Brooke Sutherland is a Bloomberg Gadfly columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

The collapse of Pfizer's $160 billion combination with Allergan is the headline-grabbing casualty of the Treasury Department's inversion crackdown. But a host of other companies that have little to do with inversions will also face major repercussions.

The drugmakers' gigantic combination seems to have been particularly felled by the first part of the Treasury's new tax proposals rolled out this week. By exempting American assets Allergan had acquired in the past three years, the company was no longer big enough to make the inversion math work with Pfizer. A lot of people lost a lot of money, not to mention time, but the rule that caused that merger's downfall doesn’t actually mean all that much for the other pending inversion deals (most of which look like they can still proceed), and it doesn't make such transactions impossible.

New Normal
Allergan shares took a dive after the company's merger with Pfizer was first placed in doubt, and generally stayed there once the deal was declared dead.
Intraday times are displayed in ET.

The second piece of the Treasury's proposal -- a crackdown on the practice of "earnings stripping" -- is the part worth paying attention to.  Earnings stripping was a key benefit of inversions, the loss of which makes such transactions including the Pfizer-Allergan merger less appealing, but the tactic is also employed by big multinational companies.  The Treasury had to be broad its application of the new rules because a perceived discrimination against inverted companies would have raised big red flags. But going so broad raises other issues. 

Here's how earnings stripping typically works: U.S. subsidiaries essentially print up an I.O.U to their foreign parent, often for the purpose of covering legitimate things like funding operations or paying royalties. (This often isn't like a regular loan in that money doesn't always change hands.) The interest paid on that inter-company debt is then tax-deductible in the U.S. This has the effect of essentially shifting profit earned in America to countries where taxes are lower. Put another way, foreign multinationals use earnings stripping to arbitrage the difference in tax rates in the countries in which they operate.

The new Treasury proposals would change this by reclassifying that debt as equity, which has the effect of making the interest payments more like a dividend and taxable in the U.S. Which is not to say a foreign parent couldn't lend money to its U.S. subsidiary to pay for things like a factory. That type of loan could be considered legitimate debt. But the company would have to jump through all kinds of other hoops to prove it -- like showing creditor remedies in the event of default and a reasonable expectation for repayment -- and even then there's no guarantee that the loans will be treated as debt, said tax expert Robert Willens. However you slice it, companies' whole tax calculus has to be redone. How widespread is this?  

``Every foreign company that has operations in the U.S., I think it's safe to say, is engaging in earnings stripping," says Willens. ``You'd be almost negligent if you didn't. You want to reduce your global tax obligation.''

Nestle has already spoken out about the changes, telling the Financial Times that they would ``have a chilling effect on jobs and investment in the U.S."

Stripped Away
Nestle gets 29 percent of its revenue from the U.S. and has said investments there would be ``less palatable" under the new Treasury proposals.
Source: Bloomberg

That may just sound like foreign companies moaning, and it's easy to say that corporations should pay their share of U.S. taxes if they operate here. But the international operators do have a point. A higher U.S. tax bill means a lower rate of return on investments in this country. If you're not sure that inter-company debt used to pay for a new plant in the U.S. will actually be treated as debt, then maybe you think about building that plant somewhere else.

As my Bloomberg View colleague Leonid Bershidsky notes, U.S. companies would be up in arms if a similar rule change went into effect overseas. Indeed, Treasury Secretary Jack Lew himself isn't too pleased about the European Union's corporate tax investigation, which has included probes into Apple, McDonald's and Starbucks. In a letter to European Commission President Jean-Claude Juncker, Lew questioned whether the approach disproportionately targets U.S. firms and creates "disturbing international tax policy precedents."

Tax lawyers say the earnings-stripping regulations are the part of the Treasury's proposals most likely to draw a challenge. Previous attempts to regulate the debt and equity dynamic in the 1980s failed, and there's a good chance this latest attempt will never be formalized. The Treasury itself may not have completely thought out all of the implications of the earnings stripping clampdown, said William Dantzler, a tax partner at White & Case. Or perhaps the agency isn't all that worried about these proposals being implemented -- as long as just the prospect of a crackdown continues to scare U.S. companies away from inversions.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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Brooke Sutherland in New York at

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Beth Williams at