Deals

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

One target of President Donald Trump's tax reform plan (scant on details as it is) is the corporate inversion, a tactic companies use to lower their obligations to the U.S. government by shifting their headquarters overseas. That's sort of like coming up with a plan to make dinosaurs extinct. One of this week's biggest deals explains why.

Vantiv Inc., based outside of Cincinnati, agreed on Wednesday to acquire its U.K.-based payments rival Worldpay Group Plc for about $10.4 billion. The two companies are the right size to pull off a deal that would have placed the combined entity's legal home base in an overseas country where tax rates are lower, but they decided to keep a U.S. domicile, noting that an inversion "might not offer significant value enhancement." This is a stark reversal from not too long ago when one of, if not the, selling point for foreign targets was the ability to reap tax savings. It's perhaps even more notable given that Vantiv could have used some help to offset the expensive price tag.

Premium Asset
Vantiv is paying a high valuation to acquire Worldpay. Some tax savings might have helped justify that.
Source: Bloomberg

What this suggests, says tax expert Bob Willens, is that the regulations rolled out by President Barack Obama's Treasury Department in an effort to curb inversions are in fact having their desired effect. President Trump's administration and Republican lawmakers have raised the prospect of rolling back those regulations, specifically a crackdown on the use of a tactic known as earnings stripping. They're instead contemplating a more aggressive tax overhaul to combat such tax avoidance, but they may be attacking a problem that doesn't exist anymore.

Remember These?
Here are some examples of recent efforts by U.S. companies to change their legal domicile. Such moves have shrunk in popularity after the Treasury Department rolled out restrictions.
Source: Bloomberg, Bloomberg Quicktakes
Note: Naked inversion refers to an inversion done without a merger partner.

Earnings stripping is used by inverted firms as well as global enterprises to effectively shift profit to lower-tax countries by having a U.S. subsidiary pay interest to a foreign parent on inter-company loans. The savings reaped can often be more important to the economic calculus on an inversion than just an inherently lower rate or the ability to have less-fettered access to overseas cash.

For example, Vantiv shareholders will own 57 percent of the entity created through its merger with Worldpay, putting it below the threshold at which many of the Treasury Department's restrictions take effect. That means, in theory, it would have been able to take advantage of traditional inversion benefits such as access to overseas cash. But without earnings stripping, it's harder to comfortably quantify the benefits of going through with an inversion.

Vantiv and Worldpay apparently decided the payoff wouldn't be significant enough to outweigh the taxes U.S. investors typically bear in an inversion situation on the exchange of their stock. Historically, such shareholder taxes have been viewed as a necessary means to a much greater end, and most investors have been willing to accept it, given the greater profitability and stock price that can come down the road with fewer obligations to Uncle Sam.

This doesn't mean there aren't still loopholes in the U.S. tax system that companies might exploit. For example, Huntsman Corp. shareholders will own less than 50 percent of the entity formed through its proposed merger with Swiss chemical maker Clariant AG, allowing it to achieve both a foreign domicile and avoid tax penalties for its U.S. holders. And companies don't need to do an inversion to avoid paying U.S. taxes on their foreign earnings as long as they keep their hoard safely stockpiled overseas, a problem lawmakers still need to contend with.

A move to a territorial system -- where profits are taxed only in the country where they're earned and not subject to an additional levy once brought back to the U.S., as is the current practice -- would go much further toward removing all motivations for an inversion.

But at this point, the incentive seems low enough as it is. 

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

  1. Notably, the restrictions on earnings stripping were softened in October in an effort to limit the effect on common cash management practices that aren't aimed at tax avoidance. That wasn't enough for Representative Kevin Brady, chairman of the House Ways and Means Committee, who has said he hopes Trump will "stop those regulations cold."

  2. Companies can sometimes offset this penalty with a cash payment, but there are restrictions on where that can come from. 

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net