................................... 216
IMPACT OF THE U.S. TAX CODE ON THE MARKET FOR CORPORATE CONTROL AND
JOBS
----------
THURSDAY, JULY 30, 2015
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Homeland Security
and Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 9:32 a.m., in
room SD-342, Dirksen Senate Office Building, Hon. Rob Portman,
Chairman of the Subcommittee, presiding.
Present: Senators Portman, Lankford, Ayotte, Sasse, Johnson
(ex officio), and McCaskill.
Staff present: Brian Callanan, Mark Angher, Matt Owen,
Andrew Polesovsky, Daniel Strunk, Gabriel Krimm, Arielle
Goldberg, Brandon Reavis, Sarah Garcia, Mel Beras, Tom
McDonald, Amanda Montee, Emerson Sprick, Kelsey Stroud, Zachary
Rudisill, Liz Herman, Samantha Roberts, Satya Thallam, Bryan
Barkley, and Chris Barkley.
OPENING STATEMENT OF SENATOR PORTMAN
Senator Portman. Good morning. Thank you all for being
here, and I appreciate the fact that Chairman Johnson joined
us, too.
I want to begin by thanking Claire McCaskill. This is
Senator McCaskill's and my first hearing together as Chair and
Ranking Member of the Subcommittee. I am glad to have a chance
to team up with her again. We actually led a Subcommittee on
Oversight in the last Congress. I was in that chair, she was in
this chair. But we worked very well together, and as some of
you know, she is a former State auditor and a prosecutor all in
one, so she is very effective at oversight. And we will see
that again today and going forward with so many of our
projects.
This is a unique organization, this Subcommittee. The
Permanent Subcommittee on Investigations (PSI) has
investigative powers that allow us to do deeper dives in
conducting our oversight of the Federal bureaucracy. We also
want to use this Subcommittee to build a foundation for policy,
and that is really what we are doing today. And then, finally,
we are going to be rooting out some private wrongdoing that
warrants a public response. Together, Senator McCaskill and I
have a number of very interesting, long-term projects underway
at PSI today that would fit in each one of these three
categories.
This morning, we are going to focus on an important policy
issue, as I say, and that is, frankly, how the U.S. Tax Code
affects the market for corporate control. This topic involves
the jargon of corporate finance, as we will hear today, but
what it really involves is jobs and investment. And it is
negatively impacting our economy today because our Tax Code is
not working.
We see the headlines every week, practically, about the
loss of some American corporate headquarters. More often than
not, it is to a country that has a more competitive corporate
tax rate--that is easy to find when you have the highest rate
among all the developed countries--but also countries that have
a different international system, a territorial system of
taxation.
Our Tax Code, frankly, just makes it hard to be an American
company, and it puts U.S. workers at a disadvantage. At a 39-
percent combined State and Federal rate, the United States does
have the highest rate among the industrialized world. Adding
insult to injury, our government taxes American businesses for
the privileges of taking their overseas profits and reinvesting
them here at home, which is something we should be encouraging,
not discouraging.
Economists will tell us that this burden of our tax on the
corporate side falls primarily on workers in the form of lower
wages, fewer job opportunities, and, again, that is really what
is at stake here.
All of our competitors have cut their corporate taxes and
eliminated repatriation taxes, including our neighbor to the
north; just about all of them have. We have not touched our
corporate tax rate really since the 1980s. We have not changed
our international code in any significant way since the 1960s.
In the meantime, every one of our competitors has. As a result,
too many American businesses are headed for the exit, and this
is at a loss of thousands of American jobs.
The unfortunate reality is that U.S. businesses are often
more valuable in the hands of foreign acquirers who can reduce
their tax bills. It is one reason that you see this big
increase in foreign acquisitions of U.S. companies. Last year,
we now know, the number of foreign takeovers increased. In
fact, last year it doubled to $275 billion from the year
before. So doubling in terms of the value of foreign
acquisitions of U.S. companies last year from the previous
year.
This year, we are on track to surpass $400 billion--so it
went from $275 to $400 billion--according to Dealogic, again,
far outpacing the increase in overall global mergers and
acquisitions.
It should be very clear that foreign investment in the
United States is essential to economic growth. We want more of
it. That is not the issue. But we want a Tax Code that does not
distort ownership decisions by handicapping U.S. businesses.
That is not good for our U.S. economy, and that is what we have
today.
What is happening is that the current tax system
increasingly drives U.S. businesses into the hands of those
best able to reduce their tax liabilities, not necessarily
those best equipped to create jobs and increase wages here at
home. That is, of course, bad for American workers and bad for
our long-term competitiveness as a country.
To better understand the trend and inform legislative
debate over tax reform, this Subcommittee has decided to take a
hard look at this issue. Over the past several months, the
Subcommittee has reviewed more than a dozen recent major
foreign acquisitions of U.S. companies and mergers in which
U.S. firms relocated overseas. Again, this was a bipartisan
project. Senator McCaskill's experienced team at PSI worked
with us every step of the way. I am grateful for that.
Today's hearing is the culmination of that hard work. We
will hear directly both from U.S. companies that have felt the
tax-driven pressures to move offshore and from foreign
corporations whose tax advantages have turbocharged their
growth by acquisition.
One such foreign company is Quebec-based Valeant
Pharmaceuticals. Over the past 4 years, as we will talk about,
Valeant has managed to acquire a slew of U.S. companies worth
more than $30 billion. The Subcommittee reviewed key deal
documents to understand how tax advantages affected Valeant's
three largest acquisitions to date, including the 2013 sale of
New York-based eye care firm Bausch & Lomb and the 2015 sale of
North Carolina-based drug maker Salix. We learned that in those
two transactions alone, Valeant determined it could shave more
than $3 billion off the target company's tax bills by
integrating them into the Canadian-based corporate group. Those
tax savings meant that Valeant's investments in its American
targets would have higher returns and pay for themselves more
quickly--two key drivers, of course, of any acquisition. All
three Valeant acquisitions we studied, unfortunately, came with
job loss in the United States.
Beyond inbound acquisitions, America is also losing
corporate headquarters through mergers in which U.S. companies
relocate overseas. The latest news is the U.S. agricultural
business Monsanto's proposed $45 million merger with its
European counterpart, Syngenta. A key part of that proposed
deal, as we understand it, is a new global headquarters not in
the United States but in London.
To better understand this trend, the Subcommittee chose to
review in detail the 2014 merger of Burger King with the
Canadian coffee and donut chain Tim Hortons, an $11.4 billion
agreement that sent Burger King's corporate headquarters north
of the border. A review showed that Burger King had strong
business reasons to team up with Tim Hortons. But the record
also shows that when deciding where to locate the headquarters
of the combined firm, tax considerations ruled out the United
States.
At the time Burger King estimated that pulling Tim Hortons
into the worldwide U.S. tax net rather than relocating to
Canada would destroy up to $5.5 billion in value over just 5
years--$5.5 billion in an $11 billion deal. Think about that.
The company concluded it was necessary to put the
headquarters in a country that would allow it to reinvest
overseas earnings back in the United States and Canada without
an additional tax hit. They ultimately chose, of course, Tim
Hortons' home base of Canada.
Both Valeant and Burger King played by the rules. I think
that is an important point to be made. They and their deal
partners responded to economic pressures, opportunities, and
incentives created by our tax laws. If there is a villain in
this story, it is the U.S. Tax Code. And, frankly, it is
Washington not doing what Washington should be doing to reform
it.
My goal is to use these examples this morning and others we
will hear about today to better understand the need to overhaul
our broken corporate Tax Code and put U.S. businesses and
workers on a level playing field.
Again, I thank the witnesses for being here, and I would
like to hear now from Senator McCaskill her opening statement.
OPENING STATEMENT OF SENATOR MCCASKILL
Senator McCaskill. Thank you so much, Chairman Portman.
Let me say what a great honor it is to sit on this dais for
the first time as the Ranking Member of the Permanent
Subcommittee on Investigations. This is the Truman Committee.
This Committee was formed when Harry Truman got in his car with
no staff and drove around the country investigating war
profiteering in World War II. This is how he made his
reputation in the U.S. Senate, and many historians say it was
his work on this Committee that vaulted him into consideration
for the Vice Presidency and ultimately the Presidency of the
United States.
I am a huge Harry Truman fan for many reasons. His mouth
used to get him in trouble almost as much as my mouth gets me
in trouble. And he also did some courageous things that were
not poll-driven in his day. I am honored to hold his seat in
the Senate, and I am thrilled--it is a lifelong dream--to be
able to sit on this investigative Subcommittee and try to do
the kind of work that taxpayers would be proud of.
I know that Chairman Portman and I can work together well
in a bipartisan way to uphold PSI's long history of
bipartisanship in a way that is worthy of President Truman's
legacy.
I am also pleased to see a long-time Missouri business here
today--Emerson Electric Company, now celebrating 125 years in
St. Louis. Mr. Galvin, we are happy to have you here today to
offer your thoughts on this important issue.
Today I think we are in agreement that the current U.S. tax
system is broken and needs reform. Our corporate tax rate is
among the highest in the industrialized world. Our worldwide
tax system is out of sync with the territorial models our
economic peers have implemented. We lag behind other countries
in the Organisation for Economic Co-operation and Development
(OECD) in the value of the research credits we provide, and we
risk losing out as our European allies move forward with new
plans to incentivize the flow of intellectual property to their
borders.
On a very timely note, we are putting the Export-Import
Bank in jeopardy of existence, which is also another tool that
our manufacturers use in this country to compete on a worldwide
basis, since most of our economic peers have a similar type of
bank in their countries that is helping finance exports and
imports.
We see the effects of these problems every day. We see more
and more profits and intellectual property shifted out of the
United States to low-tax jurisdictions overseas. We see U.S.
companies stashing over $2 trillion in earnings overseas to
avoid the tax rate they would face upon bringing that money
back to our shores. And we see increasing numbers of U.S.
companies heading for the exits, whether through an inversion
or by otherwise relocating overseas.
At the same time, we are witnessing a huge upswing in
cross-border mergers and acquisitions activity--$1.3 trillion
in deals in 2014 alone, with foreign takeovers of U.S.
companies accounting for $275 billion of that total. This is
double the value of takeovers in 2013, and every expectation is
the boom will continue throughout 2015. This increasing trend
merits an examination about the causes of this merger impact
and the larger impact on jobs, tax revenue, and innovation.
Some argue that, absent the advantages the U.S. Tax Code
provides to foreign multinational corporations, many of the
U.S. companies acquired in these takeovers could have remained
in American hands. In this view, the combination of a high U.S.
corporate tax rate and a worldwide taxation system makes U.S.
acquirers uncompetitive, while foreign acquirers can employ
aggressive tax planning strategies that boost the value of U.S.
assets and allow them to make higher offers.
The reality may not be quite so simple. We know from
previous hearings before this Subcommittee that many U.S.
multinational corporations are adept at avoiding repatriation
of their overseas earnings and are just as active as their
foreign counterparts in shifting income and IP out of the
United States. As a result, effective corporate tax rates for
some U.S. multinationals can fall below the low statutory rates
in other countries.
In 2013, for example, the Government Accountability Office
(GAO) reported that the 2010 effective worldwide U.S. corporate
tax rate for profitable companies was only 12.6 percent.
Similarly, a study from the University of Michigan found that
the effective tax rates of the 100 largest U.S. multinationals
from 2001 to 2010 were actually lower than the rates for the
100 largest multinationals in the European Union.
The solutions offered to address the competitiveness gap
between U.S. multinationals and foreign multinationals are also
not quite so clear cut. Tax experts estimate that because of
profit shifting techniques by foreign multinationals, U.S.
companies will remain at a disadvantage so long as the U.S.
statutory corporate rate is above 15 percent--which is
significantly below the rates in previous bipartisan tax reform
proposals. The move to a territorial system also carries the
risk of providing greater incentives for companies to shift
profits overseas, and a territorial model without stringent
rules to prevent abuse and ensure transparency could cost
taxpayers over $100 billion over 10 years. Many other countries
are employing an ``innovation box'' through which business
income derived from intellectual property development is taxed
at a preferential rate. This is a very promising approach, but
there are challenges. We have to determine which IP rights we
should protect and the types of research and development (R&D)
activity that we should incentivize.
As we move forward in this discussion, I want us to keep a
few points in mind.
First, I believe that U.S. competitiveness ultimately
depends on continued investment in public goods like our world-
class research universities, our highly skilled workforce, our
strong rule of law, and infrastructure that is needed to
support business activity in the 21st Century. As a result, we
should guard against any tax reform measures that threaten to
erode the U.S. tax base and undermine these very clear-cut
advantages the United States of America offers to the business
world. This effort will require implementing anti-abuse
provisions to ensure a shift to a territorial system does not
provide an even greater incentive for multinationals to move
profits overseas.
Second, tax reform--particularly revenue-neutral tax
reform--will necessarily involve gains for some and losses for
others. As we discuss the challenges U.S. multinationals face,
we should not lose sight of the challenges faced by domestic
U.S. businesses--the companies that account for four out of
five jobs in this country. These businesses already operate at
a tax disadvantage relative to their multinational competitors,
and they should not lose out on tax credits that support
domestic manufacturing and research and development to
compensate for lowering taxes on foreign income.
Finally, we should resist the urge to demonize foreign
companies operating inside the United States. Foreign direct
investment brings $3 trillion to the U.S. economy. For every
non-U.S. company that grows through rapid acquisition and
severe cuts to research and development and employment,
countless others invest in their communities and provide much
needed manufacturing jobs. Robust foreign direct investment in
the United States is not just a consequence of globalized
competition; it is a tremendous advantage for our economy. Our
challenge is to ensure that when U.S. companies choose to grow
their businesses through domestic acquisition, our Tax Code
does not tip the scales in favor of foreign acquirers.
