April 5, 2016
By Mark Terry, BioSpace.com Breaking News Staff
In a very surprising bit of speculation, a Pfizer insider has told Reuters that the drugmaker was seriously considering walking away from its pending merger with Allergan in light of new U.S. Treasury rules regarding tax inversions.
Yesterday, the U.S. Treasury Department released 300 pages of new rules governing tax inversion deals. A tax inversion is when a U.S. company buys a company with a corporate domicile in a country with a lower tax rate, then shifts its entire tax headquarters to that country. It is the third round of regulations concerning tax inversions since September 2014.
A number of analysts have noted that the new regulations seem almost directly aimed at Pfizer-Allergan. In particular, one of the major components of the deal involves “serial inverters.” In one of two major parts of the new rules, the U.S. government would not consider the assets acquired by these companies that occurred in the last three years.
This would directly affect Allergan and the Allergan-Pfizer deal. Allergan, as it currently exists, is the byproduct of several cross-border deals. The first was the inversion of Actavis (ACT) in 2013, which at that time was a New Jersey-based company, which was acquired by Ireland-based Warner Chilcott PLC. Between 2013 and 2015, several more deals occurred, including the 2015 acquisition of Allergan by Actavis for $66 billion. The merged companies then changed its name to Allergan.
Under the new rules, all of those acquisitions—and the resulting market value of the company—would not be taken into consideration under the tax law. As a result, due to other existing regulations regarding tax inversions, the Pfizer-Allergan deal would not meet the necessary requirements to gain the tax inversion status.
Even to non-expert eyes, this seems like a peculiar bit of legal maneuvering on the part of the Treasury Department, looking at the market capitalization of a company three years prior to determine value for a current deal.
The other major portion of the new regulations concerns earnings stripping. It builds on the fact that inverted companies and all non-U.S.-based companies can lend money to their subsidiaries. That creates deductible interest in the U.S., which cuts the amount of revenue subject to the 35 percent U.S. corporate rate.
The new rules state, “Today’s action makes it more difficult for foreign-parented groups to quickly load up their U.S. subsidiaries with related-party debt following an inversion or foreign takeover, by treating as stock the instruments issued to a related corporation in a dividend or a limited class of economically similar transactions.”
Although news of the new rules immediately made analysts and investors speculate on whether or not the Pfizer-Allergan deal would continue, many analysts thought it probably would, given time and some potential legal battles.
The news that Pfizer may capitulate sooner rather than later comes as something of a surprise. The unidentified inside source indicates that the company’s lawyers have presented possible ways they can still go on with the merger, but, according to Reuters, “there was little appetite for it.”
The rationale, according to the source, which comes off sounding slightly paranoid, is that “Pfizer is aware that the Treasury will keep ruling against any solution it can come up with.”
Apparently the two companies have been prepared, however, for the possibility that the government—especially in an election year where drug prices and tax-diversion deals have become somewhat hot-button issues—might present problems with the merger. Reuters reported that, “The two drugmakers agreed that either party may terminate the deal if an adverse change in U.S. law would cause the combined company to be treated as a U.S. domestic corporation for federal income tax purposes.”
There is an apparent termination deal in place that would pay out up to $400 million, which would likely be shared between the two companies. Some sources have suggested the breakup fee could go as high as $3.5 billion, depending on how the deal falls apart.
