New Rules on Tax Inversions Threaten Pfizer-Allergan Deal
By RICHARD RUBIN and LIZ HOFFMAN
Updated April 4, 2016 8:28 p.m. ET
WASHINGTON—The Treasury Department imposed tough new curbs on corporate inversions Monday, shocking Wall Street and throwing into doubt the $150 billion merger between Pfizer Inc. and Allergan PLC, which was on track to be the biggest deal of its kind.
The Treasury move, which was more aggressive than anticipated, sent Allergan’s shares tumbling 19% in after-hours trading and could stall a trend in corporate deal-making that has seen companies searching for ways to escape the U.S. tax net. Pfizer shares edged 0.9% higher.
“It’s going to be a major impediment. They’re pretty much taking all of the juice out of inversions,” said Robert Willens, a New York-based tax analyst. “They’ve addressed literally every benefit that one attempted to gain from an inversion and shut them all down systematically.”
The new rules, the government’s third wave of administrative action against inversions, will make it harder for companies to move their tax addresses out of the U.S. and then shift profits to low-tax countries using a maneuver known as earnings stripping.
In an inversion, a U.S. company takes a foreign address, typically through a merger with a smaller firm. The combined company can then lower its tax rates through internal borrowing and can more easily move non-U.S. profits around the world and back to shareholders while avoiding U.S. taxes.
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Deal lawyers, who have made millions in fees over the past few years advising on inversions, mostly shrugged at the previous two rounds of Treasury rules, which nibbled around the edges but made few major changes.
They digested Monday’s announcement with greater alarm, with many saying it was an unexpectedly aggressive move from a Treasury Department that has expressed frustration at the limits of its own powers in curbing these transactions. Several deal makers said the rules seemed squarely aimed at the Pfizer-Allergan transaction, which has drawn fire from politicians in an election year.
Partners at tax departments of major law firms were gearing up for a long night parsing the regulations, which run over 300 pages.
Robert Holo, a tax partner at Simpson Thacher & Bartlett LLP, called the regulations a “significant escalation of the attack on inverted companies.”
“Not only does it attack the ability to invert, but puts the single greatest benefit of doing so—earnings stripping—on the chopping block,” he said.
The rules have two main parts, each of which could affect the Pfizer deal. First, the government would go after what it calls “serial inverters,” large companies created through multiple inversions or takeovers of U.S. companies. The government would disregard U.S. assets acquired by such companies over the previous three years.
Consider Allergan. The company’s current heft is the result of several cross-border deals, starting with the 2013 inversion of Actavis Inc., a small New Jersey-based drugmaker, through a takeover of Ireland-based Warner Chilcott PLC. What followed was a string of ever-larger deals, culminating in Actavis’s $66 billion takeover of U.S.-based Allergan Inc. last year.
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.
Stripping those deals out of Allergan’s closing market capitalization of $106 billion could make it too small to serve as Pfizer’s inversion partner under federal rules that disfavor lopsided mergers, or limit the financial benefits of the arrangement.
To reap the full benefits of inverting, the U.S. company’s shareholders should own between 50% and 60% of the merged entity, which requires a partner of carefully calibrated size. Above that, some restrictions apply, including rules making it harder for companies to access foreign profits. The Pfizer-Allergan deal is structured so that Pfizer’s shareholders will own 56% of the company.
Mr. Willens said the new percentage in the Pfizer-Allergan deal would be at least 60% and could approach 80%, above which all benefits of the inversion are lost.
“It certainly puts a crimp in the deal and it’s not out of the question I suppose that Pfizer would want to rethink the transaction given the development,” Mr. Willens said.
“We are conducting a review of the U.S. Department of Treasury’s actions announced today,” Pfizer and Allergan said in a statement Monday. “Prior to completing the review, we won’t speculate on any potential impact.”
Treasury’s second action would limit what is known as earnings stripping, a practice that follows many inversions and other cross-border acquisitions that helps lower companies’ effective tax rates.
Inverted companies—in fact, all non-U.S.-based companies—can lend money to their U.S. subsidiaries. Those moves create deductible interest in the U.S., reducing the income subject to the 35% 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.
The Treasury Department is basically giving itself more authority to revoke tax advantages of debt for inverted companies.
A senior Treasury official said the limits would apply only to debt between related parties and wouldn’t apply to debt used for investments such as expansions of U.S. facilities.
“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—all while shifting a greater tax burden to other businesses and American families,” said Treasury Secretary Jack Lew.
The government’s new rules would apply to all deals that close after Monday and all intercompany debt transactions issued after Monday. That likely means that companies that have already closed inversion deals will be unaffected by the three-year rule, though the earnings stripping guidelines could be a factor for them.
It isn’t clear how the new rules will affect other pending inversion deals. The volume of such deals has diminished amid the Treasury’s push.
“Treasury’s step is big economically,” said Steve Rosenthal, a senior fellow at the Tax Policy Center in Washington who had urged the government to take some of the actions. “Heretofore Treasury only penalized inversions, not foreign takeovers, which left U.S. companies as attractive targets for larger foreign companies.”
As he did upon releasing anti-inversion rules in September 2014 and November 2015, Mr. Lew again called for Congress to pass short-term anti-inversion legislation and a broader revamp of the U.S. business tax system.
“These regulations will make potential inverters and foreign acquirers think twice before making the leap, and those bad actors should be on notice that we intend to clamp down even further,” said Sen. Charles Schumer (D., N.Y.).
Rep. Kevin Brady (R., Texas), chairman of the House Ways and Means Committee, criticized the rules as “punitive” steps that would hurt U.S. companies and discourage investment.
Write to Richard Rubin at
richard.rubin@wsj.com and Liz Hoffman at
liz.hoffman@wsj.com