My hope for the hearing today is that our witnesses can
help us understand the role the U.S. Tax Code plays in
competition between U.S. acquirers and foreign acquirers. I
also hope we can gain insight into how the Code influences
corporate decision-making and how we can address the problems
in the existing tax system while still ensuring that the United
States continues to build the infrastructure and maintain the
tax base necessary to be a leader in innovation, research and
development, and business opportunities.
I think I could not agree more with the Chairman. Our Tax
Code is broken. Our Tax Code needs to be fixed. We are going to
have to have the political will to do it. And blaming companies
for doing the math that our Tax Code represents is a waste of
time. And what Congress needs to do instead is hold the mirror
up to ourselves because it is our inability to come together
and compromise in a comprehensive way that is holding us back
from reforming our Tax Code in a way that levels the playing
field for our businesses, not just in the global marketplace,
but right here in the United States of America.
I look forward to working hard with my colleague Senator
Portman and Senator Johnson and other Republicans, Senator
Lankford, to find those compromises necessary to level that
playing field and quit blaming companies for simply doing the
math.
Thank you, Mr. Chairman.
Senator Portman. Thank you, and great points.
Senator Johnson has to go to another hearing in a moment,
so I am going to ask him if he has a brief opening statement as
well. And, Senator Lankford, thank you for joining us as well.
Senator Johnson.
OPENING STATEMENT OF CHAIRMAN JOHNSON
Chairman Johnson. I will be very brief.
First of all, I just want to commend both the Chairman and
the Ranking Member for holding this first hearing. I think it
is very appropriate. If you take a look at the weaknesses in
our system that are preventing us from growing, it really is a
very uncompetitive tax system. And, I really appreciate Senator
McCaskill's saying we should not be demonizing businesses and
we should be looking at these structural problems we have, and
we should be incentivizing job creation, pointing out that the
true villain really is a Tax Code that is completely
uncompetitive.
I come from the business world. A basic principle in
business is benchmarking yourself against your competition.
Well, as a Nation state, we have to do the same thing. We have
to benchmark our Tax Code, our regulatory environment, against
our global competitors. It is not that hard to do. What is
difficult is developing the political will and achieving those
compromises to actually enact it.
So, again, I have read the briefing. I think the staff--I
want to commend them as well--has done an excellent job of
laying out the case. I have often said that the first step in
solving any problem is you have to properly define it and you
have to admit you have it. And so rather than demonizing
businesses, let us point out that the villain here really is a
very uncompetitive Tax Code. This is that first steps in
defining the problem so we can take--the real first step is
admitting we have it.
And, again, I just want to commend you. I wish I could be
here for the whole hearing. I will pop in and out as best I
can. This is an excellent first hearing, so thank you.
Senator Portman. Thank you, Senator Johnson.
We will now call our first panel of witnesses for this
morning's hearing. The hearing is entitled ``The Impact of the
U.S. Tax Code on the Market for Corporate Control and Jobs.'' I
would like to welcome our three panelists here on the first
panel.
The first one is Jim Koch. Jim is founder of the Boston
Beer Company, the brewer of Sam Adams beer.
The second is David Pyott. David is the former Chairman of
the Board and Chief Executive Officer (CEO) of Allergan. Thank
you, David.
And then Walter Galvin is here. He is the former Vice
Chairman and Chief Financial Officer (CFO) of Emerson Electric.
All three have great experience and expertise to bring to
bear on this, and we appreciate their willingness to come
forward this morning.
I would ask you to stick with our timing system this
morning. All of your written statements will be included in the
record, and we want to have plenty of time for questions with
you. We are going to ask you to limit your oral testimony, if
you could, to 5 minutes. Mr. Koch.
TESTIMONY OF JIM KOCH,\1\ FOUNDER AND CHAIRMAN, BOSTON BEER
COMPANY
Mr. Koch. Thank you, Chairman Portman, Ranking Member
McCaskill, Senator Johnson, Senator Lankford. It is an honor to
be here today as your Subcommittee investigates how the current
corporate tax structure in the United States should be reformed
to lessen the obstacles to starting, growing, and maintaining
an American business.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Koch appears in the Appendix on
page 47.
---------------------------------------------------------------------------
It is a little uncomfortable for me because I am not used
to talking without a beer in front of me, but I will try to do
it on plain old water. [Laughter.]
Senator McCaskill. We could probably send out for one if
you need one. If you get halfway through it and you need a
beer, just let us know.
Mr. Koch. That would be good. Thank you.
The Boston Beer Company had humble beginnings. I used my
great-great grandfather's recipe actually from the Soulard
district of West St. Louis, where his brewery stood in the 19th
Century. And I started brewing in my kitchen in 1984. I went
from bar to bar to sell the idea of a rich, flavorful American
beer, which was quite novel. Thirty years ago, I named my beer
after the American revolutionary and Founding Father Samuel
Adams, whose statue stands in the capitol representing
Massachusetts. Boston Lager was released in April 1985. And 6
weeks later, it got picked as the ``Best Beer in America'' at
the Great American Beer Festival.
Today, our family of beers includes over 60 varied and
constantly changing styles of beer. We are now available in all
50 States and in 30 foreign countries. Today Boston Beer
Company is a team made up of 1,300 American employees with
breweries in Boston, in Cincinnati where I grew up, and in
Pennsylvania. We have invested over $300 million in those
breweries in the last 3 years, and we are proud that today the
craft beer industry, which when I started was just a handful of
semi-lunatics, has grown to over 3,600 local businesses all
across the United States.
But despite that growth, today almost 90 percent of the
beer made in the United States is made by foreign-owned
companies. And foreign-owned breweries have now begun acquiring
American craft brewers with 9 of the most successful ones
having been acquired in recent years. So I am concerned that
growing and expanding an American-owned brewery is increasingly
difficult because our corporate tax structure places American-
owned companies at a competitive disadvantage to our foreign
counterparts.
It is not uncommon for me to receive visits from investment
bankers interested in facilitating the sale or the merger of
Boston Beer Company to foreign ownership. One of the principal
financial benefits of such a transaction is to reduce the tax
rate we pay. We are vulnerable because we currently report all
100 percent of our income in the United States, and as a
result, we pay a tax rate of about 38 percent on all of that
income. Under foreign ownership, that rate, I am told by
investment bankers, would be reduced to the range of 25 to 30
percent immediate through various practices like expatriation
of intellectual property, earnings stripping and the strategic
use of debt, offshoring of services, and transfer pricing. So
that means that a dollar of pre-tax earnings is worth 62 cents
to me under American ownership but about 72 cents under foreign
ownership. To put it another way, Boston Beer Company is worth
16 percent more to a foreign owner simply because of the
current U.S. tax structure.
Why haven't we sold Boston Beer Company to a multinational
or another foreign entity? The simple answer: It is just not
who we are. I named my beer ``Samuel Adams'' after our patriot
namesake. We were born in America. We have grown because of the
advantages available in the United States, and we do not mind
paying our taxes here in the United States in gratitude for the
opportunities that exist in this country and that I certainly
have enjoyed.
But do not mistake that for good financial decisionmaking.
I have to explain to shareholders why we have not taken
advantage of some of the strategies available to reduce our
corporate tax burden by moving overseas. In response to
economic pressures, other companies are saving millions, or
hundreds of millions of dollars through complex tax planning
every year. And rest assured Senators, while we are sitting
here talking about corporate tax reform, there are folks in
offices and boardrooms all over the world making their own
version of corporate tax reform every day. The difference is
that not one of them is accountable to your constituents. So
Congress' inaction on this subject has created a system of do-
it-yourself corporate tax reform that is available to few and
understood by even fewer. Because of our broken corporate tax
system, I can honestly predict that I will likely be the last
American owner of the Boston Beer Company.
Due to hard work, innovation, and diligence, American craft
brewers have created thousands of well-paying manufacturing
jobs and created respect for American beer all around the
world. I know of no manufacturing sector in the United States
that has grown for 30 straight years and achieved double-digit
growth for 16 straight quarters. But when these foreign
acquisitions occur, American jobs are often cut or shipped
overseas, less investment is made here in the United States,
and other cost-cutting measures on management and sales forces
are implemented along with reductions in local philanthropy and
community involvement.
The solutions are pretty clear: Cut the highest-in-the-
world U.S. corporate tax rate to the mid-20s; bring America's
international tax system in line with the rest of the
industrialized world by allowing U.S. companies to bring their
overseas earnings home--just like the British and Canadians
allow their businesses to do. And Senator Portman's recent
proposal with Senator Schumer provides a strong, bipartisan
road map on the international piece of tax reform. With these
reforms, I believe we can unleash a lot of job creation and
innovation in this country. And without them, I fear America
will fall behind economically.
Thank you.
Senator Portman. Thank you, Mr. Koch. Mr. Pyott.
TESTIMONY OF DAVID E.I. PYOTT,\1\ CHAIRMAN AND CHIEF EXECUTIVE
OFFICER (1998-2015), ALLERGAN
Mr. Pyott. Thank you, Chairman Portman and Ranking Member
McCaskill, Senators Johnson and Lankford.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Pyott appears in the Appendix on
page 49.
---------------------------------------------------------------------------
My name is David Pyott, and I am the former Chairman and
CEO of Allergan. Until it was acquired by Actavis in March
2015, Allergan was a great 65-year-old American pharmaceutical
company, a world leader in ophthalmology, medical aesthetics,
and Botox therapeutic as well as cosmetic.
In my 17-year tenure as CEO, Allergan experienced
tremendous growth, going from $600 million in sales in 1997 to
more than $7 billion in 2014. Lots of jobs were created, going
from 4,000 to 10,500.
Growth was principally organic and R&D-driven. Allergan's
R&D investments increased from less than $100 million in 1997
to over $1 billion in 2014, leading to a steady stream of
regulatory approvals by the Food and Drug Administration (FDA).
In early 2014, Allergan's outlook was bright: We projected
double-digit revenue growth and mid-teens increases in earnings
per share for the next 5 years.
But, ultimately, those qualities--sustained growth, robust
R&D, and $4 billion in cash, most of it located overseas--made
Allergan a very attractive target for acquisition, especially
for a foreign company.
The U.S. Tax Code, as we have heard, creates advantages
that are worth billions for foreign acquirers to buy up
American companies.
So what happened in 2014? We were targeted by Valeant, a
Canadian company that has acquired over 100 pharmaceutical,
medical device, and OTC companies in the last 7 years in a
roll-up strategy. Valeant has the clear strategy of not
investing in R&D. Valeant had just completed an $8 billion
acquisition of Bausch & Lomb in 2013 and was too weak and laden
with debt from that transaction to be able to buy Allergan on
its own. So Valeant entered into a partnership with Pershing
Square, run by activist investor Bill Ackman, to go after
Allergan together. It was the first-ever partnership of its
type. In the February to April 2014 timeframe, using stock
purchases and then options and derivatives, Pershing Square was
able to accumulate 9.7 percent of Allergan's shares without
making any public announcement.
On April 22, Valeant bid $47 billion to buy Allergan, an
increase from the $37 billion valuation when Pershing Square
initiated its first purchases of stock, a premium, obviously,
of $10 billion, or about 25 percent. Such a premium was enabled
by the enormous tax savings available to Valeant, with a 3-
percent worldwide corporate tax rate, allied with their
rapacious cost-cutting plan.
In its pitch to investors, the Valeant plan was to reduce
Allergan's 26 percent effective tax rate to 9 percent, a
difference of 17 percent, or $500 million per year. Applying a
price earnings multiple to this $500 million, this gives
Valeant and Pershing Square roughly a $9 billion valuation
advantage. In simple terms, thinking back to the math, Allergan
was worth $9 billion more--simply by being moved to foreign
domicile.
On the day of announcing the bid, Pershing Square
interestingly posted a profit of almost $1 billion. I sincerely
hope that the SEC will investigate this novel structure
regarding possible breach of the insider trading laws and other
securities regulations.
But back to Valeant. The Allergan Board felt that the offer
substantially undervalued the company. Valeant's plan was also
to strip Allergan, cutting overall operating expenses by 47
percent, slashing R&D within that from more than $1 billion to
just over $200 million per year, along with other market-
building investments.
Valeant planned to load up Allergan with more than $22
billion in new debt, taking the debt load of the combined
company to more than $50 billion.
After assessing many strategic alternatives, the Allergan
Board ultimately decided to seek out a so-called white knight.
Of the potential suitors, it was clear to me that only a
foreign-domiciled company could be in a position to outbid
Valeant while still creating value for their own stockholders.
Obviously, as we have heard, foreign acquirers have lucrative
tools: debt pushdown, migration of intellectual property.
Valeant contemplated both.
In November 2014, Irish-domiciled Actavis bid $66 billion
for Allergan. Similar to Valeant, Actavis could immediately
reduce Allergan's effective tax rate--from 26 percent to 15
percent. Beyond just selling to the highest bidder, the
Allergan Board assessed an acquirer's commitment to innovation.
Unlike Valeant, Actavis was and is committed to maintaining the
best of Allergan in the combined company.
Given the premium that had to be paid to secure control of
our company, cost synergies, of course, had to be found, about
$1.8 billion, a modest 11 percent of operating expenses across
both companies.
As for jobs, I am no longer with the company, but estimate
that about 1,500 jobs will be eliminated from the legacy
Allergan side, mostly in California. The reduction in R&D thank
goodness has been modest.
With this sale, we could salvage what we could of a great
American company. The last operating year was the best in our
65-year history. Sales increased by 16 percent, or over $1
billion to $7.1 billion. As a point of pride, Actavis adopted
Allergan as the new corporate name in June 2015.
Looking back, I am convinced that Allergan today would have
remained an independent, American company had it not been for
the significant disadvantages caused by our uncompetitive U.S.
corporate tax system. The implications are clear, not only for
the pharmaceutical and biotech industry, but extend across many
industries that are global. Unless Congress acts, I believe
that many more innovative American companies will be lost.
Thank you for the opportunity to testify about my
interesting experience.
Senator Portman. Thank you, Mr. Pyott. Mr. Galvin.
