Tax Geography as Structural Design

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“The country’s tax and accounting system, moreover, encourages the assumption of debt—as occurs in these leveraged takeovers—at the expense of equity. Corporate income is taxed to corporations, and dividends are taxed to shareholders, creating a double tax. It is easier for a corporation to pay interest (on debt), which is tax deductible, than to pay dividends (on stock), which are not. A company in the 50 percent tax bracket can afford to pay a rate of 16 percent interest as easily as a rate of 8 percent in dividends. And the individual investor, who has to pay taxes on either the interest or the dividend, will generally prefer the higher interest payment.”

“The major difference between Riklis’ debt-laden acquisitions and those of Milken’s later acquirers was that Milken’s chosen would issue the bonds for cash and then give the cash to the shareholders, while Riklis would issue the bonds directly to the shareholders. Both Riklis and his successors a generation later, however, would be using to their advantage the same debt-favoring provision of the U.S. tax laws: interest (on bonds) is deductible, but dividends (on stock) are not. Therefore, assuming roughly a 50 percent corporate-income-tax rate, a company that can pay shareholders a rate of return of 7 percent on dividends can just as easily pay 14 percent interest on subordinated debt, because it can deduct the interest.”

“Their conversation became crucial for a very important decision, to move Tetra Pak abroad. The family had long been worried about Sweden’s heavy taxation on profits, capital, and inheritance. Hans had calculated that if he died, the children would be forced to pay an inheritance tax of a total of 350 percent, as the tax would be paid with already taxed funds. If they wanted to keep the company within the family dynasty, staying in Sweden was not an option, he assessed.”

“It took Hans fifteen years of pondering and preparations, equating to three years in terms of full-time work, before everything was ready for the move. In 1982, they increased the dividends in the Swedish parent company from five million to 79 million kronor, a sum that “coincidentally” matched the very low recorded value of the foreign subsidiaries – the market value amounted to about five billion. But the ingenious part was that the dividend was not paid out in money but in shares of the subsidiaries. Through another Tetra company, the shares were then transferred to Dutch Tetra Pak. In this manner, they very elegantly avoided being stopped by the currency regulations.”