Administration Focus Has Chilling Effect on Inversions

By Richard Rubin

Aug. 7 - If the Treasury Department was trying to scare investors away from corporate inversions by saying the U.S. would examine ways to stop the deals, it worked.

Stock markets punished companies pursuing inversions on Aug. 6, and investors have genuine reason for concern about the prospects for cross-border mergers that limit U.S. corporate taxes.

The policy landscape on inversions has shifted significantly since earlier this month, when U.S. lawmakers-deadlocked on tax policy-left Washington for a five-week break. The lack of congressional action and the Obama administration's reluctance to move on its own had given companies and investors confidence that pending deals wouldn't be affected by government action.

President Barack Obama said Aug. 6 that he wants the U.S. to act "as quickly as possible" to discourage inversions using whatever authority the government already has.

"We don't want to see this trend grow," he said. "We don't want companies who have up until now been playing by the rules suddenly looking over their shoulder and saying, you know what, some of our competitors are gaming the system and we need to do it, too."

As Congress bickered, Obama began speaking about inversions in late July, turning a corporate tax proposal buried in his budget into the centerpiece of a speech on the economy.

A former Treasury official outlined steps the government could take without Congress. And Democrats last month began pressing Obama and Treasury Secretary Jacob J. Lew for action.

Treasury Shifts Tone

With one statement Aug. 5, Treasury changed the market assumption that the government wouldn't act without Congress to stem inversion transactions.

"Treasury is reviewing a broad range of authorities for possible administrative actions that could limit the ability of companies to engage in inversions," the department said in a statement. Changes may include "approaches that could meaningfully reduce the tax benefits after inversions take place, to at least provide a partial fix."

Obama said the administration was reviewing how it interprets existing laws and that he wouldn't announce details "in dribs and drabs."

But experts told Bloomberg BNA that the Treasury's legal authority for administrative action could be a stretch.

"The arguments for Treasury regulation are based on laudable policy instincts," said Edward Kleinbard, a professor of law at the University of Southern California and former chief of staff of the U.S. Congress's Joint Committee on Taxation. "But they are very strained readings of the relevant regulatory authority." In fact, he said, those arguments would do more harm than good to "Treasury's ongoing relationship with Congress, and its ability to take courageous stands through regulation in the future."

Even without clarity on what powers Treasury might invoke, investors indicated that the U.S. possesses regulatory tools that could unwind the mergers or make them less attractive.

'Obscure' Provisions in Spotlight

The Treasury statement was a reversal for Lew, who had said July 16 that the government had scoured "obscure" tax code provisions and would be doing more if it could.

Tax lawyers say Treasury has constrained powers to make inversions less attractive. Its tools include limiting companies' access to foreign cash to finance the deals and making it harder for them to engage in earnings-stripping transactions that reduce their U.S. taxable income after the inversion is completed.

"If people don't think they have authority, they're wrong," said John Buckley, former chief tax counsel for Democrats on the House Ways and Means Committee. "Whether they'll exercise it or not, that's a different question."

The rules could affect at least eight pending inversions along with other companies considering similar deals. Depending on how the rules about earnings stripping are written, they could also affect companies such as Ingersoll-Rand Plc that inverted before the current wave.

Maintaining Pressure

Politically, the administration's statements maintain pressure on companies to consider the consequences of inversions even as it somewhat relieves Congress from taking quick action. For investors, the Treasury statement caused them to question whether the pending deals would face unforeseen hurdles.

The stock of companies involved in planned inversions-including AbbVie Inc., Medtronic Inc., Mylan Inc. and Shire Plc - fell as broader U.S. markets were little changed. The market reaction to Treasury's announcement came even though Treasury hasn't committed to doing anything and the U.S. government has said its tools are limited without legislation.

Walgreen Stays

For investors, the only thing worse than the risk of a canceled inversion is a deal that is actually canceled.

Walgreen Co. shares plunged after the drugstore chain opted against an inversion, citing opposition in Washington and potential Internal Revenue Service enforcement among its reasons. Walgreen said Aug. 6 that it would buy the portion of Alliance Boots GmbH that it doesn't already own without changing its address for tax purposes.

Walgreen, based in Deerfield, Ill., said a decision to shift its legal address out of the U.S. might have backfired because it could have been challenged under IRS tax-abuse rules. The largest U.S. drugstore chain warned of "almost certain, intense, protracted IRS scrutiny" that might have taken a decade to resolve.

Republicans Want Tax Revamp

The administration and Democrats propose to make it effectively impossible for companies to invert by buying smaller foreign businesses. They want to make the change retroactive to May, which would affect the Medtronic and AbbVie deals, among others.

Such legislation hasn't advanced, in part because Republicans want to address the issue through a broader revamp of the tax code and because they are concerned about retroactive changes.

 

With assistance from Tara Lachapelle and Zachary R. Mider in New York and Alex Wayne, Margaret Talev and Lisa Lerer in Washington

To contact the reporter on this story: Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at jschneider50@bloomberg.net  

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