Why Burger King's Claims That Its Tim Hortons Deal Isn't About Taxes Aren't Entirely True

Daniel Schwartz, Burger King's CEO, repeatedly said that tax savings from the deal were minimal and not a driver of the deal. But while that may be true today, the more the company grows overseas, the better deal it gets from being Canadian.

Jean-Paul Pelissier / Reuters

On a conference call with analysts and reporters Tuesday to discuss its $11 billion deal with Canadian coffee-and-doughnuts chain Tim Hortons, Burger King CEO Daniel Schwartz repeatedly insisted that the potential for tax savings was "not a driver of this deal."

The claim goes against one of the most basic principles of corporate deal-making: that tax savings are one of the primary drivers of merger and acquisition activity, along with cost-related synergies. Executives, however, were eager to downplay any potential tax consequences so that it could tamp down the backlash that erupted over concerns that it was simply another "inversion," where a U.S.-based company buys a smaller, overseas firm and incorporates in the target company's country expressly for the purpose of lowering its tax bill.

These types of deals have drawn harsh criticism from President Obama, who said they were "unpatriotic"; Burger King's Facebook page was flooded with critical comments (and a call for a boycott); and two Democratic senators issued statements criticizing the deal after news of deal talks broke.

"Burger King has and will continue to pay taxes in the United States," Schwartz said. Alex Behring, who will be executive chairman of the newly formed Canadian parent company of the two brands, also noted that the two companies have similar tax rates despite being headquartered in the U.S. and Canada, respectively. In 2013, Burger King's effective corporate tax rate was 27.5%, while Tim Hortons' was 26.8%. Tim Hortons' headquarters will remain in Oakville, Ontario, after the deal is completed, while Burger King's will remain in Miami.

"We don't expect there to be meaningful tax savings or a meaningful change in our tax rate," Schwartz said.

But while Schwartz's claim may be true today and during the regulatory review process for the deal, the company could reap significant tax savings if it continues to grow overseas. A Burger King spokesperson did not comment on a set of questions about the tax advantages of the deal.

Terms of the deal call for a new company to be created and based in Canada that will be 51% owned by 3G Capital, the private equity firm run and founded by Brazilian billionaire Jorge Paulo Lemann, while Burger King's existing shareholders will own 27% of its shares and Tim Hortons' will get the remaining 22%. And, as executives emphasized on the call, the deal is about growing Tim Hortons overseas. It "represents a transformational opportunity to bring two iconic brands together on a common platform for global growth," Behring said.

Here's where the devil is in the details: The U.S. tries to tax all income earned overseas, whereas Canada has tax deals with many countries that allow Canadian companies to avoid taxation on overseas income.

This means that for Burger King's overseas subsidiaries, having a Canadian parent company could lead to lower taxes if it is transferred to the new company, said Lee Sheppard, a contributing editor at Tax Notes. Totally new subsidiaries, Sheppard said, "are going to be underneath the new Canadian parent. So in the future, that new subsidiary doesn't owe U.S. tax because it's under the new Canadian parent."

Put another way, had Burger King located the joint company in Miami, money earned from Hortons' expansion or new Burger Kings could be subject to U.S. corporate taxes or have to be held outside the United States. Schwartz said that the new company will be based in Canada "because that is the largest shared market for the company." This is true largely because Tim Hortons locations are overwhelmingly located in Canada, which is also one of Burger King's largest overseas markets.

Many companies, including Burger King, keep their overseas income out of the United States to avoid paying high corporate rates. Burger King has some $499 million of overseas earnings that it classifies as "permanently reinvested." In 2013, Burger King had $428 million in revenue from outside the U.S. and Canada — 42% of its $1.15 billion in revenue — but provided for only $1 million in taxes on the $2.7 million of the foreign profits it expected to bring back to the U.S.

Further, much of Burger King's recent strategy has been to grow quickly and widely overseas, meaning the overseas cash is likely to continue piling up, in addition to what Tim Hortons accumulates outside of the U.S. or Canada under its new leadership. Schwartz admitted on Tuesday's call that the future growth of the two companies could affect its tax situation and that "over time it will evolve as a function of where we develop restaurants around the world."

In a conference call earlier this month, for instance, Schwartz described France as a place to "quickly grow the Burger King brand." He also said that expansion into India could be a "key growth driver for years to come" and that a meat plant in South Africa may "one day accelerate our expansion into the rest of Sub-Saharan Africa."

"The future benefits of foreign earnings depend on the success of your foreign expansion," Sheppard said. "To have no taxes on foreign earnings you have to have foreign profits in the first place."

While the number of Burger Kings in the United States and Canada has been roughly stable, with 7,550 in 2010 and 7,436 in 2013, the number overseas has grown from 4,701 to 6,231 in the same time span — a 33% increase. The fast food chain's percentage of revenue derived from outside the U.S. or Canada grew to 42% last year from 35.8% in 2011, and based on its expansion plans, that growth should only continue.

"There are a number of geographies where we continue to either not have a presence or we're very under-penetrated," Burger King Chief Financial Officer Josh Kozba said at a conference in June. "So, we feel [like we have] really long runway of growth for the brand, which is what makes us very excited."

Despite what executives are claiming today, then, Sheppard said of the deal: "There's a huge tax aspect to it."



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