Medtronic deal could sting for long-time shareholders

Bloomington retiree Jim Furber considers Medtronic Inc. a great asset to the state and says he's thankful for the company's growth and stock appreciation over the years.

But like many Minnesotans who proudly invested in the homegrown company years ago, the former manufacturer's rep feels blindsided by an unexpected tax bill from Medtronic's proposed $42.9 billion takeover of Covidien PLC. Furber and his wife estimate they'll shoulder a tax bill of up to $15,000 when they exchange their Medtronic stock for shares in the new Ireland-based Medtronic.

"Would we remain shareholders? That's a big question mark in my mind," Furber said. "I think on this they really kind of screwed up."

"I'd vote against it if it I thought it would help."

The proposal to merge with Dublin-based Covidien and drop anchor in lower-tax Ireland is stunning enough for Minnesotans, but the "taxable event" has sent longtime shareholders scrambling to financial planners, accountants and lawyers to determine the best move to preserve retirements and manage monthly finances. Many are bitter about having to do so.

Medtronic, blanketed by calls and e-mails from investors and employees concerned about their tax obligations, has insisted that the move will be good for shareholders in the long run. All the freed-up cash means the company can reinvest more aggressively and accelerate earnings, so the argument goes. Since Covidien's headquarters is in Ireland, "the most financially efficient structure was to incorporate the new company there," company spokesman Fernando Vivanco said.

When asked whether the company fully considered the deal's impact on its longtime shareholders, Vivanco said the taxable event was "flagged" in all its communications since the June 15 announcement.

For investors like Furber, it's a tough pill to swallow.

Some express resignation, saying Medtronic is only doing what many other U.S. companies have done to free up billions of dollars that would be stuck overseas to avoid high U.S. corporate income taxes. The country's 35 percent corporate tax rate is the highest in the world; Ireland's is 12.5 percent.

That's the core problem, said retired Medtronic executive Dale Wahlstrom, former CEO of industry group LifeScience Alley. Wahlstrom says he'd prefer to remain invested in the new Medtronic but still doesn't know if that's the right move for him.

"We're all talking to our tax people and attorneys," Wahlstrom said.

The tax hit at issue affects individual shareholders of Medtronic and Covidien, primarily those who hold stock outside of a retirement plan and who bought it when the stock was really cheap. People with Medtronic stock in tax-deferred accounts — such as IRAs, profit-sharing plans and 401(k)s — are not affected until they start drawing funds from the accounts. The unvested, restricted stock and unexercised stock options that Medtronic employees have are also not affected, Medtronic said.

For some of those affected, the tax obligation feels deeply unfair.

"The word I would use is disgusted," said Richard Cohen, a retired Twin Cities stockbroker and decades-long Medtronic investor. "It's clear to me that this company couldn't care less about the individual shareholder."

The repair shop that Earl Bakken and his brother-in-law Palmer Hermundslie started in Hermundslie's northeast Minneapolis garage (a structure reportedly made out of two railway boxcars) in 1949 eventually made history with its cardiac pacemaker. Minnesotans know the story well. Medtronic took on corporate rock-star status, the brightest in the constellation of medical companies that emerged in the Twin Cities.

As Cohen sees it, he stuck by the medical device maker patiently through hard times and missteps, when the stock tanked after 2001, when it got beaten by competitors or its R&D faltered. The stock has only recently recovered to where it was in 2001.

"The thing that bothers me the most is that this is a Minneapolis-based company that depended on the Minnesota investment community for its initial financing, that attracted investment from Minnesota investors first," Cohen said. "The ones that were there in the beginning are the ones that are going to get screwed."

Elizabeth Chorvat, a professor at the University of Illinois College of Business in Champaign, has studied dozens of so-called inversion deals, in which companies shift their tax address to low-tax countries. Chorvat said she's unaware of shareholders ever voting one down.

Chorvat said she was "extremely surprised" to find that the average return rates for companies that inverted have been substantially higher than average market returns. She said she's worried that shareholders will pressure more companies to move, even when it's not warranted.

Martin Sullivan, chief economist at nonprofit tax publisher Tax Analysts in Falls Church, Va., takes a dim view of the current wave of corporate inversions. He damns them as costly, unfair and inefficient.

"You have companies playing by two different sets of rules, and that's not good," said Sullivan. "It's like the worst possible tax system you can imagine."

Howard Richards, a certified financial planner at Securus Wealth Management in Plymouth, offers a worst-case scenario: a taxpayer subject to the top federal capital gains rate of 20 percent, an Obama­care tax of 3.8 percent and Minnesota's top marginal rate of 9.85 percent. With 10,000 Medtronic shares bought at a split-adjusted cost of $1 a share, the person would pay about $212,000 in taxes, assuming a $64 stock price on closing day.

His financial planner estimates that he faces a tax bill of $274,000.

"I've been loyal to the company and thought well of them and bragged them up, and to have the rug pulled out … it's just devastating," he said. "It completely knocked the wind out of my sails and still does."

Adding to the sting, Med­tronic is picking up part of the tax bill for executives and directors. While all shareholders — including Medtronic's executives and directors — must pay capital gains taxes on their stock gains, the company covers the extra excise tax that executives and directors must pay on "certain stock compensation." It's applied to their unvested restricted stock and unexercised stock options, both vested and unvested, according to a recent company filing.

Excise taxes are special taxes on certain goods, such as motor fuel, and the rate is based on the capital gains rate. Congress slapped excise taxes on the stock compensation for insiders of companies shifting overseas back in 2004 as it tried to crack down on inversions. Companies countered by picking up the tab.

The excise tax deal outrages some investors. "I guess we're the ones that are stuck with the bill," said Furber.

"They should not be discouraged from taking action that they believe is in the best interest of Medtronic and its shareholders," Vivanco said.

Vivanco said he doesn't know what CEO Omar Ishrak's tax bill for the inversion will be. As of June 23, Ishrak directly owned just 67,000 shares of Medtronic common stock that is subject to the capital gains tax. He holds rights to more than 500,000 other shares in various awards of options and stock, such as restricted stock, but that compensation is subject to the excise tax that the company is picking up.

Vivanco could only say that Ishrak "will pay capital gains on his impacted shares like everyone else, the amount of which has not yet been determined."

Staff writer Lee Schafer contributed to this report.