Merger Rush for Offshore Tax Break Bets on U.S. Stalemate
U.S. companies are racing to complete tax-reducing offshore mergers before a credible threat to stop them emerges from Congress.
AbbVie Inc. (ABBV), maker of the arthritis medicine Humira, announced the largest such inversion deal July 18 with a plan to move its tax home to the U.K. in a $55 billion purchase of Shire Plc. (SHP) It joins seven other companies, including Medtronic Inc. (MDT), with pending deals that would be unwound, renegotiated or penalized under plans from the Obama administration and Congress to make tax changes retroactive to May.
Each deal puts additional pressure on lawmakers to act while making it more disruptive if they change the rules retroactively. Democrats want to stop U.S. companies from moving their addresses abroad through purchases of smaller businesses overseas. Republicans have resisted, labeling such proposals punitive and porous.
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“As more deals get announced and expectations are created and expenses are incurred to move these deals along, it becomes harder and harder to hold to that May effective date,” said Robert Willens, a corporate tax consultant in New York. “The bankers and the lawyers are telling them that, ‘Hey, the sooner you announce this thing, the greater the chances are that the deal will go through as you intend.’”
Still, companies including Medtronic and Salix Pharmaceuticals Ltd. are including contingencies that allow them to back out if Congress acts unexpectedly, showing how crucial the tax ramifications are to such deals. AbbVie and Shire don’t have such a clause in their agreement.
No corporate inversion deal has closed since May 8, when Senate Finance Chairman Ron Wyden wrote an opinion piece in the Wall Street Journal intended to mark that day as the effective date for anti-inversion legislation that he wants to pass.
Wyden, an Oregon Democrat who had first said he wanted to wait to address inversions as part of a broader tax-code revamp, said last week that he is exploring near-term options. So far, without a Republican partner, the Democratic push for immediate retroactive legislation is stalled.
“The promise of tax reform must not be used as an excuse to do nothing while more and more companies invert to avoid U.S. taxes,” Representative Sander Levin, a Michigan Democrat, wrote in a letter today to Republican Dave Camp of Michigan, chairman of the House Ways and Means Committee.
Wyden’s committee will hold a hearing on inversions and international taxes tomorrow. Senator Orrin Hatch of Utah, the top Republican on the Finance Committee, said July 17 that he’s willing to consider a narrower proposal to address inversions. He opposes the Democrats’ approach and hasn’t offered details on what he would support.
At least eight pending inversions by U.S. companies announced before and after May could be affected by legislation backed by Wyden, Senator Carl Levin and Treasury Secretary Jacob J. Lew. They are: AbbVie, Medtronic, Mylan, Salix, Auxilium Pharmaceuticals Inc. (AUXL), Chiquita Brands International Inc., Horizon Pharma Inc. (HZNP) and Applied Materials Inc. (AMAT)
Under current rules, U.S. companies can change their tax home through a merger if the former shareholders of the foreign company own at least 20 percent of the combined company. Executives aren’t required to move and many inverted companies are run from the U.S.
The proposed law would raise that threshold to 50 percent. It wouldn’t affect companies with completed inversions, such as Eaton Corp Plc and Actavis Plc.
“Our politicians want to lock the doors,” Steve Miller, chairman of American International Group Inc., said today on Bloomberg Television. “The real answer would be, let’s put out the fire, which means to make our U.S. tax system competitive on a global scale.”
Congress also should limit inverted companies from using offshore profits that haven’t been taxed by the U.S., said Edward Kleinbard, former chief of staff of the congressional Joint Committee on Taxation.
Medtronic, for example, has $20.5 billion in accumulated offshore profits and is borrowing from that stash to finance its purchase of Dublin-based Covidien Plc. Under the rule suggested by Kleinbard, that foreign loan would be subject to U.S. taxes, just as if the money had been loaned or repatriated to the U.S. parent company.
Changing the threshold and the access to offshore earnings would “stop virtually all of these trades in their tracks,” Kleinbard said.
Companies, he said, would have little reason to proceed with deals that would impose taxes on U.S. shareholders without the tax advantage for the corporations.
The consequences would be even more severe if Congress passes a retroactive law after the deals close, because they wouldn’t be able to renegotiate or unwind the agreements.
