Post-Inversion-Rule World: The State of Corporate Transactions

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By Allyson Versprille

Companies are facing penalties and adjusting their tax strategies, as they navigate a 2016 package of IRS rules cracking down on corporate inversions.

The anti-inversion regulations “make it more likely that a transaction will be treated as an inversion” even if it doesn’t look like one “on its face,” Joe Calianno, a tax partner in BDO USA LLP’s Washington office, told Bloomberg BNA.

It’s easy to fall into an “accidental inversion,” so tax advisers need to be more careful when scrutinizing potential cross-border mergers and acquisitions for clients, Calianno said.

The Treasury Department and the Internal Revenue Service took steps to cut down on inversions beginning in 2014. The issuance of an anti-inversion regulations package, including final, temporary, and proposed rules, in April 2016 was a pivotal moment in the Obama administration’s crackdown. The rules are intended to stop companies from moving their tax addresses overseas to shrink their U.S. tax bills.

It’s unclear if President Donald Trump will pare down the Obama-era regulations or maintain the status quo. Regulations from the 2016 package designed to prevent multinational companies from “stripping” income out of the U.S. through loans to subsidiaries are being reviewed by the new administration.

Potential changes made through tax reform—such as lower corporate rates and a shift from a worldwide to a territorial tax system—could help determine whether a stricter stance on inversions is necessary.

Although the Obama administration’s anti-inversion rules have only been in place for a short while, recent real-world examples can shed light on how companies are adjusting.

1. Chilling Effect

The anti-inversion regulations have, for the most part, had their desired effect of halting inversion activity, tax consultants and a professor of accounting told Bloomberg BNA.

Pfizer Inc. and Allergan Plc aborted a $160 billion merger—which would have been the largest inversion in U.S. history—shortly after the IRS released the 2016 anti-inversion regulatory package.

The package included regulations under tax code Section 7874 (T.D. 9761). Under the rules, companies have to take into account new adjustments that may increase the ownership percentage of former shareholders of a U.S. company in a foreign acquiring company, which could lead to inversion penalties. The IRS also issued a set of inversion rules (T.D. 9812) in January that made tweaks to the temporary regulations issued in the April 2016 package.

With the 2016 Section 7874 rules, the IRS issued the earnings-stripping rules under Section 385 that drew criticism from multinationals and Republican lawmakers. The rules became final (T.D. 9790) in October 2016.

“We haven’t seen a whole lot of inversions since those regulations were put into place,” said Jim Seida, an associate professor in the Department of Accountancy at the University of Notre Dame’s Mendoza College of Business.

The Congressional Research Service said in an Aug. 17 report that recent Bureau of Economic Analysis data indicates that acquisitions by foreigners in 2016 fell by 15 percent from 2015. “Some of the largest declines were in countries associated with inversions, such as Ireland, where acquisitions fell from $176 billion to $35 billion,” the CRS said.

Seida said the earnings-stripping rules are especially effective at deterring inversion activity because they eliminate one of the primary sources of tax savings that companies used to get from inversions.

2. Penalties

A recently completed transaction between Palo Alto, Calif.-based Hewlett Packard Enterprise Co. and U.K.-based Micro Focus International Plc is facing penalties under the anti-inversion regulations.

HPE on Sept. 1 announced completion of the transaction, which involved a spinoff and subsequent merger of the company’s software business with Micro Focus.

Immediately after the merger, HPE stockholders held 50.1 percent of Micro Focus’ ordinary shares on a fully diluted basis, according to a Sept. 1 news release.

In the month leading up to the merger’s completion, Seattle SpinCo Inc.—HPE’s spun-off software business—said the transaction is expected to violate an ownership test in the anti-inversion rules. The rule kicks in when former shareholders of an acquired U.S company own 60 percent or more of the new foreign parent’s stock.

The former Seattle SpinCo shareholders are expected to cross that 60 percent ownership threshold because of adjustments required by the anti-inversion rules.

“Accordingly, the limitations on the utilization of certain tax attributes (including net operating losses and certain tax credits), and the adverse consequences under the Temporary Section 7874 Regulations, are expected to apply to Micro Focus and its U.S. affiliates,” Seattle SpinCo said in an August filing with the Securities and Exchange Commission.

