September 23, 2014 / 4:28 PM / 3 years ago

New U.S. tax rules chill 'inversion' deal-making; shares dive

The Burger King logo is seen through a Tim Horton's doughnut hole in a photo illustration outside a restaurant in Toronto August 29, 2014.Chris Helgren

WASHINGTON/NEW YORK (Reuters) - Tough new U.S. government rules on corporate "inversion" deals, aimed at making the tax-avoidance transactions less desirable, undermined share prices in nearly a dozen companies on both sides of the Atlantic on Tuesday.

Analysts and tax lawyers were studying the damage to deals currently in the works and the outlook for future such deals, in which U.S. companies escape high taxes at home by shifting their domiciles abroad.

Although the new rules will make some deals costlier and others more difficult, fast-food chain Burger King Worldwide Inc BKW.N said it will proceed with its $11.5 billion transaction with Canada's Tim Hortons Inc THI.TO.

"This deal has always been driven by long-term growth and not by tax benefits," the two companies said in a statement.

Corporate deal-makers were surprised by harsher-than-expected changes to the inversions rulebook unveiled by the Treasury Department late on Monday. Inversions have surged this year and caused concern in Washington about the threat they pose to the U.S. corporate income tax base.

Rule changes include blocking what the Treasury dubbed "creative" strategies to move cash around or to bring overseas profits into the United States without paying U.S. taxes, and redefining inversions to make shifting tax domiciles more difficult.

Effective immediately, the rules will mean little for companies that have already inverted. But for at least 10 companies in the midst of completing deals, and for those considering inversions, the impact could be significant.

Tax experts said the rules would have the biggest impact on companies that invert to gain lower-cost access to unrepatriated profits, or earnings held overseas to avoid U.S. taxes.

Burger King was not in this situation, said Ken Kies, managing director of Washington tax lobbying firm Federal Policy Group. "It really depends on whether or not a favorable tax treatment of unrepatriated earnings was a key aspect of the economics of your deal," he said. "If it wasn't, then what they've done here won't have much of an impact."

Still, most pending deals could become more costly for the buyers. They include AbbVie Inc (ABBV.N) and its $54.7 billion deal to acquire Ireland's Shire Plc (SHP.L), as well as Medtronic Inc (MDT.N) and its $42.9 billion takeover of Covidien Plc COV.N.

Neither of those transactions, the biggest of the year, was expected to fall apart completely, partly because paying a break-up fee to walk away would likely be even more costly. AbbVie would have to pay Shire a $1.6 billion penalty if it were to renege on their merger agreement, for instance.

Medtronic has a contract that lets it or Covidien walk away from their deal if the U.S. Congress changes tax law. The Treasury’s new rules fall short of that, so a break-up fee likely would loom in this case, too, if the merger were called off.

Experts said companies would likely scrutinize the new Treasury rules for potential legal challenges, but that they could not count on the rules being overturned.

CHALLENGES POSSIBLE

With a grid-locked Congress failing to act, investors had been expecting an Obama administration clamp-down on inversions. But the rules it announced were farther-reaching than anticipated, analysts at Deutsche Bank said.

An inversion typically involves a U.S. company buying a smaller, foreign rival and reincorporating in its home country, where taxes are lower, opening a range of options for the combined business to lower its U.S. and global tax bills.

About 50 such deals have taken place since the early 1980s, but the pace has picked up, with half of them completed since the 2008-2009 credit crisis, according to a Reuters review.

One of the new Treasury rules will prevent inverted companies from using "hopscotch" loans that allow them to avoid dividend taxes when tapping tax-deferred foreign profits.

Another rule bars inverters from gaining access to offshore profits by using "decontrolling" strategies that restructure foreign units so they are no longer U.S.-controlled.

The Treasury is also tightening limits on the levels of ownership that former U.S. investors can retain in an inverted company for it to qualify for foreign tax treatment under U.S. law, a move that will make doing the deals more difficult.

Finally, new rules would restrict "skinny down" and "spinversion" restructuring strategies that companies use to try to get around existing restrictions on inversions.

The U.S. Treasury has acknowledged that one rule, which officials said was "relatively small," is broad enough to hit even companies that are not inverting. A senior official said some cash transfers from non-inverted foreign corporations to U.S. subsidiaries could now be taxed.

Treasury officials said any deals completed as of Monday were not affected, while deals completed later would be.

Legal experts said companies would have more leeway to challenge the rules if they had been applied retroactively, which the Treasury decided not to do. But the rules will still be scrutinized, said Eugene Scalia, a lawyer at Gibson, Dunn & Crutcher who has successfully challenged other federal rules.

"When a federal agency says it's acting because Congress won't, that always raises the question whether the agency has proper authority under current law," Scalia said.

Bankers and analysts said they expect more action on tax inversions from the Obama administration.

"This move is a good and necessary start toward discouraging corporate inversions, which cost U.S. taxpayers billions in lost revenue," said Thomas Hungerford, a tax expert at the Economic Policy Institute, a think tank.

SHARES DIVE

In London, AstraZeneca (AZN.L), which had been the target of a failed inversion bid by U.S. drugmaker Pfizer Inc (PFE.N), slid 3.6 percent. The Treasury rules were seen as possibly deterring Pfizer from making another bid after a $118 billion takeover attempt failed in May.

AbbVie closed down 2 percent in New York, while Pfizer, the biggest U.S. pharmaceutical company, dipped 0.4 percent. Burger King closed down 2.7 percent.

AbbVie officials had no immediate comment.

Other U.S.-listed issues under pressure from the Treasury actions included Abbott Laboratories (ABT.N), down 2.1 percent; Covidien COV.N, down 2.5 percent, and Medtronic (MDT.N), down 2.9 percent.

Additional reporting by Dan Burns and Alison Frankel in New York, Ben Hirschler in London, Lisa Baertlein in Los Angeles, Solarina Ho in Toronto, Jason Lange and Emily Stephenson in Washington; Editing by Leslie Adler and Dan Grebler

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