Burger King Deal Advances Amid U.S. Inversion Crackdown

Jacob J. Lew
Jacob J. Lew, U.S. Treasury secretary. Photographer: Mario Proenca/Bloomberg

Burger King Worldwide Inc.’s deal to buy Tim Hortons Inc. and move its address to Canada will proceed, a day after the U.S. Treasury Department announced plans to crack down on corporate inversions.

Scott Bonikowsky, a Tim Hortons spokesman, said the deal is “moving forward as planned” and is driven by long-term growth and not tax benefits. The actions to curb inversions announced yesterday by Treasury Secretary Jacob J. Lew are getting an immediate test as eight U.S. companies with pending deals decide whether to move forward.

“These rules do not strike anything like a mortal blow to the pending deals,” Robert Willens, a corporate tax consultant in New York, wrote to clients today as he assessed the likelihood that Medtronic Inc. and AbbVie Inc. will complete their mergers. “Such deals should proceed to completion without missing a beat.”

Still, health-care stocks in the U.S. and Europe dropped in response to Treasury’s actions. And companies with unannounced deals may be reconsidering their plans, particularly if the benefits would stem from access to U.S. companies’ foreign earnings.

“It potentially changes in a meaningful way the financial calculus that merger partners are going to undergo as they look at inversion,” Neil Barr, co-head of the tax department at Davis, Polk & Wardwell LLP in New York, said in an interview today. “The needle appears to have moved pretty meaningfully.”

Reconsidering Deals

Lew’s goal was to have companies reconsider inversion deals they’re already working on. He also left open the prospect of future action aimed at earnings stripping, the post-inversion transactions that companies use to reduce taxes on U.S. income.

“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 foreign addresses to lower their tax bills. Lew and President Barack Obama made clear that they were prepared to use rulemaking authority to try to stop some deals, even at the risk of a backlash from the companies and from Republicans, who complained that Lew went too far.

Pfizer, Walgreen

A wave of inversions caught lawmakers’ attention this year when large U.S. companies including Pfizer Inc. and Walgreen Co. explored transactions and Medtronic, AbbVie and Burger King moved forward with deals.

Investor reaction to the announcement was swift today. Abbott Laboratories, which has a deal to sell a generic-drug unit to Mylan Inc., was down 2.1 percent at the close of trading.

Pfizer, which this year attempted to buy AstraZeneca Plc and move abroad, fell as much as 2.3 percent. It closed down 0.43 percent after Bloomberg News reported that the company was considering buying Actavis Plc, which has an Irish address.

Medtronic fell 2.9 percent in closing prices and AbbVie was down 2 percent.

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.

Pending Deals

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.

The Burger King deal was already exempt from some U.S. restrictions because the combined company will have substantial Canadian operations.

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.

Treasury’s actions may raise Medtronic’s cost of financing without imperiling its deal or AbbVie’s, Willens said.

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 for the risk of a second round of Treasury rules affecting maneuvers known as earnings stripping.

‘Big Leap’

“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.”

Writing regulations aimed at earnings stripping, which analysts had expected could be part of the first wave of Treasury action, can be a difficult exercise. The government will be trying to curb abusive transactions without hurting all foreign-based companies operating in the U.S.

Henrietta Treyz, an analyst at Height Securities LLC, said Treasury is leaving open the possibility of future action to maintain pressure on companies.

“A steady stream of ‘updates’ and further ‘announcements’ should be expected to come from Treasury throughout September and October and almost regardless of the outcome of the midterm election, through the remainder of 2014 as senators and the administration try to keep the business community on their toes and apprehensive of future action that may render inversions less attractive,” she wrote in a note to clients today.

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.

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. 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.”

Kenric Tyghe, a Toronto-based analyst with Raymond James, said it’s unlikely the changes proposed in the U.S. would affect the Burger King-Tim Hortons deal.

Strategic Rationale

David Woollcombe, a Toronto-based partner at McCarthy Tetrault LLP, said he doesn’t see the regulations having much effect on deals or potential deals that are driven by a strong strategic rationale, as opposed to tax arbitrage.

The changes proposed will apply to pending and future deals and will likely diminish the tax advantage that U.S. companies have sought from an inversion, he added.

“They are trying hard to plug a leaky boat with a series of stopgap measures, as the prospect of meaningful U.S. tax reform in the short term is very low,” Woollcombe said in an e-mail. “The Democrats need to be able to point to some action having been taken in advance of the midterm elections as inversions have become a political lightning rod.”

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.

80% Limit

In the absence of legislation, the Treasury Department looked for ways to make it harder for companies to get around the 80 percent limit.

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 so-called old and cold foreign companies with cash and other passive assets as merger partners to meet the rules.

Foreign Subsidiaries

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.

Inverted companies would still be able to avoid U.S. taxation of future profits around the world.

E-mails and calls to spokesmen at Mylan Inc., AbbVie Inc. late yesterday 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.

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