The transaction seems to have avoided the worst penalty under the anti-inversion rules, which would transform Micro Focus into a domestic corporation for U.S. federal income taxes purposes. This rule applies if the ownership percentage meets or surpasses 80 percent.

Based on the terms of the merger and certain “factual assumptions,” the former Seattle SpinCo shareholders aren’t expected to be treated as owning 80 percent or more of Micro Focus, the SEC filing said. However, the IRS could disagree with that conclusion, the filing said.

A Micro Focus spokeswoman told Bloomberg BNA that circumstances haven’t changed since August.

3. Choosing Best Option

Companies may want to consider possible ownership percentage adjustments when deciding what types of transactions to engage in.

Huntsman Corp. subsidiary Venator Materials Plc—the company’s pigments and additives division—in May filed for a $100 million initial public offering, just weeks before Huntsman announced plans to merge with Swiss company Clariant AG. The IPO—launched in July—was used to split off the pigments and additives business in lieu of the spinoff that Huntsman originally planned to use.

Practitioners who previously spoke to Bloomberg BNA said the IPO was a smart decision because in conjunction with the Clariant merger, the Venator spinoff probably would have been taxable. The IPO is also a wise move due to ownership percentage adjustments that may have been required under the anti-inversion rules had the company used a spinoff, said Robert Willens, president of tax and consulting firm Robert Willens LLC in New York.

“If you do a spinoff, you’ve made what’s called a non-ordinary course distribution,” Willens said.

“The inversion rules require a recalculation of the ownership percentage in the ensuing inversion to take into account these non-ordinary course distributions,” and a spinoff “would clearly have been a very large non-ordinary course distribution,” he said. “That, in turn, would have almost certainly increased the ownership percentage of the Huntsman shareholders in Clariant—probably above 60 percent and maybe” close “to 80 percent for all we know,” Willens said.

An IPO, on the other hand, isn’t a non-ordinary course distribution and wouldn’t require any recalculation of the ownership percentage, he said. By using an IPO, “they have absolute certainty that the ownership percentage is way below the threshold, and therefore all of the benefits of an informal—as opposed to technical—inversion would be available to them.”

A Huntsman spokeswoman told Bloomberg BNA that the decision to do an IPO instead of a spinoff wasn’t driven by the new tax inversion rules. It “was viewed as the best opportunity to maximize value for our shareholders,” she said in an email.

4. Tweaking the Calculus

Seida said the anti-inversion rules have “undoubtedly” changed the calculus for a company deciding whether to engage in a cross-border merger or acquisition.

The rules reduce the amount of tax savings that companies can get from an inversion, he said. What hasn’t changed is the tax that shareholders typically bear in an inversion situation, Seida said. Under IRS rules, if the former shareholders of an acquired U.S. company own more than 50 percent of the new combined company, exchanging the old stock for the new stock can trigger capital gain.

Shareholder taxes have proven to be a headache for some companies. Shareholders of medical device company Medtronic Inc. are suing the company over taxes on capital gains incurred after the company completed its 2014 inversion with Irish Covidien Plc. The Minnesota Supreme Court in August ruled that the shareholders may proceed with the capital gains tax claims.

U.S. credit card processing company Vantiv Inc. recently decided against an inversion-type transaction with Worldpay Group Plc because of the adverse tax consequences to certain shareholders. Instead, the company in August secured a deal to buy its U.K.-based rival for about $10.4 billion. Vantiv and Worldpay shareholders are expected to own about 57 percent and 43 percent, respectively, of the combined company’s shares once the merger is complete.

In theory, Vantiv could have structured an inversion that would have kept its shareholders below the 60 percent ownership threshold at which the anti-inversion penalties take effect. But in an August SEC filing, Vantiv cited both shareholder-level taxes and the possibility that an inversion wouldn’t offer “significant value enhancement” as reasons for remaining U.S.-domiciled for tax purposes.

Willens told Bloomberg BNA shortly after the decision was announced that this was the first time he had seen a company perfectly capable of structuring an inversion forgo that opportunity because it would subject its shareholders to tax. In the past, most companies have taken the stance that the long-term corporate tax benefits of inverting outweigh the initial burden on shareholders, he said.

The company’s statements may suggest that the new anti-inversion rules are changing the old equation, Willens said.

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

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