U.S. Treasury Drops Bomb on Tax Inversion Deals, Threatens Pfizer-Allergan Merger

April 5, 2016
By Mark Terry, BioSpace.com Breaking News Staff

In a surprise move, the U.S. Treasury Department released a new set of rules yesterday to make it more difficult for U.S. companies to conduct so-called tax inversions. Basically, a tax inversion is when a U.S. company buys a company that is based in a country with a lower tax rate than the U.S., then shifts its headquarters to that country in order to get the lower tax rate.

The new rules, which run over 300 pages, seem aimed at the $160 billion Pfizer -Allergan merger, which was expected to close sometime this year. There are two earlier rounds of Treasury rules, but they didn’t do much to stop inversions. This new set, however, appears to have shaken up some attorneys involved in these types of deals.

“It’s going to be a major impediment,” Robert Willens, a New York-based tax analyst, told the Wall Street Journal. “They’ve addressed literally every benefit that one attempted to gain from an inversion and shut them all down systematically.”

Although it’s unlikely that every aspect of the new rules has been analyzed fully by anyone except the Treasury’s attorneys, it appears to have two main components. Both of those aspects of the rules could affect the Pfizer deal.

The first part takes on “serial inverters.” These are large companies that are large because they have undergone numerous inversions or takeovers of U.S. companies. In a rule that seems almost directly aimed at Pfizer-Allergan, the U.S. government would ignore U.S. assets acquired by these companies over the last three years.

Which puts Allergan directly in the crosshairs of the regulations. Allergan, as it currently exists, is the byproduct of a number of cross-border deals that started with the inversion of Actavis in 2013, which at that time was a New Jersey-based company. It was acquired by Ireland-based Warner Chilcott PLC. Several more deals occurred until Actavis took over Allergan for $66 billion in 2015 and changed its name to Allergan.

As the Wall Street Journal writes, “Under the new Treasury regulations, those deals would be disregarded for the purposes of determining Allergan’s size under the tax law. The three-year window would cover the 2015 merger of Actavis and Allergan, Actavis’ $25 billion purchase of Forest Laboratories Inc. in 2014, and the original $5 billion Warner Chilcott deal.”

And as a result, by viewing Allergan without those companies’ market capitalization, it becomes too small under current Treasury laws to be Pfizer’s inversion partner.

The second major part of the new regulations involves earnings stripping. This is a more complicated issue, but it builds on the fact that inverted companies and all non-U.S.-based companies can lend money to their subsidiaries in the U.S. The Wall Street Journal says, “Those moves create deductible interest in the U.S., reducing the income subject to the 35 percent U.S. corporate tax rate and shifting income to a lower-taxed jurisdiction. If a U.S.-based company tried the same technique by borrowing from its offshore subsidiaries, the government would tax that income at the U.S. rate.”

Treasury Secretary Jack Lew said in a statement, “After an inversion, many of these companies continue to take advantage of the benefits of being based in the United States—including our rule of law, skilled workforce, infrastructure, and research, and development capabilities—while shifting a greater tax burden to other businesses and American families.”

Which may be the case, but these new rules seem to have broader implications for the U.S. economy, and probably unforeseen complications. Steve Rosenthal, a senior fellow at the Tax Policy Center in Washington, told the Wall Street Journal, “Treasury’s step is big economically Heretofore Treasury only penalized inversions, not foreign takeovers, which left U.S. companies as attractive targets for larger foreign companies.”

Rep. Kevin Brady (R., Texas), called the rules “punitive.’ He is chairman of the House Ways and Means Committee. It seems likely that he’s not the only politician—a given in an election year and pretty much with the current Congress—that conservatives and probably numerous tax attorneys will accuse Treasury of overreach. Certainly the first part of the rules, even for non-experts, raises eyebrows.

For their part, Allergan and Pfizer issued a terse joint statement yesterday, saying, “We are conducting a review of the U.S. Department of Treasury’s actions announced today. Prior to completing the review, we won’t speculate on any potential impact.”

But analysts are. Many think it’s going to cause a major problem for the two companies, although undoubtedly a battalion of attorneys are working overtime on it at this very minute.

Corey Davis, an analyst at Canaccord Genuity in New York, told Bloomberg, “There’s little chance this will affect Pfizer’s proposed acquisition of Allergan, since the tax consequences were never the main thrust of the acquisition.” He also believes that Allergan’s ongoing plan to sell its generics units to Israel-based Teva will go through.

Pfizer appears relatively unaffected by the new regulations. Shares traded on Mar. 31 for $29.64 and are currently trading for $31.04.

Allergan , however, took a hit, and is currently down about 17 percent to $231.24.