Retroactive tax legislation is “quite common,” according to a 2012 Congressional Research Service report. For example, in January 2013, Congress passed a law that revived and extended dozens of tax breaks that lapsed at the end of 2011.
U.S. courts have upheld retroactive taxes, with the exceptions coming in cases where fresh taxes were created retroactively or where the law reaches back over an extended period, according to the CRS report.
“It would be rare for a tax provision to be characterized as a ‘wholly new tax’ so long as taxpayers were on some kind of notice that a tax might be imposed,” the report said.
The most recent congressional limits on inversions were passed retroactively, following a pattern that Wyden is trying to emulate.
In 2002, the top Democrat and Republican on the Senate Finance Committee -- Max Baucus of Montana and Charles Grassley of Iowa -- announced their plans to limit inversions and set an effective date of March 21, 2002. The law wasn’t signed by President George W. Bush until October 2004 -- and after negotiations had changed the effective date to March 4, 2003, letting several companies avoid the higher tax.
Lew’s mention of the May 2014 effective date in a July 15 letter to lawmakers was designed to put companies on notice about the administration’s intentions, a senior administration official said last week, speaking on condition of anonymity.
The official said the administration supports cross-border economic activity -- just not when it’s being done for tax reasons that are causing economically inefficient behavior.
The potential legislative risk to the deals isn’t deterring companies from acting in a competitive market, said Juliane Keppler, a managing director of the global, tax and regulatory team at the NASDAQ OMX Group Inc.
“Companies are going full-speed ahead with any plans they have in place,” she said. “I don’t think companies or their advisers or their shareholders want to take a wait-and-see attitude. And frankly, they don’t expect it to necessarily be retroactive.”
The clause in the Salix deal is written so that the company could back out of its agreement with Cosmo Technologies Ltd. if there is a “change in law or official interpretation” that would make Salix a resident of the U.S. and not Ireland for tax purposes.
It also lets Salix exit the deal if the U.S. Senate and House have passed “substantially identical” bills on the issue, even if they haven’t become law.
Those clauses have “petrified” some investors who bought the stock of the target companies and are worried about any reason why the deals might not be concluded, Willens said.
“When you explain it to them,” he said, “it’s something that they’re really uncomfortable with.”
The possibility of the U.S. limiting inversions is causing other companies to think about a move. Among those considering an inversion is Walgreen Co., the retailer with wider name recognition among U.S. voters compared with the drugmakers that have inverted in the recent wave.
“It’s impossible to predict what Washington is going to do,” said Vamil Divan, a drug industry analyst at Credit Suisse Group AG in New York. “But they have to be talking about it in the boardrooms of pharma companies and biotechs.”
The momentum to move abroad has offered a rich opportunity for companies that have a foreign tax address to put on the plate. Shire is getting a 49 percent premium to its average share price in the 20 trading days before AbbVie confirmed its pursuit of the company in June. That compares with a median takeover premium of 33 percent among the 40 biggest pharmaceutical and biotech takeovers in the past five years, according to data compiled by Bloomberg.
Valuations like the one AbbVie paid may depend on the likelihood of action from Washington.
“At some point this inversion stuff will slow down,” Divan said. “If you’re getting a massive premium because you have that asset, if you consider an ex-U.S. domicile an asset, the value of that could go down in the next couple of years.”
Other risks from Washington to such deals include federal contracting ban proposals working their way through Congress.
Those proposals have attracted some bipartisan support. Previous attempts to bar inverted companies from getting federal contracts contained gaps that companies have exploited.
A version that passed the House in four separate bills would impose a limit on companies that moved addresses to Bermuda and the Cayman Islands. A provision in the Senate’s defense-spending bill encompasses a larger group of companies.
“That could be a sleeper,” Willens said. “That sounds like it could get pretty serious, pretty quickly.”
The proposed limits in annual spending bills won’t have much effect, though, because many companies don’t rely on the U.S. government as a major customer, said Robert Burton, a federal procurement lawyer at Venable LLP in Washington.
“If Congress wants to address what they view as a problem, they really need to take on the difficult job of reforming the tax code and not penalizing contractors through the procurement system,” he said.
The Democratic bill is S. 2360.
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