Burger King Shareholders Can Dodge a Whopper of a Tax Bill

The latest in a string of U.S. companies buying foreign firms so they can skirt the IRS marries a burger-and-fries icon (Burger King) with coffee-and-donut icon (Tim Hortons). When the new firm reconstitutes itself in Ontario, U.S. corporate tax revenues will go on diet. Normally, these so-called inversions that cut corporate taxes can trigger a painful hike in individual income tax for shareholders.

But the latest deal is carefully structured to give shareholders a choice. Burger King shareholders can choose between receiving shares in the newly merged company (that will trade on the New York and Toronto stock exchanges) or units in a newly formed partnership (that will trade on the Toronto Stock Exchange). Those who choose the partnership units will be allowed to defer taxation of gains that have accrued to date until they sell those units. Those who choose the shares, however, could face a nasty tax bill—the kind faced by shareholders in most other so-called inversions. Their fate is discussed in the following story that appears in the September 2014 issue of Kiplinger’s Retirement Report:

There's plenty of wailing in Washington about "inversions," the practice of U.S. companies merging with foreign firms to escape U.S. taxes on foreign-source income. Lost in the fracas is the cost such mergers can impose on investors in the companies or in mutual funds that own shares of the companies. Shareholders in the U.S. company become shareholders of the new foreign entity. And as far as the IRS is concerned, the deal involves selling shares in one company and buying shares in another. That sale can trigger capital-gains taxes.

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Just how serious this matter can be is illustrated by an example uncovered by the St. Paul Pioneer-Press this summer. It tells the story of an 84-year-old investor who since the late 1970s has been buying shares in Medtronic, a medical devices manufacturer that plans to merge with an Irish firm and move its corporate headquarters from Minnesota to Dublin. If the merger goes through, the investor could owe around $100,000 in capital-gains taxes. And unlike investors who really sell shares, this deal would leave her with no proceeds to tap to cover the tax bill.

Daniel Wiener, editor of a newsletter that focuses on Vanguard mutual funds, uses another case to illustrate how fund investors can be burned. Just before a deal closed combining U.S.-based Forest Laboratories and an Irish firm, Vanguard's popular 500 Index Fund owned about 2.5 million shares of Forest Labs. While admitting that it's impossible to know how much built-up capital gain was released by the merger, Wiener suggests that about $150 million is a reasonable guesstimate. That profit and as much as $30 million in tax liability will be passed on to fund shareholders.

There's not a lot individual shareholders can do about tax bills born of corporate deal making. If you were hoping the tax on appreciation would disappear if you held the shares until you die, you're out of luck. Before the deal is approved, you could give away highly appreciated shares to a family member in a lower tax bracket or to a charity. And be on the lookout for larger-than-expected payouts from mutual funds at year-end. Also, prepare to scour your portfolio for paper losses that you can realize to offset the tax bill.