TESTIMONY OF WALTER J. GALVIN,\1\ VICE CHAIRMAN (OCTOBER 2009-
FEBRUARY 2013), AND CHIEF FINANCIAL OFFICER (1993-2010),
EMERSON
Mr. Galvin. Good morning, Chairman Portman, Ranking Member
McCaskill, and Members of the Committee. My name is Walter
Galvin. I am the former Vice Chairman and Chief Financial
Officer of Emerson, a $25 billion global manufacturing company
founded in St. Louis 125 years ago. Emerson has over 110,000
employees and operations in more than 150 countries.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Galvin appears in the Appendix on
page 54.
---------------------------------------------------------------------------
In each of the last 3 years, Emerson paid $1.3 billion in
taxes worldwide. Over half was paid in the United States.
Emerson's business is global. Over 55 percent of our sales
are outside the United States, and several of our major
competitors are domiciled abroad. Being domiciled in the United
States means we pay more in taxes on a worldwide basis.
My testimony will focus on three areas: first, why
America's tax cost on foreign profits is such a disadvantage to
U.S. companies; second, how other nations have set examples we
can follow; and, third, how Emerson can serve as an example of
an American-based multinational that lost out to foreign
competitors because of our Tax Code.
To begin, the combination of our high corporate tax rate
and the way the U.S. taxes foreign profits can make U.S.
companies more valuable in foreign hands--which is leading to
American businesses being stripped away.
A recent analysis by Ernst & Young found that, from 2004
through 2013, foreign buyers acquired $179 billion more of U.S.
companies than we acquired of theirs. Additionally, data
provider Dealogic reports that the gross value of foreign
takeovers of U.S. companies doubled last year to $275 billion
and, at the current rate, will surpass $400 billion this year.
These takeovers reflect thousands of U.S. companies leaving
American shores.
How can we stop this accelerating exodus? Congress must
remove the premium only American companies pay by moving to a
territorial system and reducing the top corporate tax rate.
We know it can be done. Other nations, like the United
Kingdom (U.K.), have successfully reduced their top rates. In
2009, the United Kingdom switched to a territorial system while
their corporate rate stood at 28 percent. Now that rate is 20
percent, and earlier this month, the United Kingdom released a
plan to drop that rate further to 18 percent.
Companies are taking note. Monsanto, an American company
also founded in St. Louis more than 100 years ago, is
attempting to merge with a competitor and set up a new parent
company in the United Kingdom. It is no mystery why.
I have two real examples of how Emerson's investors,
shareholders, and employees have been directly impacted by
America's out-of-date Tax Code.
In 2006, Emerson sought to acquire a company called
American Power Conversion (APC), a Rhode Island-based producer
of high-tech electronic equipment. At that time over half of
APC's earnings were made outside the U.S. Emerson competed
against Schneider Electric, a French company, and Ohio-based
Eaton Corporation to buy APC.
Emerson valued the company at just under $5 billion, but
Schneider ultimately acquired the company by bidding $5.5
billion. The principal reason Schneider's valuation of APC was
higher was due to the French tax law on repatriation.
Headquartered in France, 95 percent of Schneider's
repatriated profits are exempt from French taxes, so APC's
profits are worth more to Schneider because they can be
repatriated at a tax rate of under 2 percent. By contrast, if
Emerson repatriated those earnings, we would be subject to a
tax rate of approximately 17 percent. That 17 percent is the
difference between our 35-percent corporate rate and foreign
taxes we pay. The difference between Schneider's rate of 2
percent and Emerson's rate of 17 percent on a discounted cash-
flow basis is worth $800 million more to Schneider. Therefore,
Schneider was able to outbid Emerson, and what had once been an
American company became a subsidiary of a French-domiciled
company.
As for Eaton, they dropped out of the bidding process early
and about 6 years later acquired Ireland-based Cooper
Industries. Eaton is now an Irish-domiciled company, enjoying a
lower worldwide tax rate.
Second, America's worldwide system creates a perverse
incentive to keep foreign profits abroad. A few years ago,
Emerson bought a company in the United Kingdom called Chloride
for about $1.5 billion with cash we had earned abroad and kept
abroad. We considered other options for that cash, but the
United States would have charged us 10 to 15 cents in taxes on
every dollar we bring back home. So where will we get a higher
expected return--from one dollar invested in the United Kingdom
or only 85 cents in the United States?
We need to reform the Tax Code sooner rather than later.
Every time a company is acquired and the headquarters is moved,
there is a real community impact. In addition to costing
American jobs, this impacts local communities because of a
decline in State and local taxes and a loss of corporate
philanthropy and jobs.
I am grateful that the Portman-Schumer framework is moving
the conversation forward.
In closing, we cannot expect to create more jobs at home if
we continue to punish businesses like Emerson who want to
remain headquartered here. America's businesses and workers are
the best in the world, and we are not asking for a tax handout.
We are asking for a level playing field. With that, we can
compete with anyone in the world and win.
Thank you, and I welcome your questions.
Senator Portman. Thank you, Mr. Galvin. And, look, I
appreciate all three of you being here and testifying, and
specifically going into some detail on case studies that
involved your companies. We want to focus on the facts here,
and you have given us some great studies.
We are going to have a couple rounds here. The first round
will be 7 minutes each. The second round will be 5 minutes
each. We have some colleagues who have shown up, and I know
everybody is under pressure, so I am going to try to keep my
initial questions to less than 7 minutes.
I want to focus on a couple things. One, what I am hearing
from you all is that there are a number of problems with the
U.S. Tax Code and the perverse effect it has on U.S. jobs and
investment. One is you are just less competitive, and it makes
more sense to have your businesses in the hands of a foreign
acquirer because of the tax savings. And there are some amazing
numbers you have provided us here today, to the extent to which
that is true.
Second, you talked about--and Mr. Galvin just mentioned the
fact--that it is harder to grow as an American company, because
when you are competing for acquiring another company, you are
finding foreign competition coming in that can pay a premium
because of their after-tax profits.
And then third is this whole issue that you have all
referenced but that Mr. Galvin talked about, which is when you
have this lockout effect, you have the money stuck overseas
because you cannot bring it back because of the prohibitively
high rate, it is an incentive to make your investments
overseas, all three of which are bad for U.S. jobs.
So I guess I start with Mr. Koch, and I thought your
analysis was really interesting. I heard you say something
about investment bankers giving you a proposal frequently. Can
you sort of pull back the curtain on that a little bit and tell
us what is happening in the real world? Do you get proposals
from investment bankers or others saying, why don't you do this
inversion or why don't you make yourself a target for a foreign
acquisition?
Mr. Koch. Sure. And as we heard from the other panelists,
if you are an attractive American company, you have the things
that characterize American business. Innovation and creativity,
willingness to sort of create a new industry--those things are
very attractive to foreign owners, and that puts you on the
radar screen. So investment bankers, that is what they do. They
find these opportunities, and they work both sides, put them
together. So it is a regular feature of my life, talking to
investment bankers who can do the math.
Senator Portman. Yes, so you have U.S. investment banking
firms coming to your companies and saying, ``Why don't you do
this? This makes sense for you.''
One final question. You talked about the fact that you may
be the last U.S. owner of your company, sadly, and you talked a
little about the shareholder pressure. Are you responding to
that shareholder pressure by saying, we can become a foreign
company and maybe make some savings, but, we have a commitment
to this country? And how does that conversation go?
Mr. Koch. Well, I am very fortunate, for two reasons. One,
I have all the voting shares. [Laughter.]
So that helps. It is a wonderful form of democracy. I vote.
Senator Portman. I wish I had that here. [Laughter.]
Mr. Koch. It is a good thing. And the other is under
Massachusetts law, I am not legally required to maximize
shareholder value. I am not legally required to run the company
only for the benefit of shareholders. But under Massachusetts
law, I am allowed to take into account the interests of other
stakeholders. So that is about as good as it gets.
Senator Portman. I suppose it is clear to everybody on the
panel that that is a highly unusual situation, both in terms of
having voting shares and also having this fiduciary
responsibility be broader than it is in most of your cases. And
I really appreciate your patriotism and your coming here today.
Mr. Pyott, if you could tell us a little more about
shareholder pressure yourself. You had an amazing story to
tell. Among others, you talked about the fact that when Valeant
first made an offer for your company, it offered about a 25-
percent premium, as I heard it from you, and you thought that
they had about a $9 billion valuation advantage related just to
taxes, that meaning that Allergan was much more valuable in
their hands just because of the Tax Code.
Can you take us inside the board room for a minute? What
were those conversations like? How do shareholders react to an
offer like that?
Mr. Pyott. Well, as you can imagine, the intent both by
Valeant, allied with Pershing Square, because they could do
different things, one being an activist, one being a strategic,
was basically to put us into a tub of boiling hot fat. That was
very clear, to bring us to the negotiating table ASAP.
Well, we stood back and, of course, we had a proud track
record, because I was fortunate when I started at the end of
1997, the company was worth $2 billion. And thanks to the
enormous growth that I spoke about, by the beginning of 2014 it
was worth $37 billion on the New York Stock Exchange so people
could not really complain that much about my team's poor
performance.
So, of course, then comes the bid, and, of course, given
the numbers I gave you, pretty much all of the bid premium was
courtesy of the tax, right? So we knew this was, likely to be
much higher, and, of course, we had our investment bankers at
hand, and one of their principal jobs was to run numbers under
various valuation metrics. What was the value of Allergan to a
public shareholder? And it was very clear that the value was
substantially higher than what was being offered, and so as a
board, we could very much look in the mirror, look at
ourselves, and say we have to do a lot better than this to get
something approximating what we think--and not just we--the
experts with our numbers reflect the true value.
And so we then got into a huge fight that lasted 8\1/2\
months, and I was screamed at, every time I went out, whether
it was the media or especially the investment community to go
and negotiate. And I said, look, I will not negotiate until
there is a number on the table that is so close that one would
think the market will clear. If somebody is a million miles
off, beyond just shouting at each other, you do not get any
reasonable outcome.
And due to some major performance-enhancing measures we
took ourselves, because we had to get into our own cost-cutting
campaign--right?--to drive up earnings per share or to drive up
the intrinsic value of the company, we were able to really move
up the value. And, happily, due to the culture we have, the
team did not get distracted because you can imagine people were
saying, you are on a path to hell, because with all this media
opprobrium, literally I could not keep out of the newspaper for
more than 2 days. I am sure you all know what that feels like.
And I said to our team, if you do not focus on the
business, we are lost. And they did a fantastic job, the best
result for 65 years, which tells you about the spirit of the
people.
And so that is the way we just kept moving things along,
always steadily increasing the value of the company, until we
reached a point where, in fact, I knew I could no longer hold
the line, although I was constantly thinking--do I really go to
a shareholder vote? And I seriously thought of it.
If I may, just one last thing, because I am giving you the
various angles. The role of Pershing Square was very
interesting, because, of course, having 10 percent of the vote
out of the box is a powerful position. And then, clearly, the
goal was to kind of create a wolf pack with those firms whose
business is investment firms to pile in, in the so-called
event-driven world of hedge funds. We were able to contain that
whole community, Ackman plus the others, to actually 31
percent. And as you well know, 31 percent does not mean you
lose the election. And my job was to win and keep the long-
oriented investors in our position so that we theoretically
could have won, 50 and one percent would have done it--right?--
to keep control of the board. And then I am sure you want to
come back to how then Actavis came in from the other side.
Senator Portman. Yes, and I want to move on because I want
to give my colleagues a chance to ask questions.
Mr. Pyott. Absolutely.
Senator Portman. But we are going to dig deeper into that,
and also, Mr. Galvin, you are not off the hook here. I will be
asking you some further questions in the second round, but I do
want to go to my colleagues. Let me just make one comment, if I
might. You were consistently named one of the best CEOs in
America, and this was not a company that was floundering where
an acquisition, might have made sense in order to change the
management or to improve the business performance. This was
tax-driven, clearly. So I think it is interesting to hear your
story this morning, and, again, we will get into some further
detail as to the next step and what the consequences were of
the Tax Code on the actual acquisition and what has happened
since. Senator McCaskill.
Senator McCaskill. Thank you very much.
I am curious, Mr. Koch. I confess I have not paid close
enough attention to your marketing, but are you marketing that
you are the largest American beer company in the United States
of America?
Mr. Koch. Not really. I mean, we try to sell our beer on
the quality of the beer, the care and----
Senator McCaskill. You might think about it.
Mr. Koch. OK.
Senator McCaskill. I am just telling you.
Mr. Koch. OK.
Senator McCaskill. I do not think most Americans realize
that you are the largest fully owned American beer company.
Mr. Koch. It is sort of sad because we are little over one
percent market share.
Senator McCaskill. I get it, but I am just saying.
Mr. Koch. It is kind of crazy.
Senator McCaskill. I am just telling you, just for what it
is worth.
I wanted to go back momentarily, Mr. Pyott, to your
testimony. Did you say that Pershing posted $1 billion of
profit the day they tendered the bid?
Mr. Pyott. Very close. The number is $950 million.
Senator McCaskill. Is that being investigated now?
Mr. Pyott. I sure hope so. But, of course, as you well
know, if officials from the SEC come before you, they have to
speak with enormous caution, and I have to admit that I have
visited many Senators' offices, many Members of the House of
Representatives, doing my best to encourage whatever oversight
is possible.
Senator McCaskill. The former prosecutor in me kind of
went, ``What did he just say?''
Mr. Pyott. Yes. Well, I mean, you can tell I'm a person of
principle, and a lot of people in my shoes just move on.
Senator McCaskill. Goodness.
Mr. Pyott. I am afraid I feel pretty strongly about a lot
of things that happened last year. It was not just the Tax
Code. You can say, the very slow reporting periods that our
rules provide, are antiquated. Something has to happen in
financial services as well. And those members agree with me.
Senator McCaskill. Let me talk to you all about the anti-
abuse erosion measures. If we move to a territorial tax system,
which I think all of us understand is--everyone should
understand is, I believe, inevitable, everyone agrees that it
has to include measures to prevent abuse and to limit the
erosion of the U.S. tax base.
