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Allergan (NYSE: AGN) and Pfizer (NYSE: PFE) could structure a deal that would comply with the US Treasury’s new anti-inversion notice, according to US-based tax specialists.
On 19 November, the Treasury Department issued new proposed rules to deter US companies from moving their headquarters to lower-tax jurisdictions.
The notice, along with comments from Treasury Secretary Jacob Lew, come as US-based Pfizer and Ireland-based Allergan hammer out the final details of their proposed merger. A number of other inversion deals are pending or expected.
The full rules for the restrictions had been eagerly awaited by dealmakers anxious to assess the impact on deals that are inflight.
Both an EU-based tax attorney and a US-based banker thought an obstacle to a deal between Pfizer and Allergan could be the Treasury’s “substantial business test” requiring that 25% of the post-merger business must be based in the home country of the foreign parent company.
This test was previously applied to determine that an inverting company would be considered a US company if 25% of employees, their compensation, the assets or the income is derived from the US. The latest rules require the merged entity to be a tax resident of the country of the foreign parent, essentially flipping these criteria.
“They couldn’t do this,” the EU-based tax inversion lawyer said, regarding Pfizer’s ability to overcome that test.
The newly issued rules note that Section 7874 of the Internal Revenue Code grants the Secretary “authority to prescribe the regulations as may be appropriate to determine whether a corporation is a surrogate foreign” entity.
But advisors pointed out the over-arching ownership requirement – that places restrictions on US inverting companies owning 60-80% of the merged entity – should mean that the Pfizer/Allergan transaction can be crafted in such a way as to escape the new tightened rules.
A third US-based tax attorney pointed out that Pfizer could structure a deal with a 30% premium to Allergan’s trading value, which would result in Pfizer owning 59% of the combined entity and thereby circumvent the Treasury’s substantial business test.
Alex Mostovoi, director of tax at Focus Financial Partners, thought there could be even more leeway to avoid the rules in terms of their impact on the Pfizer-Allergan deal.
As part of the combination with Allergan, Pfizer will acquire some valuable drugs, but could also repackage and sell some unwanted assets, Mostovoi said, a move that would fit with Pfizer’s publicly stated consideration of a plan to split the company. “When you take this aspect of the transaction into account, it will provide a lot of flexibility in dealing with the new inversion requirements, including the 25% test.”
A healthcare banker agreed the new rules will not prevent a deal between Pfizer and Allergan.
“I think the deal goes through,” the banker said. The EU-based lawyer and the banker pointed out, however, that politicians do not want to see Pfizer’s tax revenues leave the country. The lawyer added that if Pfizer does manage to invert, competitors could follow suit.
Peter Schuur, a tax attorney at Debevoice & Plimpton, said the notice is not transformative. More than anything, it is a tightening up of Treasury’s previous notice from September 2014. “People are a little surprised the government didn’t go further,” he said.
The highlight of the 19 November notice was that a firm cannot buy a foreign company in an inversion and relocate that company to a third country, according to Bill Dantzler, a tax lawyer at White & Case.
Although the notice was aimed at chilling inversion activity, the new rulemaking announcement is “a stretch on [Treasury’s] authority,” Dantzler said.
In an interview, a Department of Treasury official responded that the department had closely reviewed and considered the new notice. “We think that our authority is clear to take these actions,” the official said.
The department is accepting comments on the 19 November notice, and there is currently no projected end-date to the comment period. “We don’t have a timeline on when the proposed regulations will come out, but it’s something we’re working on,” the official said.
Notably, Treasury still has not issued regulations to implement its September 2014 notice on inversions. Those regulations are expected “in the coming months,” the official added.
The third US-based tax attorney pointed out that based on the new rules for companies of a similar size, tax inversion deal-making is likely to continue. This attorney thought that new guidance on earnings stripping, the process where a company moves earnings from a high tax jurisdiction to a lower one often through subsidiary loans, would be more meaningful.
As Secretary Lew noted in his comments, “This is an important step, but it is not the end of our work. We continue to explore additional ways to address inversions — including potential guidance on earnings stripping — and we intend to take further action in the coming months.”
Treasury media affairs did not comment.
by Ryan Lynch in Washington DC, Dane Hamilton and Bhavna Kaul in New York and Lucinda Guthrie and Eunice Ng in London
As seen in the mergermarket newsletter on 20/11/2015