Tim Hortons, Burger King deal would base burger chain in Canada

In what could be a whopper of a deal for Tim Hortons, Burger King is in talks to buy the iconic Canadian company.

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A joint statement by the companies says they hope to form a new corporation that would be based in Canada although they would continue to operate as standalone brands.

Brazilian investment fund 3G Capital owns a little over two-thirdsof Burger King and is effectively proposing to build a Canadian holding company that would ownboth chains but operate them independently.

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Right now, Burger King is based in Miami; Tim Hortonsheadquarters are in Oakville, Ont. But the coffee chain only recently returned to its origins as a purely Canadian company. For years,it was owned by U.S. burger chain Wendy's before being spun out in an IPO in 2006.

This means TimHortonsis going to go full bore with a huge expansion into the U.S.- Investment manager Barry Schwartz of BaskinFinancial

If a merger is completed, the new company would become the world's third-largest quick-service restaurant chain, with more than 18,000 locations and sales of about $22 billion.

The markets reacted positively Monday to the possibility. Tim Hortons (TSX:THI) was up 20.97 per cent to close at $83.20 on the Toronto Stock Exchange, while Burger King climbed 20.80 per cent to $32.75 US in New York.

The companies aren't saying much, but it's clear there's a lot of potential benefits up for grabs.

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Degroote School of Business professor Marvin Ryder says the two companies could be very well suited to help each other. Burger King currently operates in 98 countries around the world, experience the donut chain could certainly lean on. "To have a big brother helping you to open locations, helping to tell you where to locate, what are the good markets... this could be a good partner for them," Ryder said.

Investment manager Barry Schwartz at BaskinFinancial in Toronto likes the deal a lot for both companies.

"With3G'sbacking and smarts, this means TimHortonsis going to go full bore with a huge expansion into the U.S.,"Baskinsaid, adding that he sees no possible reason for Canadian regulators to kibosh the deal.

"This would create a large, world-class company based in Canada, and paying taxes in Canada," Schwartz said."It would also increase the exposure of Canada and theTSXand potentially lead to more [deals] of U.S. and foreign companies coming to Canada."

Tax savings

Business commentator Michael Hlinka said on CBC Toronto's Metro Morning on Monday thatBurger King may be making a "tax inversion" play with this move.

The basic U.S. corporate tax rate is about 35 per cent, while Canada's, depending on the province,is around 26 per cent.By merging with a Canadian company and setting up a head office in Canada, U.S. companies can sometimes achieve significant tax savings, Hlinka said.

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"You've got to merge with a company one-quarter your size ... then you can technically set up your headquarters in Canada, even though you still keep everybodyin the United States. It's almost like a mailing address more than anything else," Hlinka said.

A number of U.S. pharmaceutical companies have triedsimilar moves in recent years, most notably Valeant, which bought up Mississauga, Ont.-based generic drugmakerBiovail in 2010. Valeant was U.S.-based at the time, but is now headquartered in Laval, Que.,after buying what was then Canada's largest drug company.

Pfizer also recently tried to buy AstraZeneca in order to move itself to England, which has a much more favourable tax regime. Two other U.S. drug firms, Medtronic and AbbVie, are also in the process of trying to buy two Irish drug companies, again, largely for tax reasons.

But it's not just a tax move

That's not to suggest that taxes are the only factor at play here Burger King is, after all, trying to get its hands on asuccessful business in its own right.

Tim'sreleased earnings on Aug.6that beat expectations, and the stock has been rising ever since. Share in Tim Hortons on the TSX had gained almost 15 per cent in the last two weeks even before the Burger King news broke over the weekend.

Burger King shares have also been doing well, so the deal won't be cheap for 3G shares in both Tim Hortons and Burger King have never been more expensive.

Canada's federal corporate tax rate is 15 per cent, and Ontario currently tacks on another 11.5 per cent, putting the total tax bill fora company residing in Ontario at 26.5 per cent.

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Burger King's latest annual report reveals that thanks to some generous tax breaks on overseas profits, the company's effective tax rate last year was 27.5 per cent. Contrast that with the 26.8 per cent tax that Tim Hortons says it paid last year.

Indeed, beyond any marginal tax savings, Burger King may also be trying to keep pace with a key competitor,Hlinkasaid.

"McDonald's has become very serious about making a good cup of coffee in the past several years and Burger King hasn't really stepped up, so maybe this is how they're going to compete with McDonald's globally," he said.

So what's the upside for Tims?

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"If Tim Hortons gets its coffee into all those Burger King stores worldwide, that would be absolutely huge for it, and I think that might be part of this strategy as well," Hlinkasaid.

The company also says any transaction will be structured to deepen the connections each brand has with its customers, franchisees, employees and communities.

For its part, the federal government cautiously welcomed the news, with a spokesman for Industry Minister James Moore telling CBC News that Canada's recently lowered corporate taxes have made Canada "one of the best countrys in the world to do business."

NDP Industry critic Peggy Nash said Monday the opposition would seek more details about any possible deal and called for greater transparency under the Investment Canada Act, which covers large foreign takeovers in Canada.