Has Obama Successfully “Inverted” Inversions?

Corporations and their “cunning” methods of avoiding taxation have been a talking point for a long time, with many being targets, recently, for governments worldwide. One such method, which has been brought to light, in event of recent developments, is Inversion.

Inversion deals are a way for companies to lower their tax burden by acquiring companies based in regions with low tax rates, and re-domiciling post the acquisition. Corporate tax rates in the US are currently set at 35%, and this has prompted several corporations to resort to inversion deals.

In fact, inversion deals in 2014 have soared to new highs. According to a recent news article in CNBC (which has derived the figures from Dealogic), M&A deals related to tax inversion had a combined total value of $315.3 billion (13 deals in total) by the end of the 3^rd quarter of 2014. For the same period in 2013, the number of inversion deals was to the tune of $71.7 billion.

A four-fold increase in attempts to escape taxes has clearly upset Uncle Sam, and this was evident when the Obama administration introduced new tax rules, which limited the economic benefits of inversion deals, on September 22. And the US government has ensured that any deals, which close on or after September 22 will be affected by these new rules, thereby sending a strong message to corporations.

Some of the key elements of the new rules are as follows:

•  A U.S. company will be prohibited from reducing its size pre-inversion by issuing extraordinary dividends just prior to launching an inversion.
• U.S. firms will be prevented from transferring assets to the newly formed foreign corporation that it spins off to its shareholders. 
• Companies will be prohibited from counting passive assets, such as cash & marketable securities, to inflate the foreign target's size, though financial institutions would be exempted.

Source: The Street (23/09/2014)

The repercussions were immediate. Upon hearing the news, AbbVie decided to terminate its $54 billion planned acquisition of Shire Pharmaceuticals, which would have been the biggest inversion deal in U.S. history, and which would have allowed AbbVie to relocate to the UK, thereby reducing its tax bills. AbbVie will now have to pay Shire approximately $1.6 billion in penalties as a result of the termination. Yet another US pharma giant, Salix Pharmaceuticals decided to terminate its acquisition of Italy’s Cosmo Pharmaceuticals SpA citing “changed political environment” for its change of heart. The new rules have also resulted in an increase in activity on K-Street. According to a recent report in Bloomberg, 41 companies have hired lobbyists on the issue, compared to a mere 14 in the previous quarter, a “desperate times call for desperate measures” situation.

So, now the pertinent question arises: Has the Obama Administration successfully killed Inversion M&A? Answer: Not Really!

Although the new tax rules successfully thwarted attempts by which MNCs can utilize cash stacked in their foreign subsidiaries without having to pay taxes on it, a method known as “hopscotch loan”, there are other ways through which corporations can still dodge taxes. One such strategy is the reason why banana giant Chiquita decided to go ahead with its acquisition of Fyffes and relocate to Ireland, according to a recent news article in the Huffington Post. This strategy, on which Chiquita will rely upon, is called “earnings stripping” whereby ChiquitaFyffes, the proposed parent company will provide loans to the US based Chiquita, and then write-off most of the US profits as interest payments on loans, which will remain tax deductible even under the new rules. Long story short, mission inversion still successful!

So although some trends, such as AbbVie’s case, indicate that Obama might have won round 1 in his fight against inversions, I have a feeling that with intense corporate lobbying, it would be the corporations who would deliver the final knockout punch!