According to the Treasury Department, a territorial system
without full rules on the allocation of expenses could result
in $130 billion in lost revenue over 10 years.
So, some proposals are committed to revenue neutrality,
which has raised difficult questions about how we compensate
for lost revenue as a result of lowering corporate tax rates.
So I would like to hear your perspective as business leaders on
these hard choices. What kind of anti-abuse measures do you see
would work or that you might support so that we do not fix a
system and then all of a sudden wake up the next day and
realize it is being gamed by everybody shifting expenses to
once again do the kind of math calculations that put you in the
position you were in? Let us start with you, Walter, if you
would. Do you have recommendations on how we can put some rules
in place that would provide a cautionary note for the abuses
that could occur?
Mr. Galvin. Well, my personal opinion would be you need to
keep it relatively simple. You already have a tax rate with 35
percent base and all the earnings and profit calculations. So
if you consider--and American corporations have always said a
base rate of 5 percent is very attractive. A lot of the other
international companies have a 2-percent base rate. So,
internationally, if a company pays 10 percent in international
taxes against the 15, they get that credit. They would only pay
a 5-percent tax. But if an international company paid--a U.S.-
based company paid a 2-percent international tax rate, which is
probably suspicious even though totally legal, they would have
to pay an additional 8, or a total of 13 percent. So you would
scale it back down.
Certainly, for a lot of companies, if you look at what the
international tax rates are where companies participate, it's
nowhere close to the tax rates currently being reported. So I
think you need to do something. While it is a lot of work with
the earnings and profit calculation, having a sliding scale
between 5 and 15 should prevent some of the abuse, and
companies that are paying a more ordinary tax rate over 10
percent should not have a problem with it.
Senator McCaskill. Do you agree with that approach in terms
of preventing the kind of abuses that could really erode our
tax base?
Mr. Pyott. Well, my sort of general view is that I think if
we can get our headline tax rate down into the same kind of
target zone as the rest of the industrialized countries, then
we have solved a lot of problems of what I call ``around the
edge.'' And I think the whole matter of how you account for
revenue, especially cost sharing, is pretty well laid out.
I could talk a little bit about R&D partnerships because
that is the big deal in the pharmaceutical industry where,
clearly, to give you sort of a framework of what I meant: a
company like ours, we could at the time make a choice of
saying, OK, we will establish the intellectual property in
Ireland. We had a very large operation Ireland, the biggest, in
fact, outside the United States. We had thousands of employees
in the Republic of Ireland. And, of course, if you do that and
you say, OK, the Irish entity owns the intellectual property,
if the drug finally makes it, that is a fantastic answer
because their corporate tax rate is 12 percent.
But the bad news is for somebody like me who, does not last
forever, because CEOs normally last for 5 years, right? A few
masochists like me did it for 17. In the short run, you do not
get the deduction. So, obviously, if you did the same research
in the United States, you get a full deduction as a legitimate
business expense. But, of course, we did all that math and say
presuming we win and we got the drug approved, that will still
over a 20-year period be the right answer to position the
intellectual property in this case in Ireland versus the United
States.
Senator McCaskill. So the deductibility of expenses was not
sufficient to overcome the hurdle of what you would gain once
you made it across the finish line in terms of the tax rate on
the profits?
Mr. Pyott. That is right, 35 versus 12. There you go.
Senator McCaskill. There you go. Math again. Thank you.
Thank you, Mr. Chairman.
Senator Portman. Thank you. Senator Lankford.
OPENING STATEMENT OF SENATOR LANKFORD
Senator Lankford. Mr. Pyott, let me continue on that same
line on the intellectual property issue. Intellectual property,
how is that connecting with the repatriation issues,
territorial, worldwide system? Do you see that in the same
vein? Do you see that as separating that out? How would you
handle that? Because if you are dealing with the intellectual
property issues and ownership, what do you see as the best
resolution on that specific issue? Then, Mr. Galvin, I have a
question coming back to you on some of your math you were just
doing as well.
Mr. Pyott. Right. Well, at a very high level, I think, as I
said before, resolving the headline tax rate is the real
important thing. Around that, of course, there are other tools
available that other countries have used, like the Netherlands,
the United Kingdom in particular, on the innovation or patent
box. And that will encourage where R&D takes place and where
intellectual property is located. And, of course, just as I
said before, once you know exactly what the rules are, then our
peoples' job is to set up a stream of numbers where you decide
what is the best answer for that particular program and your
own particular corporation.
Senator Lankford. It does, but we are in this race that we
are currently standing still while everyone else is running on
the tax issues, when other countries drop their corporate rate
and try to encourage people to come. We are in the same race on
intellectual property as people continue to find innovative
ways to be able to encourage R&D to happen in their country
while we are standing still in it. So I guess the nature of my
question is: What can we do as a Nation to encourage R&D to be
here beyond just the rate itself?
Mr. Pyott. In addition to rate?
Senator Lankford. Yes.
Mr. Pyott. I think a patent box would be helpful. It is not
the solution. It would be a palliative or an aid.
I think, earlier we heard from, in Senator McCaskill's
remarks, we have, thank goodness, still have some huge inherent
advantages in the United States. And in our industry;
pharmaceutical, biotech, most innovations occur here, and in my
view, that is due to the knowledge base that we have, which is
due to the country's investment in National Institute of Health
(NIH), in great universities, and then the whole financial
system to enable startup companies to find capital and----
Senator Lankford. Right, but that is the asset side of it.
Mr. Pyott. The liability.
Senator Lankford. The liability side of this.
Mr. Pyott. Yes, yes. So I think what I am trying to answer
is to say, first and foremost, it has got to be rate. And then
I think after that you can probably bridge some numbers, you
know, if there is a difference between--I will toss out
numbers--a 30-percent rate and a 25-percent rate by using these
other tools, you can tilt the advantage back in the favor of
the United States.
Senator Lankford. Mr. Galvin, let me ask you a question
about rates as well. There has been a lot of conversation about
25-percent rate and how that ends up being this normative rate
in multiple countries. But you are also talking about countries
that may be 12 percent, 2 percent, whatever it may be, to try
to compete there, intentionally setting a corporate rate low,
where their individual rates may be much higher, but their
corporate rate is low intentionally to target companies.
So the question I have is: If we get a rate down to 25
percent, which has been discussed, or whatever that may be for
a corporate rate, that does not really solve the problem, it
does not seem like.
Mr. Galvin. It makes a significant improvement in the
situation. So if you could get the corporate or business tax
rate--and I will use ``business'' rather than look at the legal
entity, C corporations and everything else. If you made the
business tax rate 25 percent and you put in place a territorial
system that is similar to the vast majority of our competitive
countries, you would find that we would not have the
significant disadvantage that we currently have.
Also, as you look at intellectual property, all those other
countries also, in addition to those lower rates, a territorial
system, do have large R&D incentives. So you need a tax system
that is competitive with the rest of the world. Certainly you
are not going to get a rate or should not try, I do not think,
to get a rate to 12 percent because there are a lot of
potential problems if you have the rate there, because then
other countries would just continue to follow it down. We need
a rate that is just competitive with the vast majority of our
competition.
Senator Lankford. OK. So I would tell you just my American
attitude screams at me when I say let us try to get down to
average. I like to win. Right now we are losing because we are
at this rate that is noncompetitive. But dropping it to average
does not seem exciting to me. How do we win in this, obviously
not trying to shoot ourselves in the foot in the process, but
to incentivize businesses to be able to be here rather than
just say if we get to average, maybe we will not lose as many.
I do not want to just lose as many. I want to win.
Mr. Galvin. I think if you look at--because taxes are only
one aspect of the manufacturing, technology, employment issues
that you have. If you drop the rate further, as we did in 1986,
the last time, we saw the other countries just brought it down
even more. So if, for lack of a better term, you want to create
a price war, which generally----
Senator Lankford. Which we are already in.
Mr. Galvin. Yes, but be competitive at least. You have to
match prices in the markets that you serve. If you do not, your
volume goes down tremendously. That is what we are
experiencing. If you drop it to 12, I do not know how long
other countries, which have other levers to pull, will not just
do the same and you have not accomplished anything.
Senator Lankford. OK. Fair enough. Can I ask about debt
financing as well and the strategy and the advantages that
foreign companies have in trying to compete to buy American
businesses based on debt financing in that process? Do you have
any insight on that?
Mr. Galvin. Yes. I would say an example is the United
States has fairly liberal thin cap rules on acquisitions, as I
think some of the other panelists suggested, that when the
companies were acquiring them, they used a lot of debt
financing. And as you look at other countries as to debt
financing in acquisitions, in studying the rules, other
countries tend to use other instruments besides their tax laws
to prevent the debt financing.
When we tried to acquire a company in China, which we did,
for $750 million, we were trying to look at some debt financing
because it generated--this was in 2000--a lot of cash and you
could pay it off. The tax law would say you could do debt
financing, but their equity investments and other controls
within China said it all had to be equity. So we had to put in
$750 million of equity.
If you look at the French tax code, it is fine to have debt
financing. But if you look at what they would say are transfer
pricing on inter-company loans, it precludes it.
So we have, in my opinion, weak thin cap rules, and for a
company--go back to a Missouri company that I am sure Senator
McCaskill is quite close to, with Anheuser-Busch--and I think,
Mr. Koch, you have probably heard of that company. The amount
of debt financing that was used in that transaction was
substantially significant, and they were able to finance it----
Senator McCaskill. Just say ``huge.'' [Laughter.]
Mr. Galvin. Yes, it was a huge number. It was a very big
number. And what you had then is companies not only--the
acquirer likes to put all this debt in the United States where
you get the benefit of a 35-percent tax shield of all the
operating profit of Anheuser-Busch. And so it is another case
of where--if you are a capitalist around the world, where would
you rather have your debt located? In Ireland at 12 percent, in
Germany and most of the developed at 25, or in the United
States at 35 percent? You would load it all into the United
States. That is what they do. They acquire the companies, and
they lever it up. Then when you see also what happens, which
being familiar in the St. Louis community, the amount of job
losses that occur are significant. When the U.S. companies are
acquired, jobs in the corporate and also manufacturing
locations, the R&D location, you lose jobs. No one likes that.
That is what the Tax Code does.
Senator Lankford. OK. Thank you.
Senator Portman. Senator Johnson.
Chairman Johnson. Thank you, Mr. Chairman.
I want to pick up on the point you just made, because I
make a similar point in terms of where do you want to load up
your operating profit. If you are a global manufacturer and you
want to take advantage of what I think we have in terms of
global advantages, competitor advantages, we are the world's
largest market here in the United States, right? I came from a
manufacturing background. I know manufacturers want to be close
to the customers, so that is an enormous advantage. Plus we
have abundant and relatively cheap power. So if you are one of
those global manufacturers, you want to come manufacture close
to the world's largest customer with cheap energy, are you
going to site your plant in Toronto at 15 percent or Detroit at
35 percent? Isn't that what we are talking about? So you are
going to want to site your operating profit or locate your
profit in low-tax zones, and you are going to put your debt in
a high-tax zone. Correct.
Mr. Galvin. Yes.
Chairman Johnson. I want to talk about the total decision,
because we are always talking about a territorial versus a
worldwide system, which is a problem, traps profit overseas.
But then we also have tax rates.
Mr. Koch, you talked about--and I thought it was a very
powerful figure--that for every dollar of profit under U.S.
ownership, you get to keep 62 cents; under foreign ownership,
you would keep 72 cents. So that is a combination, though, of
not only a territorial system but also tax rates. Correct?
Mr. Koch. For us, we keep everything simple. We report
every dollar of income in the United States.
Chairman Johnson. Right.
Mr. Koch. So the territorial thing does not really affect
us.
Chairman Johnson. But it affects any other decision here.
Mr. Koch. Absolutely.
Chairman Johnson. It is a combination of the two factors.
It is really difficult to separate both of them out. Is that
basically correct?
Mr. Galvin. Yes, and I would give you an example, that for
Emerson, with 58 percent of our sales outside the United
States, more than 50 percent of our profits are in the United
States. And if you look at our sales and exports, we export
from the United States to trade customers and to our
internationally owned subsidiaries $1.6 billion more from the
U.S. abroad than we export from those own subsidiaries back to
customers in the United States. So, yes, you make other
decisions as well.
Chairman Johnson. Mr. Koch, you are largely a family owned
business still?
Mr. Koch. Yes.
Chairman Johnson. What is your ownership in terms of
outside?
Mr. Koch. We are a publicly traded company, but the
publicly traded shares are non-voting shares. And then I have
about 30 percent economic interest, and that is all the voting
shares.
Chairman Johnson. So, again, as an individual, as a
patriot, you are saying, ``I do not care about the 10 cents. I
am going to keep the business here, and I will pay that 10
cents on every dollar penalty.''
But I want to go to a public company, and the fiduciary
responsibility of a CEO and the board of directors that are
reporting to shareholders, which are unions and everybody else,
and the pressure and, quite honestly, the fiduciary
responsibility they cannot give up that 10 cents, can they? Mr.
Pyott.
Mr. Pyott. Yes, exactly. So that is why, U.S.
multinationals, as we heard, do appropriate tax planning
following the rules. And in our case, I would say we were maybe
just over the middle of the pack, where we paid 26 percent
worldwide effective tax rate, in our case, with 40 percent of
our sales being outside the United States. And I can certainly
say in terms of the locus of decision of where to manufacture,
clearly for a long period of time, 25 years plus, we invested
most of our non-U.S. capacity into Ireland because, obviously,
a good workforce, well educated, hardworking, and a tax rate--
and given our kind of business, where, you are selling eye
drops in a little bottle of 5 or 10 ml., freight costs really
do not play any role at all.
Chairman Johnson. Now, what Senator McCaskill was saying,
people that run these large corporations can do the math. But,
again, they also have that fiduciary responsibility. But it is
way more than just making a decision or being a patriot. It is
about being able to compete, correct? If you do not make that
decision, if you take that 10-cent-per-dollar penalty, or even
greater, eventually you will not be able to compete, and then
you will lose jobs. Is that basically a correct evaluation?
