Schafer: Medtronic had no choice but to cover the excise tax

Medtronic's plan to buy an Irish device company and move the merged operation's headquarters over there has kicked up a lot of controversy, not the least of which concerns the company's plan to pick up millions of dollars in taxes the deal creates for Medtronic's top leaders.

But while the Covidien deal itself is fair game for debate, there really was no choice but for the company itself to cover the special excise tax meant for top executives and other insiders. It was only a question of how.

Shareholders may not like Medtronic's decision but they need to be clear on what this isn't, and it isn't a special deal for the top execs. Their total, after-tax pay won't change a single nickel. What they got was avoiding the pain of a special tax meant just for them.

That tax on stock-based compensation was meant to be so painful that it would stop transactions like Medtronic's, called inversions. As the decision by Medtronic once again proved, it's turned out to not be nearly painful enough.

Now it's just another deal cost, to be noted on a spreadsheet and then paid along with the bills from the law firms.

The final number won't be known until the day of closing, but Medtronic has estimated $63 million in expense related to the excise tax. The idea here is that Medtronic will eliminate any penalty to the officers and directors. It's paying the excise tax and then paying all the taxes due on the value of paying the tax.

The important point here is that the CEO and the others aren't netting anything. It's about an excise tax, not an income tax. There's no income.

If they sell it in two years for $75, now that tax is calculated based on $10 of gain, not a gain based on the cost of their original investment.

A reset to a higher cost for any future taxes may be small beer for longtime shareholders, and I'd be sore about it, too. But it beats the situation of the insiders. They faced a personal tax more or less for nothing.

It's a small group, too, only 10 executives and 10 non-employee members of the board of directors.

Fridley-based Medtronic has 19 executives listed on its website, not 10. The president of the U.S. region isn't in the filings as facing an excise tax, and neither is the senior vice president for medicine and technology. Those certainly sound like meaningful executive positions, and it's fair to assume both have pay packages rich with stock options.

This little excise tax goes back to the American Jobs Creation Act of 2004, enacted in a similar era of distress over corporations leaving the country. The law itself could more accurately have been called the American Tax Code Tweaks Act of 2004.

There were some other, unrelated provisions in the law, but much of act dealt with making an inversion deal more difficult. Among the measures was adding section 4985 to the tax code, which would tax stock-based compensation held by the insiders.

Looking back at what was written at the time about this legislation, there is no chance that this was anything other than a punitive measure designed to make an inversion so personally painful that few CEOs would seek one and few directors would approve one.

Much as has been the case in 2014, members of Congress had grown increasingly alarmed by the wave of inversions that had been happening. In that era, it was far easier to pull off an inversion than it is now. Big companies appeared to be acquiring post office boxes in Bermuda and calling themselves Bermuda-based.

As was the case with high-profile deals like Medtronic and Burger King this year, what really brought the controversy to a head was a plan to leave the country announced by Connecticut-based Stanley Works, an iconic American company best known for its Stanley hand tools.

Stanley ultimately changed its mind, but not before a local congressman complained that "Connecticut hasn't seen such a shameful day since Benedict Arnold sailed away."

They became harder but, clearly, not impossible. In 2014 pulling one off typically means buying a foreign company, which is precisely what Medtronic is doing by buying Ireland-based Covidien.

In facing the choice about how deal with the excise tax as the deal came together, it's fair to conclude that no one in Medtronic's leadership seriously considered letting its officers and directors pay.

Besides reimbursing in cash, the only other option is to let insiders exercise their stock options early, and then they pay tax on the resulting income. That way there are no options to tax. That's what Jazz Pharmaceuticals and Applied Materials have done.

Medtronic rejected that option, indicating in a filing that letting the executive team exercise options early would have "undercut Medtronic's compensation philosophy of ensuring that executive officers hold long-term, performance based compensation."

The filing doesn't say so, but the next problem would have come the morning after closing, when the CEO and nine other executives came to work without any stock options. They would have exercised all of them, and the board would probably have had to grant a bunch more.

In this case, that's the Medtronic shareholders.