Schafer: Medtronic/Covidien deal sends the wrong message

"Be in favor of what's going to happen," is an old bit of wisdom in politics. Don't look like a sore loser when the roll call is taken. Don't look wrong.

Medtronic's shareholders on Tuesday are almost certain to approve its acquisition of Covidien, a deal that ends up moving Medtronic's home to Ireland. It's going to happen.

The right way to vote on the Medtronic deal is still no.

Yes, I know the no vote is likely going to get swamped. If you look at the share price, the shareholders have already overwhelmingly approved the deal, never mind the formal vote to be announced this week.

Medtronic and Covidien, formally an Irish company with its operating headquarters near Boston, announced their deal in June. Since then the stock of Fridley-based Medtronic is up nearly 18 percent, while the stock prices of rivals like St. Jude Medical and Johnson & Johnson have gone nowhere.

If what the shareholders are telling us is that the strategic case for merging with Covidien is a good one, then I agree. The newly merged Medtronic will be an even more important supplier of health care technologies to its customers and to government health ministers.

But I can't vote for the structure, a so-called inversion that re-creates Medtronic as an Irish company largely owned by its current shareholders.

Please understand my no vote should not be seen as a vote against Medtronic chief executive Omar Ishrak. If anything, my respect for him has only increased.

He's handled himself well, having been repeatedly peppered with questions about structuring the $48 billion Covidien merger as a tax inversion. The point to remember is he's trying to fix a problem not of his making.

Those shareholder questions about taxes would be better directed to William George, currently enjoying life as a corporate statesman, author and senior fellow at the Harvard Business School.

George last served as CEO in April 2001, but by then the company was well down the path of one day having billions of dollars stashed overseas for tax reasons.

Medtronic's effective tax rate for fiscal 1999 was 34.3 percent. It came down by about two percentage points by 2001, according the company's annual filings, "due to tax planning initiatives including proportionally higher profits generated in low tax jurisdictions. The company expects to further reduce its effective income tax rate in fiscal 2002 as it pursues additional tax savings opportunities."

By the time Ishrak joined the company in 2011, Medtronic's effective tax rate for the previous fiscal year had fallen to 16.8 percent. There is no particular mystery as to how, as about 57 percent of the 2011 sales were in the United States, a high tax jurisdiction, but only 39 percent of the pretax income.

By driving what profits it could through its non-U.S. subsidiaries, the company as of the end of the 2011 fiscal year had not recorded a U.S. income tax expense on about $15 billion of undistributed earnings from abroad.

Bringing those profits home to pay dividends or invest in promising technologies would have made them subject to U.S. taxes on top of what got paid abroad.

If Ishrak wasn't thinking about what to do about this $15 billion when he was interviewing for the CEO job, he certainly had to start the first day he reported for work. It would have been unprofessional to complain that this offshore profits snowball should never have been allowed to get that big. CEOs are hired to fix problems.

Buying Covidien was how to do it. As an Ireland-based company Medtronic can use cash profits generated by the legacy Covidien businesses as it sees fit and have that same flexibility with profits from new subsidiaries. All without being subject to higher U.S. taxes.

An inversion doesn't come without pain, however. Longtime individual shareholders face a long-term capital gain tax. Inversion rules also call for an excise tax on the stock-based compensation held by the officers, directors and other insiders. The company had no real choice other than covering these excise taxes, but this, too, made individual shareholders unhappy.

Both of those things, however, are maybe best thought of as costs of the deal. Neither of them makes the case for voting against the deal.

After more than six months of thinking about it, I can't approve of a transaction that transplants an American company in Ireland for tax reasons.

There's no denying that Medtronic is an American company, either. It grew into a global giant because of access to the American capital markets, access to dynamic markets here for its products and access to American intellectual capital.

Even more fundamental, however, is the basic unfairness of a transaction structure that's really only available to the top tier of corporations. Shopping around the globe for favorable tax treatment is a game only open to the likes of the Fortune 500s.

Just before Christmas a corporate attorney explained to me that he was busy reincorporating subsidiaries of a big company in Singapore. So why Singapore?

Well, here's the way Singapore's own official economic development board puts it: "With one of the lowest corporate tax rates in the world, on top of a host of other tax schemes and incentives, Singapore is easily one of the best countries in Asia for companies to grow their businesses."

The owners and managers of small companies in our state play on a different field. They pay taxes much closer to the 35 percent statutory corporate income tax rate, or comparable personal income tax rates if they pass business income through to owners via a partnership structure.

We keep moving further and further toward a world where the only businesses that pay full fare are the Mom-and-Pops. A 16.8 percent effective tax rate isn't within reach. Neither is a relocation to Dublin.

So as much as I'd like to be in favor of what's going to happen, in this case what's important is being on the record saying that what's smart and legal still isn't what's right.

lee.schafer@startribune.com • 612-673-4302