Mr. Pyott. That would be true. In our case, I think we were
so strong that we were able to overcome the tax disadvantage
because we had innovated. And, again, when I started, we were a
very small firm. It was less than $1 billion. And we competed
against large U.S. multinationals--Pfizer, Merck--and people
used to say, ``How will you survive?'' Well, happily, we were
so focused in eye care that both those companies for different
reasons left that business, and we were the ones that prevailed
and gained market share year in, year out.
Chairman Johnson. Well, eventually you were not able to
survive as a U.S.-owned company. That is the bottom line.
Again, we can demonize those individuals that took a look at
the Tax Code--and, again, if there was insider trading, that is
a totally different subject. But let us assume there was not.
But those--we will call them ``corporate raiders''--they are
simply using a Tax Code and looking at global tax jurisdictions
and saying this is a financial transaction that makes a lot of
sense, and there was in the end nothing you could really do
about it, other than find a white knight----
Mr. Pyott. Which happened to be a foreign----
Chairman Johnson. A foreign company, because, again, that
is the only way they could compete.
Mr. Pyott. That is right.
Chairman Johnson. So this is about math, this is about
competition. And, again, we can demonize American companies
that are trying to survive, which is the wrong way of looking
at this, or we can take a look and, as the Chairman said, point
to the real villain, which is the Tax Code, which forces this.
And, again, if we ignore that reality--and that is what I want
to get to. The reality of the situation is we have an
uncompetitive Tax Code, and if U.S. businesses do not respond
to that, they will be put out of business because they will not
be able to compete. Is that basically a true statement, Mr.
Galvin.
Mr. Galvin. Yes.
Mr. Pyott. I would like to follow on to what you really
suggested, and that is, companies that are either foreign or
have become foreign through the inversion process typically
have then used that hunting license and that advantage to keep
going. And there are many examples where the original
transaction was, let us call it, $10 billion, and 4 or 5 years
later, the quantity of deals they had done was multiples of
that, three, four, or five times. So you can see there is a
secondary effect here as well.
Chairman Johnson. OK. I will just close, again, by
commending the Chair and Ranking Member. This is so important.
Senator Lankford just left. He is in charge of our Subcommittee
on Regulation, which is another big problem when you are trying
to track global capital and keep manufacturing jobs in America.
We have such an uncompetitive regulatory environment. But as
this hearing clearly shows, as the work of this Committee staff
has done, and the Chairman and the Ranking Member have done, we
have an uncompetitive tax system forcing companies, in order to
survive, to take over that corporate ownership, and then we
lose it all. We lose all the income in terms of being able to
tax it. So we have to become far more competitive, and we are
highlighting a reality here that we have to admit exists.
Thank you, Mr. Chairman.
Senator Portman. Senator Ayotte.
OPENING STATEMENT OF SENATOR AYOTTE
Senator Ayotte. I want to thank the Chair. I want to thank
the witnesses that are here. This is a very important topic.
But I kind of want to boil this down to a little straight talk
on this, because I think what we are seeing in the political
realm is we have seen a lot of discussion about bad
corporations who want to commit these horrible things called
``inversions.'' When we think about the workforce, the people
of this country that want a good-paying job in this country,
isn't it those individuals who get impacted the most by our
failure to take on this Tax Code issue and make sure that we
are competitive? And I would ask each of you for a yes or no
answer on that. Mr. Galvin.
Mr. Galvin. It is very difficult, how you phrased the
question, to give a yes or no answer, because there are two
types of transactions you proposed or looked at. If you are
looking at corporate acquisitions from an international company
buying a U.S. company, the employment levels I think factually
will show you have been substantially reduced. I think you can
see that very clearly in the Anheuser-Busch situation.
If you look at inversions, we are seeing a lot of
inversions, and I do not have the numbers in front of me, but I
suspect the management generally does not move from the U.S.
location where they are at. A few people, it is a domiciled
location in another country. The community involvement in an
inversion probably still remains very heavily in the U.S. So
you have a different impact on an inversion with a management,
even though they acquired another company and a new company is
set up, the legal ownership--and there are probably several
more lawyers here than I am, but that legal ownership is
abroad, the management who is running it is probably----
Senator Ayotte. I am just trying to boil this down for my
constituents to understand. Competitiveness, incredibly
important. What I get the question from your average person is,
OK, I see these corporations, the management, the leadership,
they are doing very well. How do we make sure that the people
in this country that are struggling, the middle class, that we
create greater opportunities for them? And it seems to me that
this Tax Code issue often gets misrepresented, that somehow if
we make our code rate more competitive, if we make sure that we
have the right types of laws to encourage research and
development, whether it is a patent box or something,
ultimately, it is the workforce that is going to benefit in
terms of opportunity. And that is what I am trying to get at,
because this is a question I will get out at my town halls when
it comes to the corporate rate and why should we do this,
aren't we giving an advantage, to people that are doing well
anyway. And I just want to boil this down so that your average
person can understand why this is so important.
Mr. Pyott. Maybe if I can have a stab at it, if one looks
at history around the world--and I am fortunate. I have lived
in 10 countries, worked in 7, so I could tell you the good,
bad, and ugly of all of them. And if you look, say, at extreme
examples like the United Kingdom and Sweden in the 1970s, where
we had completely uncompetitive taxes, probably uncompetitive
labor markets, and business just left the country, once that
got fixed, a lot of it came back. So that is very encouraging
that in the same way that we are lamenting the current
situation, if we can get it right, even if we were average,
things would be a lot better.
I would also like to give you an example of creation of
jobs. In my testimony I was talking about the huge investment
in R&D. In my 17 years, I started with an investment of $100
million a year in R&D, and the last year was well over $1
billion. A large part of that was you need people to do that.
You need highly educated people. Eighty percent, maybe 85
percent of those people were in the United States. They were
not in the United Kingdom, France, Switzerland, or Singapore.
They were in the United States. And, hence, why when my
explanation of what occurred, the plan to really kill R&D,
which is just factual, by Valeant to reduce the R&D spend from
$1 billion down to $200 million-plus, you can work it out what
would have happened. And I stated thank goodness the best
answer I could get was the merger with Actavis, who at the
margin is reducing R&D probably 12, 15 percent, again, not my
desire, but we are all pragmatists. It was the best we could
do. And it was the right thing for the future company and its
stockholders.
Senator Ayotte. Mr. Koch.
Mr. Koch. Yes, I would add to what the other panelists have
said. There is something different about American ownership of
a company. I mean, you live in the community. You do not want
to see in the paper that you just cut 1,000 jobs.
Senator Ayotte. Right.
Mr. Koch. But if you live in a foreign country and you fly
in and you whack all those jobs, there is no remorse. But as an
American-owned company, the people I employ, their kid, my wife
may coach them on the soccer team, you see them at a--I mean,
these are people you went to school with back in Cincinnati. It
is important to provide a livelihood for those people, and you
cannot get away from the personal commitment and desire to
continue that comes from having the decisionmakers here in the
United States in that community.
Senator Ayotte. Well, I appreciate all of you being here. I
think that you have given us a very obvious list of things we
need to do. And this is something that we have been talking
about a lot here collectively in the Congress for too long,
because it is obvious what we need to do in terms of the tax
rate, in terms of competition, in terms of making sure that
this is the best place in the world to own a great American
company that produces some really good beer.
And so I think that we, I hope that this is something we
can work together across party lines on because it will help
make sure that the 21st Century is an American century when it
comes to American jobs. So I thank you all for being here.
Senator Portman. Thank you, Senator Ayotte.
We are now into our second round of questions. We will try
to keep these to 5 minutes for each of us. Many of the
questions that you all have answers I think have shed light on
this issue of how do you come up with a better tax system. We
talked about the rate. We talked about the international
system, territorial system, enabling countries to repatriate
their profits, the U.S. system currently locking out those
profits.
But on the jobs front, I am just curious. Mr. Galvin, I
said I was not going to let you off the hook. I have some
questions for you as well. You talked a little bit about
Schneider outbidding you for APC, and this is in this category
I talked about earlier where it is not just about U.S.
companies getting taken over by foreign companies. It is about
U.S. companies not being able to be as successful as they could
be because when they try to grow, they are constrained because
foreign entities can pay a higher price for that company
because of their after-tax profits being better. They can pay a
premium. And I think what you said was that this was an
example.
So here is my second question, though, about APC. Do you
know what happened to APC? They were taken over by Schneider.
What happened to their U.S. job totals?
Mr. Galvin. They went down substantially in Rhode Island,
and a lot of the R&D was consolidated and leveraged in the
French operations, which when you have an acquisition, there
generally is a lot of leverage on that business.
We would have also reduced the Rhode Island employment, but
we would have substantially moved those jobs to Columbus, Ohio,
where we still own Liebert Corporation, which makes three-phase
UPSs as opposed to single-phase and would have kept the
workforce in the United States.
We both had a substantial share already in the UPS
business, and we could both get substantial operational
synergies in serving the world market. It would have been just
us, would have moved it to a U.S. location, which is often
where we have our centralized investments, so we still employ a
lot of people in Ohio, as you know.
Senator Portman. Now you have really piqued my interest by
mentioning Ohio.
Mr. Galvin. I thought I would.
Senator Portman. We are part of this puzzle.
Senator McCaskill. That was convenient.
Senator Portman. Thank you. [Laughter.]
So here we have a situation where you are trying to buy up
companies so you can expand and grow your U.S. company. You
lose out on the acquisition because of a foreign company can
pay a higher price because they can pay a premium. They buy the
company. This is a U.S. company that you wanted to buy. They do
the smart tax planning, which is to take intellectual property,
R&D, take it overseas, and the French do have a lower rate, and
they have the ability to take advantage of that. They,
therefore, take jobs out as well. David Pyott talked earlier
about how R&D and jobs go together, and increasingly that is
the case. I do not know, we have not really talked about the
OECD Base Erosion and Profit Shifting (BEPS) project, but
basically that is encouraging countries to go ahead and say not
only do we have a patent box, but we have a nexus where you
have to have the actual business activity connected with it,
meaning people.
So we lose jobs. You cannot expand, including in Columbus,
Ohio, thank you. But it is almost a secondary cause that I
think we do not focus on enough here, is that it is not just
about U.S. companies being taken over. It is about U.S.
companies not being able to be competitive. And this does go to
salaries and wages and benefits, because that is who, in the
end, bears the brunt of this, is the American worker. So thank
you for your work on this project of tax reform over the years,
Mr. Galvin, and we look forward to working with you going
forward on trying to come up with a bipartisan approach that is
sensible. Perhaps even in the next few months we can make
progress on that.
Back to Mr. Pyott for a second with regard to this
intellectual property issue. You talked about the fact that
other countries are putting in place these patent boxes where
they may have a lower rate than us but they have a
substantially lower rate than us with regard to intellectual
property that is often a patent or a copyright, and they define
these differently. Senator McCaskill raised the good question
earlier about a challenge for us as we look at patent boxes,
and as you know, that is something that Senator Schumer and I
recommended in our report a few weeks ago, is, what kind of
intellectual property do you include? Obviously, you have a lot
of experience with regard to the R&D side, on the pharma side,
and with regard to patents. But do you have some thoughts for
us with regard to if the United States were to go to a patent
box, how broad the definition of innovation should be?
Mr. Pyott. Yes, I think that is where you really get down
into the real nitty-gritty details, and I think to answer on a
high level, first of all, as I said earlier in my testimony,
you can overcome a couple of hundred basis points of overall
rate by making those kinds of tools available. In our case, as
I was explaining, we often chose to think very carefully about
where we would locate our intellectual property, understanding
on the long swing we had a final good answer. But, of course,
on the short swing, we were paying a lot more--it was costing
more because we did not have the full 35-percent reduction. So
that was a balancing act.
Senator Portman. The deduction you would have had in the
United States versus the----
Mr. Pyott. If we had kept the intellectual property here.
Senator Portman. Right. But the value of that IP grows as
your drug may be successful.
Mr. Pyott. That is right.
Senator Portman. And, therefore, it is worth having it
overseas.
Mr. Pyott. Yes. I think also another one for us--and that
gets back to the nexus you made between patent box and where
the R&D actually gets done, let us use that word, where the
real people sit, the real expenses are, because there, thank
goodness, we still have a huge inherent advantage. We located
most of our R&D in California, not just out of emotional love,
but that is where the real knowledge was. And even in the
United Kingdom, where we located our operation, there was
access to the kind of people we needed, but let us say the real
emphasis remained the United States. And had we moved forward
another 10 years the same way, I think it would have still
stayed the same rough balance.
Senator Portman. The final question I have is just briefly
with regard to this inter-company lending. So what you told us
this morning is not only does the rate matter, not only does
the territorial system matter, but also that these foreign
companies have an advantage because when they buy a U.S.
company, they can load up debt in the United States, take
advantage of the 35-percent rate and the deduction you get.
So this is something, obviously, that is a concern as you
are looking at tax reform, and, Mr. Galvin, you have, I am
sure, looked into this quite a bit. But one of the challenges
that we have right now as we look at how do we come up with a
new system is to try to avoid some of--the BEPS project gets
into this, of course--some of the base erosion that might occur
through inter-company debt. Can you talk about what you think
might be the right answer to that?
Mr. Galvin. Well, certainly a benefit in lowering the rate
to 25 percent and having it competitive with the rest of the
world would substantially reduce the incentive to load the debt
in the United States.
Senator Portman. Probably the best base erosion we could do
is lowering the rate.
Mr. Galvin. Yes, lower the rate, and they are not going to
load up--if it is the same rate in Germany, France,
Switzerland, whatever, you do not have the same incentive. You
are incentivizing them economically to put the debt in the
United States.
Senator Portman. Senator McCaskill.
