What If Tim Hortons Had Purchased Burger King?

If Tim Hortons (THI.TO) had announced plans to purchase Burger King Worldwide (BKW.N), would the news have gained the same attention as Burger King’s proposed acquisition of THI and move to Canada? A whopper of controversy followed the idea that a company as American as a beef patty and a side of fries was moving its headquarters abroad to reduce U.S. taxes. We sit down with a cup of coffee and look at why Burger King had to make the move north.

Tax reform is a hot topic on Capitol Hill and the debate is largely fueled by concerns related to tax inversions. The U.S. federal corporate income tax rate of 35% is the highest in the industrialized world and the argument is that this motivates companies to move their headquarters abroad. The topic gained further momentum after the Burger King/Tim Hortons announcement.

However, the flip side of this inversion story is to look at what would happen if Tim Hortons had purchased Burger King and remained based in Canada. From this point of view, the disadvantages of the U.S.’s current policy of foreign income tax become clear.

Many Americans may not be familiar with Oakville, Ontario-based Tim Hortons primarily because the coffee-and-doughnuts chain derives the majority of its revenue and income from Canada. Many often compare it to Dunkin’ Brands Group (DNK.O). However, THI’s 2013 revenue of C$3.3 billion was more than four times greater than DNK’s $713.8 million and about 2.5 times greater than Burger King’s $1.1 billion. (C$1 dollar = US$0.91) Given that Tim Hortons is larger than its acquiring company, it is important to look at the consequences of bringing a company that generates more than 95% of its operating income in Canada to the U.S.

The primary issue is that U.S. companies are required to pay 35% corporate income tax, less foreign taxes paid on foreign income. Therefore, most of Tim Hortons income would essentially be subjected to a substantial penalty. A quick calculation can demonstrate the magnitude of the impact.

EXHIBIT 1: EFFECTIVE TAX RATES FOR TIM HORTONS

Source: Eikon

The tax man cometh

Assume that THI moved to the U.S. before 2011 and everything else reported remained the same except for income taxes related to operating income from Canada. Applying a 35% tax to the Canadian operating income, less THI’s reported provisions to income taxes in Canada, provides a rough estimate of the effective tax penalty Tim Hortons would have faced.

For example, in 2013 THI reported Canadian operating income of C$665.7 million and a provision for income taxes for Canada of C$153.5 million. Therefore, given these assumptions, their provision for income taxes would have increased by C$79 million and THI’s effective income tax rate would have increased to 40.4% from 26.8%. As a result THI’s net income after taxes would have decreased by 18.5%.

EXHIBIT 2: CUMULATIVE PERCENTAGE OF S&P 500 COMPANIES BELOW EFFECTIVE TAX RATE

Source: Eikon

A tax-propelled move

The impact of moving Tim Hortons can be further demonstrated by looking at the effective tax rates for the S&P 500. The annual aggregated effective tax rate for the S&P 500 is 27.5%; this is based on filings for the last fiscal year of the S&P 500’s current constituents and excludes REITs and companies with negative net income before taxes excluding extraordinary items (NIBT).

In 2013, THI’s effective tax rate was 26.8%. Of the companies included in this study, 47% had an effective tax rate below 30%. Based on the prior example, if Tim Hortons had moved to the U.S., the company that draws the majority of its income from Canada would have been one of the 6% of companies with an effective tax rate above 40%.

Burger King, whose 2013 effective tax rate was 27.5%, will likely see some tax benefits by relocating to Canada, but the effective tax penalty it would incur on Tim Hortons’ profits if BKW stayed in the U.S. can’t be ignored. Essentially, the current tax policy forces Burger King to move abroad. At least the burgers and coffee will taste the same on both sides of the border.

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