White & Case’s William Dantzler explains why government action on inversions has not swept them off the table as a viable strategy
Tax inversion deals, where US businesses acquire foreign companies and transfer their tax domicile to secure lower tax rates, have been one of the key deal rationales behind large outbound M&A deals in 2014. AbbVie’s proposed US$54 billion acquisition of Shire (which has now been abandoned in light of the regulatory changes highlighted below), Medtronic’s US$45.95 billion purchase of Ireland’s Covidien and Actavis’s takeover of Warner-Chilcott for US$8.4 billion are all tax inversion deals. These deals have the potential to unlock substantial savings for US acquirers.
This momentum was curtailed, however, when a US Treasury notice issued in September 2014 introduced regulations that will restrict some of the advantages associated with tax inversions.
The changes have affected a key reason for inversions, namely, the acquirer’s ability to access trapped cash without incurring US tax. Many US companies have cash offshore that they cannot bring back to the United States without being taxed, even though foreign-based companies are allowed to earn cash offshore and bring it back to their parent company tax free.
Tax inversions were a way for US companies to use this trapped cash, but most of the provisions in the Treasury notice are aimed at strategies that an inverted company would use to access that trapped cash. In short, the Treasury has shut this avenue down.
Yet while some commentators saw the notice as signaling the end to these types of deals, the reality is that inversions still provide an attractive proposition for US companies in two different ways neither of which has been affected by the rule change.
Building abroad. A tax inversion allows a company to grow future businesses offshore and out from underneath a US parent. The Treasury notice has had no impact on this potential benefit. And while this has not been a key driver during this round of inversions, this recent action could mean it becomes an attractive motive for future deals.
Leverage. The main attraction of an inversion is the ability to leverage up the US operations and deduct interest against
the US taxable income. Foreign-based multinationals have always been able to do this up to certain limits. Inversions allow US business to enjoy the same tax benefits.
The new regulations will have no impact on this rationale for pursuing an inversion. The Treasury notice does not touch tax deductibility of interest. The deduction for interest is in the Internal Revenue Code. Only Congress can change that. And while this remains the case, the size of this advantage means there will still be plenty of deals out there that make sense, even when the trapped cash advantages are taken away.
The regulations issued by the Treasury will have some impact on the appetite for inversions. However, the fact that interest deductibility and building businesses offshore remain untouched means that inversions still offer companies some significant advantages.
The big question about the future for companies is what Congress will do on the back of this. The Treasury only took action because Congress wouldn’t and is unlikely to do so this session but there is a prevailing fear that the new Congress, which starts next year, will do something effective January 2015.
This is a major concern. For instance, an inversion deal involving two public companies can be, at least, a four or five month process. If they are facing the risk throughout that period that Congress may take action and rescind the advantages, it can put the whole transaction in jeopardy. The future for inversions will only be resolved when the uncertainty in Washington is resolved. And that will only come with time.