Senator McCaskill. So here is my worry about us really
getting serious about redoing this Tax Code. I have had the
pleasure or the horror of sitting in on some complicated tax
planning meetings with some of the foremost tax experts in the
country, and it is frightening. It is frightening because, for
everything we do in the Tax Code, it is an action we take, but
then there is a reaction. So you cannot just say, OK, we are
going to do 25 percent and then let it go. We have to do all of
the other stuff. I mean, if you just look at the interplay
between estate taxes and trusts, for example, and all of the
things that good tax planners can do around those two things,
that is just one example of thousands that are in the Tax Code.
So I would certainly ask all of you, those of you who have
had real-world experience with complex financial, international
transactions, to be all hands on deck helping us here so that
we can look around corners.
What we just talked about in terms of the patent box, if we
do something like a patent box, do we require, for example, Mr.
Pyott, that in order to take advantage of the patent box, you
must do the R&D in the same country? In other words, if you are
going to get the patent deal here, you cannot just have the IP
located here; you have to do all the R&D here, too. Is that a
good idea? Is that a bad idea? Are we going to have a reaction
that is not good there? What is your opinion on that?
Mr. Pyott. I think that would be very sound for the United
States given our strength in R&D and our whole background of
huge investment in the NIH, which is a national jewel, as well
as all the benefits that then spill into startup companies,
universities and so on. That takes decades to replicate.
And if I were hypothetically, in the U.S. Government, I
would say make that an item of trade negotiation as well, to
say to our partners in the OECD, ``Fine, we are good with your
patent boxes, but you have to have a level playing field,''
i.e., make the nexus, the expenses, the people have to be where
the patent----
Senator McCaskill. Require the nexus for them also as part
of trade.
Mr. Pyott. That is what I would say.
I will give you another example in the discussion that we
did not touch upon, and that was the Treasury regulation that
was put out last September to tighten up the rules on so-called
hopscotching of foreign-located cash. And, again, I think that
was a useful measure, but as I said in pretty much all my
testimony, these are things that are at the edge. But if you
get them all right in the cumulation, then it will be really
quite good. Or I think with Mr. Galvin, when I was listening to
you, if you have rules about how much debt can you put down, to
prevent, let us call it, certain limits being exceeded, those
are all things--if you just get them, like 10 of those things
broadly right, then you have probably got the whole thing
broadly right.
Senator McCaskill. I was interested to hear you say that
your R&D went to California, and the reason that interested me
is because around here California by some of my colleagues
would be considered the worst place for a business to go
because all the regulation in California and the taxes are so
high and the regulation is so awful. So the magnet was, in
fact, the higher education community and the knowledge base
that is in California?
Mr. Pyott. That is still our inherent advantage. Now, to be
fair, the company was founded in California in 1950, started in
L.A., went down to Irvine before the city even existed. I
celebrated with the mayor 2 years ago, 50 years of Irvine, and
I pointed out, ``We were here before you were,'' which was kind
of fun.
But the real point that you make, I totally agree with you.
It is the basis of people that are being produced by the UC
system, CSU, which we need to, by the way, pay attention to
because funding is disappearing from the University of
California, and then all the startup companies. It is a whole
fabric, a tapestry of people, venture capitalists, that is very
difficult to replicate. And, you see it happening in other
areas of the United States, but, really when you step back, you
can say the biotech industry is really Northern even more than
Southern California, more San Diego than Orange County. It is
the Boston area, a little bit in Maryland. And then the device
industry is very much Boston, Minnesota, and California.
I mean, there are notable exceptions, but those are the
real clusters. And, if anything, I see people moving more to
the clusters than moving away from them despite cost.
Senator McCaskill. So I think the point I am trying to make
here is it is just not as simple as the number. The math
matters and being competitive matters. I could not agree more.
But if we in the effort to lower the corporate tax rate erode
our revenues we have done NIH on the cheap ever since the
crisis. NIH has been struggling. Government shutdowns are
brutal to NIH because of the inability to have certainty in
terms of funding research, which you cannot do in fits and
starts and do it effectively, certainly not cost-effectively.
So I just want to make the point, I think the hardest thing
for us on tax reform is the partisan divide that we have, that
we try to navigate around. And the Chairman and I are, I hope,
part of a group that is working very hard to tear that down.
But I think it is important for the business community to
continue to stress that higher education in this country,
funding of NIH, the ability of our kids to afford college, that
all of these are just as important for our global
competitiveness as the number that we stick in the Tax Code.
And I hope that all of you will help us with that, and
particularly, Mr. Galvin, I know your leadership role in BRT
and the business leaders. It would be a shame if we would, have
a race to the bottom on what is our inherent strength in a
foolish race to be the lowest tax rate in the world.
Thank you, Mr. Chairman.
Senator Portman. I thank the Ranking Member, Senator
McCaskill, and I just have to say the Joint Tax Committee in
2013 did a great analysis, saying if you get the rate down to
25 percent, you actually get more revenue because you have more
economic activity. And that is the goal, obviously, that all of
us have, is to bring these jobs and investment back and to
generate more opportunity here.
Gentlemen, thank you very much for your testimony this
morning. We will now call the second panel. Thank you for being
here.
[Pause.]
Senator Portman. OK. We will call our second round of
witnesses now for this morning's hearing, and I want to start
by thanking both Mr. Schiller and Mr. Kobza for being here. And
I also want to thank them for their cooperation and their
companies' cooperation with the Subcommittee. They voluntarily
provided very important information that helps us to get to the
bottom of what we are after here, which is better tax policy.
And I appreciate their willingness to do that.
I also want to repeat what I said earlier today, which is
that we are talking here about the U.S. Tax Code being the
problem. OK? And I hope that is something that every person
watching or listening today understands. This is about a
problem here in Washington, D.C., which is a Tax Code that is
dysfunctional. It is not serving American workers. It is
antiquated, it is outdated, and it has to be more competitive.
Mr. Schiller served as Valeant Pharmaceuticals' chief
financial officer between December 2011 and June 2015;
therefore, he has a lot of experience and background that will
be helpful to us.
Joshua Kobza is the chief financial officer of Restaurant
Brands International, which is the parent company of Burger
King and Tim Hortons, the Canadian restaurant chain.
I appreciate, again, both of you being here this morning
and look forward to your testimony. We do have a time system,
which we talked about earlier. We would ask that you try to
limit your oral testimony to 5 minutes. Of course, all of your
written testimony will be printed in the record, and we look
forward to the opportunity to ask some questions afterwards.
Mr. Schiller.
TESTIMONY OF HOWARD B. SCHILLER,\1\ CHIEF FINANCIAL OFFICER
(DECEMBER 2011-JUNE 2015), AND BOARD OF DIRECTORS (SEPTEMBER
2012-PRESENT), VALEANT PHARMACEUTICALS INTERNATIONAL, INC.
Mr. Schiller. Chairman Portman, Ranking Member McCaskill,
and Members of the Subcommittee, thank you for the opportunity
to appear before you on behalf of Valeant Pharmaceuticals.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Schiller appears in the Appendix
on page 57.
---------------------------------------------------------------------------
Valeant is a multinational specialty pharmaceutical and
medical device company. We operate in over 100 countries with
approximately 45 percent of our revenue in 2014 coming from
outside the United States, with a particular focus on growing
emerging markets.
For the past 7 years, Valeant has employed and successfully
executed on a unique and differentiated business strategy
within the pharmaceutical industry. Today's Valeant was born of
the 2010 combination of Biovail, a Canadian corporation, and
Valeant, a Delaware corporation. At the time, each of Valeant
and Biovail were small pharmaceutical companies focusing on
many of the same therapeutic areas and geographies, with the
need for greater scale to compete against larger multinational
pharmaceutical companies. This was a merger of equals in which
Biovail acquired Valeant. Today we are headquartered in Laval,
Quebec, and have approximately 19,500 employees, approximately
5,700 of whom are based in the United States.
Over the past 5 years, our sales and market capitalization
have each grown tenfold to projected 2015 sales of
approximately $11 billion and a market capitalization of
approximately $87 billion. With this growth, we have been able
to expand our operations both here in the United States and
around the world, creating quality jobs in the markets in which
we operate.
The growth and success we have been able to achieve at
Valeant is rooted, we believe, in the values and core
principles that guide our business decisions. These include:
First, a commitment to the health and safety of the
patients and customers who use and rely on our products.
Second, a commitment to innovation through an output-driven
R&D approach, which is unique in our industry. We focus less on
how much we spend on R&D and more on what we get out of our R&D
efforts. We source innovation through internal efforts, through
licensing technologies from entrepreneurs and other third
parties, and through acquisitions. We believe the results of
this approach speak for themselves, with 20 product launches in
the United States alone last year and a rich pipeline of
products.
Third, a commitment to our decentralized business model
under which each business unit is given control over and held
accountable for results within that unit.
Fourth, we are committed to a disciplined approach to
business development with a focus on high rates of return and
rapid payback periods for our shareholders. I would like to
address that last principle in greater detail.
First and foremost, we only pursue transactions that make
strategic business sense for Valeant. We generally look for
businesses to complement our existing product portfolio and/or
match our focus on high-growth therapeutic areas of geographies
where we believe we can improve business operations. We have a
strong track record of deploying our management and business
strategy to grow and improve businesses we acquire and provide
superior returns to our stakeholders.
Second, we take a financially disciplined approach to
business development. When assessing acquisition opportunities,
we generally seek to achieve at least a 20-percent internal
rate of return and a payback period of 6 years or less based on
applying statutory tax rates to the projected future earnings
of potential targets. Of course, these are guidelines, not
hard-and-fast rules, and every acquisition involves a
significant element of judgment. In particular, as we have
previously stated in public statements to our shareholders,
with respect to large public company acquisitions, due to the
transparency of the public markets and other factors, we have
generally accepted rates of return below our stated targets
based on our ability to deploy large amounts of capital at
returns still significantly in excess of our cost of capital.
We do not value proposed transactions and do not decide
whether or at what price to acquire a business based on the
availability to achieve tax synergies. We do, however, enjoy a
lower overall tax rate which allows us to generate more cash-
flow for a given dollar of revenue and leaves us with more
capital to deploy in our business, which in turn allows us to
deliver higher returns to our shareholders and accelerate our
growth.
Ultimately, while the tax synergies we have been able to
achieve have certainly helped us deliver value to our
shareholders, we believe that the execution of our
differentiated business model has been the primary source of
our growth and success. Our financial guidelines have helped us
to stay disciplined in our acquisitions strategy, and as our
Chairman and CEO indicated last week in an earning calls
reviewing past deals, we are exceeding our expectations with
respect to our acquisitions overall.
You have also inquired about our views regarding U.S. tax
reform. I am not a tax expert and cannot speak to the specifics
of any particular aspects of tax reform, but we have found the
Canadian system to be very conducive to our growth and success.
I would be happy to elaborate on that further during Q&A.
Thank you again for the opportunity to appear before the
Subcommittee, and I would be pleased to answer questions
regarding these topics.
Senator Portman. Thank you. Mr. Kobza.
TESTIMONY OF JOSHUA KOBZA,\1\ CHIEF FINANCIAL OFFICER,
RESTAURANT BRANDS INTERNATIONAL
Mr. Kobza. Thank you. Chairman Portman, Ranking Member
McCaskill, and Members of the Subcommittee, thank you for the
opportunity to appear before this Committee. My name is Josh
Kobza. I am Chief Financial Officer of Restaurant Brands
International (RBI) and most recently worked in the same
capacity at Burger King Worldwide. I am here today to discuss
the recent Burger King-Tim Hortons transaction, which created
one of the world's largest ``quick service restaurant (QSR),''
chains. I understand that the Committee is reviewing the tax
effect of the corporate Tax Code on U.S. businesses and on
cross-border mergers and acquisitions. While this transaction,
like all cross-border combinations, had certain tax
implications, the marriage of these two iconic brands of
similar size under the RBI umbrella was motivated by compelling
business reasons rather than tax strategies.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Kobza appears in the Appendix on
page 70.
---------------------------------------------------------------------------
Our vision centered on combining two brands that occupy a
distinct space in the QSR landscape--both geographically and in
their menu offerings--to create new opportunities. Burger King
is the world's second largest fast food hamburger restaurant,
with over 14,000 restaurants in approximately 100 countries and
U.S. territories.
Tim Hortons is the largest Canadian-based QSR, with
approximately 45 percent of all QSR traffic in Canada.
Our new RBI family now includes over 19,000 restaurants in
approximately 100 countries. More than half of Burger King's
restaurants are located outside the United States, and we see a
significant opportunity to grow the Tim Hortons brand and
unique operating model in attractive markets all around the
world, beginning in the United States.
My testimony today focuses on this transaction as it
occurred rather than hypothetical scenarios that could have any
number of potential inputs and points of analysis.
In 2013, our management team began to evaluate future
alternatives for growth and enhancement of shareholder value,
including potential strategic transactions. Through our search,
we identified Tim Hortons as an excellent choice--a very high
quality business with an incredibly strong brand and
complementary menu offerings, where we could add significant
value by leveraging Burger King's worldwide operating partner
networks and experience in global development.
We structured the transaction in a way that honors the
history of both companies. Burger King's headquarters remains
in Miami, Florida, and Tim Hortons' remains in Oakville,
Ontario, with separate management to ensure the integrity of
each brand.
We plan to open hundreds of new Tim Hortons restaurants
across the United States, attracting tens of millions of
dollars in investment, creating thousands of new jobs, and
expanding the U.S. tax base.
As CFO during discussions between Burger King and Tim
Hortons, I was responsible for working with our professional
advisers to explore how to structure a potential transaction.
As these discussions progressed, it became clear that a
combined Burger King-Tim Hortons company should be domiciled in
Canada.
The business case for this transaction was always very
clear to us, and closing the deal required careful calibration
of the terms and structure of the transaction. Both the Tim
Hortons brand and the Burger King brand are revered
institutions in their country of origin. But given that Canada
is the country with the highest concentration of employees,
assets, and income for the combined company, Canada was the
logical choice to be the domicile of the newly formed entity.
