Lew's anti-inversion crackdown takes toll on tax-cut deals
Treasury Secretary Jacob J. Lew's crackdown on inversions will get an immediate test as eight U.S. companies with pending deals decide whether to proceed -- and other companies contemplating a foreign address now have to think twice.
That's exactly what Lew had in mind.
"This action will significantly diminish the ability of inverted companies to escape U.S. taxation," Lew told reporters on a conference call yesterday. "For some companies considering deals, today's action will mean that inversions no longer make economic sense."
The Treasury announcement heightened the tension between the government and companies considering obtaining a foreign address to lower their tax bills. Lew and President Barack Obama made clear that they were prepared to use rule-making authority to try stop some deals, even at the risk of a backlash from the companies and from Republicans, who already complained that Lew's moves went too far.
A wave of inversions caught lawmakers' attention this year when large companies such as Pfizer Inc. and Walgreen Co. explored transactions and Medtronic Inc., AbbVie Inc. and Burger King Worldwide Inc. moved forward with deals.
Investor reaction was swift. AstraZeneca Plc, Actelion Ltd. and other health-care stocks viewed as potential takeover targets fell in European trading today. AstraZeneca, the London- based drugmaker that was the target of a failed bid by U.S. rival Pfizer, declined as much as 5.7 percent. Shire Plc, which agreed in July to be bought by AbbVie Inc., dropped as much as 6.6 percent.
Pending Deals
At 8 a.m. in New York before markets opened, some companies involved in potential inversion deals fell. Medtronic traded at $63.75, down 1.9 percent from its $64.98 close yesterday. AbbVie slid 4.6 percent, Pfizer was down 1.3 percent and Burger King declined 2.1 percent in early trading today.
The new rules, which will apply to transactions that close starting yesterday, include a prohibition on "hopscotch" loans that let companies access foreign cash without paying U.S. taxes. They also curb actions that companies can use to make such transactions qualify for favorable tax treatment.
The changes will have the biggest effect on the eight U.S. companies with pending inversions, including Medtronic and AbbVie, which plan the two largest such deals in U.S. history.
In its purchase of Covidien Plc, Medtronic plans to loan some of its untaxed profits outside the U.S. to its new Irish parent company. That transaction may be penalized by the hopscotch rule.
Not Retroactive
Treasury stopped short of making the rules retroactive to deals that have been completed. Companies already reaping the benefits of a foreign tax address will face minimal changes except the risk of a second round of Treasury rules affecting maneuvers known as earnings stripping, which they use after an inversion to reduce taxes on income earned in the U.S.
"Taking a regulatory step was a big leap by the Treasury Department, yet they've only addressed part of the tax juice from U.S. companies inverting," said Steve Rosenthal, a senior fellow at the Urban Institute in Washington and a former corporate tax lawyer. "The earnings stripping remains a large problem."
Even without more authority from Congress or aggressive steps that former government officials had advocated, the new rules are expected to give companies and their advisers pause and require recalibration of some pending deals.
Congressional Inaction
Obama and Lew have urged Congress to pass a bill that would curtail inversions. When Congress left Washington for campaign season without acting, the administration did.
Lew announced the changes in a conference call with reporters late yesterday, after the close of regular trading in New York. Obama and congressional Democrats immediately followed with supportive statements, cheering the rules and seeking retroactive legislation.
"While the administration's actions are an important step, only Congress can fully close the tax inversion loophole," Senator Carl Levin, a Michigan Democrat, said in a statement. "Congress should act promptly when we return to eliminate this tax dodge."
Future Action
Henrietta Treyz, an analyst at Height Securities LLC, said Treasury is leaving open the possibility of future action to focus pressure on companies.
"In our view," she wrote to clients late yesterday, "these will come during the run-up to the election as the administration attempts to keep pressure and attention on this issue."
Treasury will release the formal regulations later. In keeping with past practice, the announcement served as a detailed notice of the government's plans.
The changes may cause complications for companies including Medtronic that are counting on the benefits of tax-free access to foreign cash. Among the pending inversions is Burger King's planned merger with Tim Hortons Inc., which would put the combined company's headquarters in Canada. Another deal involving Horizon Pharma Inc. closed on Sept. 19.
Medtronic said in a statement yesterday, "We are studying Treasury's actions. We will release our perspective on any potential impact on our pending acquisition of Covidien following our complete review."
'Hard Line'
Edward Kleinbard, a tax law professor at the University of Southern California, said in an e-mail that Treasury "has taken a very hard line on these transactions."
He cited the government's "very broad reading of its regulatory authority to address inversion deals involving accessing offshore cash" as well as "not grandfathering deals that are announced but not closed."
Lew, who said in July that Treasury lacked authority to stop inversions, reversed himself in August and the administration began studying its options.
Under current law, U.S. companies that invert through a merger are still treated as domestic for tax purposes if the former U.S. company's shareholders own more than 80 percent of the combined company. The administration wants to reduce that 80 percent to 50 percent; that requires legislation.
In the absence of legislation, the Treasury Department looked for ways to make it harder for companies to get around the 80 percent limit.
Spin-Versions
The new rules seek to limit so-called spin-versions, in which U.S. companies spin off units into a foreign company.
They also would restrict use of a technique known as skinnying down, in which companies make special dividends to reduce their size before a merger to meet the current law's requirements.
U.S. companies wouldn't be as able to seek out so-called old and cold foreign companies with cash and other passive assets as merger partners to meet the rules.
Other changes announced in the rules would make it harder for inverted companies to relinquish control of their foreign subsidiaries to get them out of the U.S. tax code's orbit. U.S. companies must pay taxes when they repatriate foreign profits.
The changes to those control provisions and the hopscotch rules would apply to inversion deals where the former U.S. company's shareholders own 60 percent to 80 percent of the combined business.
Burger King
Scott Bonikowsky, a spokesman for Tim Hortons, didn't immediately respond to messages seeking comment. Burger King, based in Miami, and New York-based Pfizer declined to comment.
E-mails and calls to spokesmen at Mylan Inc., AbbVie Inc. and after business hours weren't immediately returned. Mylan and AbbVie have inversion deals pending. Pfizer's bid for London- based AstraZeneca Plc failed in May though CEO Ian Read has said he is still looking for an inversion opportunity.
Lawmakers, who left Washington last week to campaign for the Nov. 4 election, haven't shown much interest in writing bipartisan legislation to curtail inversions. Most Republicans say the issue should be addressed as part of a broader revamp of the U.S. tax code.
"We've been down this rabbit hole before, and until the White House gets serious about tax reform, we are going to keep losing good companies and jobs to countries that have or are actively reforming their tax laws," Representative Dave Camp of Michigan, the Republican chairman of the House Ways and Means Committee, said in a statement.
"I fear this administration is only interested in doing the bare minimum -- just enough to say they care," Camp said.
The country's corporate income tax rate is 35 percent, and the U.S. is one of few industrialized nations that imposes its corporate tax on the foreign income of companies based here. That tax is imposed only when companies repatriate foreign profits, giving them an incentive to stockpile profits overseas.