Tax inversions: what the new rules mean
On Monday, the US Treasury said it was taking additional steps to “rein in inversions” — transactions in which multinationals change their tax residence by acquiring a foreign company to cut their tax bills. It is aiming to tackle “serial inverters” — foreign companies that have rapidly acquired multiple US companies.
It will reinforce efforts to curb inversions that drastically restricted the potential tax benefits in cases where the foreign acquirer was significantly smaller than the US business. In future, when calculating the size of the foreign acquirer, any assets acquired from a US company within three years before the signing date of the latest acquisition will have to be ignored.
It also set out to reduce the tax advantages of inversions by curbing “earnings stripping” — the use of intercompany loans to reduce US tax bills. This move is likely to have far-reaching implications for other multinationals and private equity-backed companies as well.
Why is the Treasury taking action?
The Treasury says that inversions are draining billions of dollars from the US tax system and President Obama has long wanted to stop inversions. A statement from the White House on Monday said that when multinationals exploit tax loopholes “it erodes the American tax base, undercuts businesses that play by the rules and ultimately leaves the middle class and small businesses to pay the tab”.
What does it mean for the Pfizer-Allergan deal?
Pfizer’s $160bn takeover of Allergan, the Dublin-based drugmaker, was due to be finalised in the second half of this year. But Allergan’s share price fell more than 22 per cent in after-market trading on Monday, reflecting market fears that the anti-inversion moves would scupper the deal.
The Pfizer-Allergan merger is structured so that Pfizer shareholders would hold about 56 per cent of the new combined company, below the critical 60 per cent threshold that would have restricted benefits of the inversion under the old rules. But this is possible only because Allergan had been enlarged by a string of serial inversions. In 2013 Ireland-based Warner Chilcott bought US-based Actavis, then in 2015, Actavis bought US-based Allergan.
Analysts think the tax benefits of Pfizer’s takeover are likely be reduced once these deals are taken into account, following the Treasury’s latest actions. Pfizer and Allergan said in a joint statement on Monday they were reviewing the Treasury’s actions and would not speculate on any potential impact.
Does this mean inversions are over?
It’s very unlikely to stop inversions altogether. Companies can still benefit from moving their tax base out of the US. Only the US taxes foreign profits when they are repatriated and — together with the high US corporate tax rate — this creates a big incentive to relocate. But the latest move by the Treasury is its most assertive effort yet to reduce inversions. It is likely to restrict the number of potential acquirers for big US multinationals, which could have a big impact on the total value of inversion deals.
What is the income stripping provision and how broadly could it apply?
The proposal is aimed at reducing the tax benefits from inversions, although its impact will also be felt by other companies that use the tactic to reduce their US tax bills. The new rules will permit intercompany debt to be recharacterised as equity as part of an audit in certain circumstances. Tax experts said the impact of this would be far-reaching. It would affect private equity- backed companies and US multinationals as well as foreign-parented multinationals
Is further action likely?
The US Treasury is continuing to look at ways to curb inversions. But it notes that only Congress can stop inversions outright, which is why Mr Obama has proposed to fully close the loophole that allows for corporate inversions in each of his last three Budgets. Republicans such as Orrin Hatch, Senate finance committee chairman, accused the Treasury of “issuing unilateral band aids that only attempt to alleviate the symptoms.” He called for reform of “our outdated tax code that burdens our job creators with the highest corporate tax rate in the developed world”.