Additionally, the Board of Directors for Tim Hortons at
first declined to discuss any possible combination and was
reluctant to engage in serious negotiations until our proposal
contained both a higher price and a commitment to locating the
combined company in Canada. Throughout our discussions with the
company's board and management, it was made clear to us that
domiciling the company in Canada was critical to concluding a
deal.
Under the transaction, Burger King remains a U.S. taxpayer
with an unwavering commitment to our Miami headquarters, the
surrounding community, and our U.S. franchisees. When compared
to the 26-percent effective tax rate paid by Burger King prior
to the transaction, our current effective tax rate is only
slightly lower--in the range of 3-percent reduction. This
modest impact underscores a crucial point: Joining Burger King
and Tim Hortons together was fundamentally about growth. Tax
considerations were never the driving force for our
transaction. Rather, our primary motivation was to realize the
greater business potential of combining these two iconic and
complementary brands.
That is not to say that the domiciling of the company in
Canada did not have any tax effects. Canada's tax regime
provided both slightly better rates and its quasi-territorial
system provided an efficient and attractive platform for
growth. As a combined company, we are focused on accelerating
our growth. Our goal is to grow our business and our brands
alongside our franchisees, employees, and other partners.
In closing, we understand that in recent years, the policy
discussion regarding the role of tax considerations in
corporate mergers and acquisitions has become more prevalent.
In this regard, we welcome the ongoing bipartisan efforts to
make the U.S. tax system more competitive to level the playing
field.
Again, thank you for the opportunity to appear before this
Committee. I look forward to answering your questions.
Senator Portman. Thank you both very much.
I am going to start with you, Mr. Kobza, and Burger King.
You just made a point that the territorial system in Canada
helped with growth, that you have a slightly better rate in
Canada. The information you provided us with regard to your
decision-making was interesting to me, in part because of what
you said about the difficulty of bringing your profits back to
the United States. You all were growing internationally. You
wanted to grow more, and that is a good thing. But you found
that it was hard to bring those rates back.
Could you turn to page 29 of the appendix? I think you have
that in front of you there.
Talk to us a little about this. Is it accurate to say that
at the time of the transaction you expected a lot of your
future growth to come from international expansion?
Mr. Kobza. So prior to the transaction, we had gone through
4 years of rapidly accelerating development around the world. I
think one of the great accomplishments of those 4 years was to
multiply the pace of our growth by about four times in terms of
net new restaurants.
Senator Portman. So you were looking to grow more
internationally. So here you are, a U.S. company wanting to
grow internationally. And what were you facing internationally?
You had, again, looking at the data you provided us, about $700
million locked out in foreign earnings, meaning earnings you
could not bring back to the United States without paying a high
tax rate. Is that accurate?
Mr. Kobza. It is accurate that we had about $700 million of
permanently reinvested earnings, and we had made the decision
prior to the transaction that we would reinvest those
permanently, whether that be through new investments in our
growth or through M&A, or investments in our joint ventures.
Senator Portman. And what were you telling your board that
your corporate rate would be if you brought those cash balances
you had overseas, that $700 million, back to the United States
of America? What was your tax rate you talked about? If you
look at the appendix, there is a number there.
Mr. Kobza. Yes, I think it is very helpful to look at page
10 of the appendix, and I think it is very important to bring
some context to this page. This is really fundamentally the
lens that we look through when we analyzed the merger with Tim
Hortons. And what you have on the left side of the page is our
base case outlook, which considered our strategic plan for the
existing Burger King business and our existing tax rate, which
was around 28, 29 percent. And we thought that with that plan
we could generate a share price of about $46 over the course of
the next few years.
So when we measured the incremental value that this merger
would add, we always looked at it versus that $46 per share. So
we looked at how much more value could we add by doing the
merger.
Senator Portman. Let me just focus you in on this one
issue, though, that we are getting at, and I appreciate your
comment earlier that you hope we could see a U.S. Tax Code that
was a more level playing field. You had $700 million overseas.
You were telling folks that under the corporate structure of
being a U.S. company, if you brought that back, it would be a
very high rate. In fact, I think you said it would likely
increase to near 40 percent would be your corporate tax rate if
you were to repatriate those cash balances. Is that correct?
Mr. Kobza. The reason for that analysis was that when we
looked at a Canadian-domiciled company, we considered that
given the quasi-territorial system, we would likely distribute
all of our foreign earnings. So as an illustrative analysis, we
calculated at a very high level what the tax impact would be if
we were to distribute all of our earnings in the existing case,
and we used an illustrative rate of 40 percent, and that is the
value that you see on----
Senator Portman. I get it. And that is sort of the point,
in part, of this hearing, to say here you were a U.S. company
and saying you would like to have the flexibility to be able to
bring some of those profits back and reinvest here and expand,
and you probably also thought this is going to get worse
because you wanted to grow more internationally and, therefore,
have more of those earnings that would get into this lockout.
So, there was a tax barrier.
The other issue is how did you choose Canada as your
headquarters, and let me preface this by saying I do not
question what you are saying at all about the business reasons
to have the combination. I think, from everything I have read
and heard about it, that is what motivated you looking at Tim
Hortons in the first place, and it sounds like it is working
for you from a business perspective.
But you had a decision to make. Where is the headquarters
going to be? And my understanding is that--and, again, I think
this is--if you look at page 25 of the appendix, you will see
something with regard to this decisionmaking as to where the
headquarters ought to be. You looked at a number of different
places. I do not see the United States of America on the list.
And I assume, based on the information that you provided us,
that that was because of the tax consequences.
So I get it that Tim Hortons wanted to stay in Canada. I am
sure they had lots of reasons for that, maybe some of which had
nothing to do with taxes, but certainly one would be taxes. Is
it accurate to say that the United States was not even on the
list of places where you might want to put a corporate
headquarters of the combined companies?
Mr. Kobza. Yes, so as we went through the transaction, I
would say there are probably three big factors that drove our
decisionmaking about why the combined company should be
domiciled in Canada.
First, Canada would be the center of operations for the
combined company. It had the largest concentration of
employees, assets, and income of the company.
And the second reason is that this was something extremely
important to the board of directors and management team of Tim
Hortons. And, in fact, in written communications to us, it was
put out as a condition to moving forward and even beginning to
negotiate in the deal. It was only after we put that in our
offer letter that the company even began to negotiate with us.
Furthermore, we had to count on getting approval from the
Canadian Government under the Investment Canada Act (ICA), and
we went through a study of all 1,500 cases that have passed
through ICA review in the past 25 years and through that study
came to the conclusion that domiciling the combined company in
Canada would be a critical success factor for getting through
that approval process. And we did not have any exit from the
merger agreement if we did not get approval, except under
extreme circumstances and in which case we would have had to
pay a $500 million penalty. So those three factors were very
strong factors in driving us to consider Canada.
That said, we also looked at the tax effects of domiciling
the company in Canada, and as you can see from the materials,
there was a reduction in the tax rate relative to the tax rate
that Burger King was paying previously, and that is something
that was factored into our analysis, into our board's analysis
of the deal as a whole.
Senator Portman. One final one is just with regard to,
again, page 25 of the appendix. The slide seems to be saying
that Burger King moving offshore would reduce your tax rate to
the low 20s and avoid this 40-percent effective rate we talked
about if you had had to bring your earnings back from overseas.
And you say here that the incremental value creation from tax
savings would be $1.4 billion without repatriated earnings and
$5.5 billion if you did repatriate. So assuming repatriation,
which your presentation does, was it your estimate at the time
that placing the combined company headquarters in the United
States would have destroyed about $5.5 billion of value?
Mr. Kobza. So the $5.5 billion calculation was a very
simplistic, high-level, and illustrative calculation that
applied that rate to the combined company. Because of the fact
that we only ever looked in-depth and explored with our
advisers in-depth the tax structuring among other structuring
considerations of a transaction moving to Canada, we never
looked in-depth at fully examining the impacts of domiciling
the company in the United States
Senator Portman. So it is an estimate.
Mr. Kobza. It is a very high level estimate.
Senator Portman. But a significant one; $5.5 billion in a
transaction of this size obviously played a huge role.
So, look, thank you again for your willingness to provide
information. We appreciate the fact that the information you
provided us is helping us to come up with, as you said earlier,
a better tax system.
And with that, I will turn to my colleague, and I look
forward to following up with questions in a moment. Senator
McCaskill.
Senator McCaskill. Thank you.
Mr. Schiller, there was a press release at the time that
you were fighting for Allergan from Allergan about your tax
strategies being more aggressive than many of your peers'
within the pharmaceutical industry. In 2014, the CEO, Michael
Pearson, stated, and I am quoting: ``We were able to get a
corporate tax structure which took our effective tax from 36
percent overall to one that was actually 3.1 percent, which we
hoped to continue to work on and move lower.''
Do you understand how that infuriates Americans? I mean, I
get it that it is the math, and I get it that it is legal. But
you understand the notion that a corporation as large as yours
that--and I think you said in your testimony the majority of
your sales are to Americans? The majority of your profits are
from Americans? That you believe you can figure out a way to
pay less than 3.1 percent in taxes when most Americans are
going, ``What is up with that? How did we get to that
situation?''
How much lower do you think you could get the rate than 3.1
percent? Nothing? I mean, do you believe that you have an
opportunity to get--are there ways you are strategizing that
you can--is your rate at 3.1 now, your overall rate?
Mr. Schiller. No. Our rate right now is around 4 percent.
Senator McCaskill. It is at 4, OK. Well, let me ask you
this: What percentage of the profit that you are generating in
Valeant comes from Medicare?
Mr. Schiller. We have a very small percentage of our
profits--I believe--of our revenue. I believe it is around 5
percent or so that is government, either Medicaid or Medicare.
Senator McCaskill. OK. Well, let us talk about Isuprel. It
is a drug to treat cardiac arrest, so I am assuming that a
large number of the people who would take this drug would be
over 65.
Mr. Schiller. Yes.
Senator McCaskill. In 2013, a company called Hospira sold
Isuprel to Marathon Pharmaceutical, which increased the price
from $44.50 per vial to $215 per vial. Do you know how much
Isuprel is paid for by Medicare in the United States?
Mr. Schiller. I do not know specifically.
Senator McCaskill. Well, I would really appreciate if you
all could get us those numbers for Isuprel, because in February
of this year, you purchased Isuprel. And according to the Wall
Street Journal, the price went--now, remember, it was $44 a
vial in 2013. The price went to $1,346 per vial. This is an
increase of more than 500 percent after you purchased the drug.
And the only thing that has changed is the label.
So I am trying to figure out how we reconcile this is a
drug that I guarantee you I would be shocked if the majority of
the people taking that drug are not on Medicare--how we
reconcile fixing the Tax Code so that it is fairer because I do
not want to demonize you for using business practices that we
allow you to use in our country, but there is something way out
of whack here. What accounts for a 500-percent increase in a
vial of a drug where the R&D has already been done and the
price had already been raised from fivefold immediately before
your acquisition of the drug? How can you do that? Because
there is no competition for the drug?
Mr. Schiller. Well, first and foremost is ensuring that our
patients have the drugs they need and they are safe and they
are efficacious. This drug that you are talking about is a
hospital-based drug. It is part of a protocol. Any patient that
needs it is getting it.
The analysis on pricing for a drug, as you can imagine, is
quite complex. There was work being done by the prior owner
before we bought it, looking at the benefits of this drug to
the system, to patients, to hospitals, and the conclusion was
that it was significantly underpriced. When we closed on the
transaction, we continued that work and took the pricing
actions that you acknowledged.
I would add, though, however, this is one out of thousands
of products that we have. The vast majority of our revenue in
the United States is governed by contracts with managed care,
et cetera, where their price increases are stipulated in
contracts and, we do not have free pricing--free ability to
raise prices like that. These are anomalies. And, a lot of it
is driven--but just that, the vast majority of the drugs, price
increases are not anywhere close to that.
Senator McCaskill. I would love to pull back the curtain
and figure out how you price that. I would love to figure out
how you did that. I would love to understand how it goes from
215 per--you did not change the drug. The drug is the same,
right?
Mr. Schiller. It is.
Senator McCaskill. The protocol is the same, right?
Mr. Schiller. It is.
Senator McCaskill. I mean, I would love to figure out the
formula. I mean, why not $2,500 per vial? Why not $3,000 per
vial? I mean, how in the world did you figure out that it was
underpriced? Because there is not a generic competitor, which I
do not get. I bet there will be soon if you are getting $1,300
a vial for it.
It is a mystery to me how that number came about. And maybe
you want to submit how that came about, because I will be
shocked if the American taxpayers are not paying the majority
of that, because if it is hospital-based, and they are over 65,
it is all Medicare, because it is not something anybody is
getting--it is not Part D, right?
Mr. Schiller. No, it would be part of the protocol, so it
is a fixed price for a procedure. So the procedure would not
cost anything more because the price of a drug went up.
Senator McCaskill. It is not the subject matter of this
hearing, but I got distracted when I saw that. I apologize to
the Chairman that it is not the subject, but it should be. We
should do one on this, how we figure out these drugs going
from--and it is happening all over the place in the
pharmaceutical industry where drugs are just magically--we are
having these mergers, and then all of a sudden drugs are going
from 50 bucks to 250 bucks, or they are going from 500 bucks to
2,000 bucks after a merger and acquisition. And I cannot figure
out why. And it is really problematic. Hopefully on the next
round I can get to something that is more topic-based, but I
could not resist.
Thank you, Mr. Chairman.
Senator Portman. Thank you, Senator McCaskill.
I have some questions with regard to the portrayal you gave
us in terms of the tax advantages of both your initial decision
to merge, and just as background you talked about this Valeant
U.S.-headquartered company had a reported tax rate around 35
percent, teams up with a Canadian pharma firm called Biovail,
kind of a merger of equals, would you say? Biovail had its
headquarters in Canada, obviously, a territorial system there
we talked about which gives them certain advantages; but,
second, they had a statutory rate of about 27 percent. How has
that merger and being a Canadian company affected your ability
to do acquisitions?
