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* Risk to tax benefits increases the more Monsanto shareholders hold in merger

* Tax inversion seen as sweetener but not key rationale behind deal

* Exact nature of tax benefits Monsanto could realise unclear

An increase in the cash proportion in Monsanto’s [NYSE:MON] bid for Syngenta AG [VTX:SYNN] would risk negating potential tax benefits resulting from an inversion, according to three tax lawyers.

Monsanto’s original bid of CHF 449 per share, with around 45% in cash, was rejected by Syngenta’s board. Monsanto is expected to submit an improved offer in the near future, as reported.

At the level of cash consideration in the rejected offer, Syngenta’s existing shareholders would end up with about 30% of the new company created by the merger, according to Dealreporter analytics.

Under the US tax code, a merged company can redomicile to another jurisdiction if shareholders of the foreign target company, hold at least 20% ownership of the new company. Several US companies have used that rule to relocate to jurisdictions with lower tax rates.

But, in September the US Treasury and Inland Revenue Service issued a notice designed to cut down the benefits of a tax inversion and make it more difficult for US entities to invert by strengthening rules around the former owners of the US company holding less than 80% of the new combined entity.

While the notice – which catches merged entities where the US company holds between a 60%-80% stake in the new company - has not been officially made into regulation, it has had a chilling effect on deals with a tax inversion element.

Abbvie’s [NYSE:ABBV] attempt to take over Shire PLC [LON:SHP] and implement an inversion last year was abandoned after the Treasury and IRS issued their guidance.

Assuming a tax inversion is attempted, the more ownership retained by Monsanto in the new company, the more likely the deal would be to raise the ire of tax authorities, politicians and the media in the US, the three lawyers and a sector banker said.

Monsanto’s market capitalisation is USD 56.2bn, while Syngenta’s market cap is CHF 39.5bn (USD 41.8bn). Assuming a total equity value of USD 97bn based on the combination, Syngenta shareholders would need to keep USD 19.4bn worth of stock, estimated Jason Kaplan, tax partner at Hogan Lovells. The cash structure of the initial bid gives Monsanto the option to invert. Monsanto could raise the cash proportion to 50%, but “that’s about it”, he said.

The proportion of cash that Monsanto can offer and be within the bounds of a tax inversion depends on how much it increases its overall offer. One banker previously estimated Monsanto could up its offer to as much as CHF 580 per share without dilution just based on its own price-to-earnings ratio and the ability to move its tax headquarters to Switzerland.

Effective income tax rates stood at 27.54% for Monsanto on a trailing twelve months basis, according to its latest quarterly report, and 14.41% for Syngenta for 2014.

At CHF 580/share offer price and maintaining a 30% minimum shareholding in the combined entity for Syngenta shareholders, the cash component of the offer could be increased to 58%, reflecting CHF 334.52 cash per share and total cash consideration of USD 33.12bn, according to Dealreporter analytics. The total consideration in this case would amount to USD 57.43bn, with USD 33.12bn in cash and USD 24.31bn in shares.

Even under existing regulations the exact nature of the benefits Monsanto could see out of the restructuring are unclear at this stage, the lawyers said.

It is unlikely an inversion would be a key reason for pursuing the deal as a whole, but would represent a significant sweetener, the lawyers and a second sector banker said. A fourth lawyer said lack of a tax inversion was unlikely to be a deal-breaker in this case.

Much of the benefit would depend upon the levels of intercompany debt between Monsanto’s US operations and the new foreign company, the second lawyer said. “Interest stripping” is used to create an arbitrage between tax deductions on interest paid in the US and tax paid on interest received in Switzerland, he explained.

The future growth plans of Monsanto’s non-US businesses would also benefit from a foreign incorporation because they would not need to repatriate as much cash to the US and could more easily avoid Controlled Foreign Corporation tax rules, the second lawyer said.

Such plans would be sure to draw negative attention because Monsanto is a large, high profile, tax-paying company in the US, but an inversion can be done legally under current regulations and would be respected, the second lawyer said.

“If they’re willing to take the heat then they could definitely do an inversion to maximise the value of the deal,” the second lawyer said. Syngenta shareholders would expect the benefits of an inversion to be factored into any offer made by Monsanto, he added.

They might also look to be compensated for the risk of the deal falling through if an inversion is blocked in some way, said Kaplan. It would be riskier to attempt the tax inversion than not, he said.

It is not clear whether Monsanto’s initial approach for Syngenta was conditional on the success of a tax inversion, but Syngenta cited “significant execution risks, including regulatory and public scrutiny at multiple levels in many countries” in its rejection statement.

The US Treasury and IRS could implement new regulations and Congress could even eventually legislate against tax inversions, which would have a high risk of affecting deals signed but not completed prior to laws being passed, Kaplan and the second lawyer said. But, Congress would not be likely to take such action prior to the next Presidential election in 2016 because the house is too polarised, the second lawyer said.