Mr. Schiller. Sure. So at the time, as I mentioned in my
opening statement, we were equal in size and small in the
context of the global pharmaceutical industry, in similar
therapeutic areas, similar geographies, focused in the United
States and Canada, and both struggling to get scale. The
companies came together. The decision to be in Canada did not
drive the discussion, did not drive the decision that the
merger made sense. But when it came down to constructing the
transaction, there was only one possibility if the transaction
were to occur, and that was to be in Canada, because if we were
to contemplate coming to the United States, there would have
been such significant dyssynergies that it would make coming up
with a price that both sides would agree to and both sets of
shareholders would agree to impossible.
Senator Portman. Including the tax advantages in going to
Canada, as we talked about earlier.
Mr. Schiller. Yes. Those dyssynergies I am talking about
are tax dyssynergies.
Senator Portman. OK. So you go there, and my question to
you is acquisitions. In that short period of time, since 2010,
you have made lots of acquisitions. In fact, you say you
started a small company. Now you have made $36 billion worth of
acquisitions, $30 billion in the United States, just in that
short period of time. So I think one of the words you used in
the testimony was it kind of ``turbocharged'' your ability to
do acquisitions. And that is part of, what we are looking at
here, not just U.S. companies leaving our shores because of the
tax disadvantages in the United States, but also once they
leave, then looking back into the United States and acquiring
additional companies. And you have been very successful doing
that.
One of the companies that you acquired was Bausch & Lomb.
We will talk about that. Another is Medicis. Another is Salix.
And in each of those, you showed us kind of what you were
looking for, which makes sense. A company is not going to
purchase another company just to make things break even. You
want to make a nice return. And you were talking about a
significant return. You were looking for 20-percent rate of
return over a 6-year--and a 6-year payback period. That is the
deal, basically will pay for itself in 6 years. And in these
three cases, it looks like you got to that, or very close to
that because of the synergies, as you say, on the tax side in
large measure--not that these did not make sense for other
reasons. So when I look at these decisions that you have made,
I see them as being tax motivated, and they have worked for
you.
Salix, by the way, we will talk about first, if you do not
mind. Here is a U.S. company. They were thinking about
inverting. The Federal Government, the Obama Administration
comes up with the regulations against inversions, particularly
the percentage of shareholders that have to be foreign. They
say, well, that is going to stop us from inverting, so let us
just become a target of a foreign takeover. So here is a
company that was blocked by Federal regulations from doing what
they were going to do, invert; instead, they say, ``Let us just
be taken over by a foreign company.'' And, indeed, 11 of the 12
companies that bid for them were foreign, and you all won that
bid.
On Salix, if you look at page 80 of the appendix, I can see
where you have laid out some different results based on what
the tax rate might be. And, again, that makes sense from your
point of view, specifically, this idea that, you wanted to be
able to show over 6 years that you could get effectively the
return to shareholders that would make the deal pay for itself
at a 20-percent internal rate of return.
My question for you is: With regard to Salix, is this
presentation made by the Valeant management to the Valeant
board one that you think was instructive to the board to make
the decision to move forward with the deal? In other words,
were these tax alternatives that you laid what really led to
the board's decision?
Mr. Schiller. Sure. So as I mentioned in my opening
statement, there is no question being a Canadian company
subject to their territorial tax regime has created significant
benefits for the company and its shareholders. I would,
however, describe the benefits and how we capture those
benefits slightly differently than as was laid out.
As I mentioned in my opening statement, when we look at a
target, we are looking at whether it is a strategic fit, first
and foremost. Second, we are looking at whether or not the
returns are sufficient for our shareholders. It is their money;
deploying capital is probably the most important responsibility
a senior management team has.
We look at statutory tax rates when we are looking at
deploying capital. We look at lots of other factors and run
lots of scenarios, including what we think the tax rate would
be, a scenario with the tax rate in our hands. That is not a
benefit we give to a seller. That is a benefit that we retain
for our shareholders.
So in the Salix case, the materials you pointed out, the
debate in the board room was whether a 15-, 16-percent return
was sufficient to go forward or whether we should wait for
higher return opportunity that meet our thresholds, and the
decision was that it was a great company, it was sufficient,
and we put a lot of capital to work very quickly, and rather
than waiting for other things to come along, uncertainty in
terms of timing, size, quality, et cetera.
The benefit that we clearly get is, in our hands, a dollar
of revenue, we will bring more of that dollar of revenue to the
bottom line than somebody that has a much higher tax rate,
which gives us the ability to reinvest in our business, expand
plants and R&D, or make other acquisitions and grow faster,
create more value, become a more attractive employer, lots of
other benefits.
Senator Portman. Well, let me just, with regard to this
question--and I will then turn back to Senator McCaskill. You
showed the board how this acquisition would play out at three
tax rates, as I see it here. One is a 36-percent rate, which
was very close to Salix's projected effective tax rate of 32.
And then the two lower rates you thought were possible after
the acquisition, 5 percent and 10 percent. That is what is laid
out in your materials.
Looking at this page, the only scenario that shows Valeant
hitting or exceeding this targeted 20-percent internal rate of
return was the company's lower-rate scenarios. So, again,
assuming a share price of 160 bucks, Valeant projected that its
internal rate of return on Salix would be 15.6 percent at the
U.S. rate, but would jump up to 21 and 22 percent at the lower
tax rates. Isn't that right?
Mr. Schiller. The numbers you called out are correct, but
the debate at the board was whether the 15, 16 percent was
sufficient.
The other scenarios are clearly meant to demonstrate the
value to our shareholders, what they will ultimately get if we
are able to achieve those tax rates. But in terms of evaluating
whether to go forward with Salix, the debate in the board room
was whether accepting something lower than our targets was
sufficient, was a good enough risk-reward for our shareholders
at that time. But, again, the significant benefit is there in
our hands, and our shareholders will get that benefit.
Senator Portman. Well, given that Valeant projects that it
would only reach your target, which is the 20-percent rate of
return, by dramatically cutting Salix's tax bill, I think it is
fair to say the tax savings were an important driver of the
deal, particularly because you told us that, you all are
disciplined about it--which makes sense from a business point
of view that you are disciplined about your financial
guidelines and ``across the board, the majority of our
transactions are delivered above that targeted 20-percent rate
of return.''
Again, this is not about criticizing a company for looking
at what the rate of return is and considering tax rates as part
of that projection. But it is very clear to me in looking at
the material you provided us--and this will come as no surprise
to anybody who has looked at the U.S. tax system--that this is
a significant reason that you all have proceeded not just with
this transaction but with other transactions, including the
other two we have looked at in some depth, because there you
were able to make your 20-percent return on acquisitions, and
without the tax advantage, you would not have been able to.
So, again, I appreciate your providing the information to
us. I do think this is an opportunity for us to dig a little
deeper in these examples, as we have in our report, to be able
to understand what the real consequences are of the United
States refusing to change its Tax Code and what it means in
terms of not just losing U.S. company headquarters, but also
losing jobs and investment.
I am going to have to go to another Committee to mark up
one of my bills, and I am going to ask Senator McCaskill if she
would please take the chair, and, again, gentlemen, both of
you, thank you very much for coming and for your willingness to
provide us important information that will help us in our
objective here, which is to come up with a Tax Code that makes
sense for our country and for our workers. Thank you.
Senator McCaskill [Presiding.] Thank you, Mr. Chairman.
I just have a couple more questions, and we will let you
go. For both of you, Mr. Galvin--did you all hear the previous
panel's testimony? So Mr. Galvin from Emerson talked about a
25-percent tax rate making us competitive because of other
factors and he said if we went down to 10 or 12 percent, then
you would have a race to the bottom by other countries that
perhaps do not have the same leverage as we have and that the
key is to make us competitive.
Do you agree with his statement that a 25-percent rate
would make us competitive?
Mr. Schiller. Honestly, we have never spent a lot of time
analyzing what rate in the United States would even the playing
field. It is a tough analysis because security, rule of law,
quality of workforce, infrastructure, there are so many other
factors that go into play. And taxes is one cost item out of a
very complex analysis.
Being competitive with--and you also have to take into
account all the other rules around rates. Harmonizing rules and
harmonizing rates would clearly take tax out of the equation.
So I think it is a bit more complex than just is 25 percent the
right number.
Senator McCaskill. Yes?
Mr. Kobza. As I mentioned in my opening remarks and in
response to Senator Portman's question, our decision to
domicile the combined company in Canada was driven by a number
of factors which were outside of tax considerations. So it is
not a question that we considered in great detail, and I am not
an expert in United States or global tax, so I would have
difficulty to respond to what exact rate would make the U.S.
competitive.
Senator McCaskill. Would it be helpful for both of your
companies--both of your companies are examples of companies
that make--you still make the majority of your money in
America, don't you?
Mr. Kobza. In fact, for the combined company with
Restaurant Brands International, only about 25 percent of our
combined earnings are in the United States.
Senator McCaskill. OK. So you do not, but you do, Mr.
Schiller, and I think there is a boatload of companies out
there that still do, even though they may be parking money
offshore because of tax reasons or being acquired by foreign
investors for tax reasons or inverting for tax reasons. I think
it would be important for us to get input about this. I think
we need to know as much as possible, because tackling the Tax
Code is hard around here, and it is not something we are going
to go back and do again the next year. If we get this done, it
will be in place for a while. So I think the more input we get,
the better.
And the other question I had for you, Mr. Schiller, that I
did not get to on my first round was: What were the benefits to
your company of shipping manufacturing activity to Canada? I
know that you did most of the contract manufacturing for both
Medicis and Salix out of Canada. What were the advantages of
manufacturing moving there?
Mr. Schiller. Well, up until Bausch & Lomb, we had no
manufacturing facilities in the United States. Bausch & Lomb
had some; Salix had none. So Valeant and Salix were using
contract manufacturers.
We did have two plants, two large--we had three plants, but
two large facilities in Canada--one in Steinbach, Manitoba, and
one in Laval. And when we bought it, it was really looking at
the cost of manufacturing through the contract manufacturing
operations (CMOs), through the contract manufacturers, as to
what we could do internally. And the plant in Laval was a
dermatology plant, so it had all the capabilities of making the
Medicis products--we have not done anything with Salix. We just
closed Salix April 1, and I do not suspect we are going to be
moving any Salix products anytime soon. So a few of the Medicis
products we did, and some of the legacy Valeant products we
have moved from CMOs as well, but it is based on the cost of
manufacturing in our own plant versus what the contract
manufacturers charge.
The Bausch & Lomb plants continue to run well, and we are
looking to add capacity there because they are very good. The
Clearwater and Tampa, Florida, plants and the Greenville, South
Carolina, plants are very efficient plants, and we are looking
to add capacity there when we can.
Senator McCaskill. Well, to whatever extent you can share
with the Committee the analysis of contract manufacturing in
Canada versus the United States and what the differentials
are----
Mr. Schiller. In Canada, it is not a contract manufacturer.
It is our own plants.
Senator McCaskill. You do not have any contract
manufacturing in Canada?
Mr. Schiller. I do not think we use contract manufacturers
in Canada.
Senator McCaskill. Well, what would be helpful to us is to
see what the differentials are on contract manufacturing in the
United States and other places. If you analyze contract
manufacturing, I am assuming you looked at analysis that would
include contract manufacturing in the United States, and it
would be helpful for us to understand what factors weighed in
there against contract manufacturing.
Mr. Schiller. Each product is unique, but in general,
contract manufacturers have 15-to 20-percent margins, and the
question is whether or not--so that is the margin they are
earning for providing a service.
Senator McCaskill. Right.
Mr. Schiller. So that we would certainly save. Then the
question is whether we can manufacture--the raw material costs
are not going to be very different. It is a question of whether
our operating costs are lower, higher, or the same, and it is
really a product-by-product analysis.
Senator McCaskill. I guess one of the reasons I am
interested is that if there was an analysis that went on on the
cost of contract manufacturing, if there was an analysis of
contract manufacturing in the United States, that is going to
have an add-on--right? But so is contract manufacturing in
Canada. If that analysis was done, it would be very helpful for
us to see it, because we have a lot of people complaining that,
the reason that Canada is more attractive is that labor costs
are lower, but they have a single-payer system up there. And so
I am trying to figure out how that all works, and as we analyze
the Tax Code, including what is deductible and what is not, it
would be important for us to have the benefit of any analysis
your company has done. We need to see what you see so we can
understand how we can be more competitive.
I think that the record will remain open for 15 days and
will close on August 14 for this hearing. There may be other
questions that we might have for you and for the other
witnesses. We have a hard job, and it is exacerbated by the
fact that we all do not see things the same way around here. So
we are going to try to do our best to make the United States as
competitive as it should be with all the other countries in the
world in terms of job growth and economic strength. In the
process, I just want to make sure that we do not diminish the
natural strengths that still make our country a beacon to the
world for R&D and innovation. I am sorry to say I am going to
try to talk the Chairman into trying to figure out how we can
look at--it is astounding--the merger and acquisitions that are
going on in pharmaceuticals. What did my briefing say, what
percentage of the income came from M&A over the last year, like
45 or--yes, I mean, a huge percentage over the last 3 or 4
years has just been through M&A. And in that process, how these
drugs are being priced I think is a fascinating thing for us to
understand, because that is what drives our debt right now, is
health care costs. That is the big problem we have in terms of
our competitiveness in the future, is how do we get a handle on
our entitlement debt, which is driven by and large by health
care costs in Medicare. Sorry, but your company--I am sure you
are not outside the realm of what is going on with other
companies. I do not mean to pick on your company. But that drug
is a great example of, I think, questions we need to ask about
how this is happening and why.
Thank you both for being here, and I thank the first panel,
and we will try to work together to see if we can level this
playing field.
[Whereupon, at 11:59 a.m., the Subcommittee was adjourned.]
A P P E N D I X
----------
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
[all]