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It appears that the move by Warren Buffett-backed Burger King Worldwide Inc. (NYSE: BKW) to buy iconic Canadian fast food chain Tim Hortons Inc. (USA) (NYSE: THI) and relocate to Canada to lower its corporate tax rate was the straw that broke the camel's back when it comes to tax inversion deals.
One has to wonder whether the wily Mr. Buffett was not only trying to make money but doing his best to accelerate much-needed tax reform when he agreed to finance BKW's expansion into the northland...
Why Mergers Are on the Rise... and the Government's Attempt to Slow Them
Year to date, M&A volume has reached $2.4 trillion, the highest year-to-date level since $3.3 trillion in 2007 according to Dealogic. One of the factors that has contributed to this boom in mergers has been a flood of tax inversion deals.
Indeed the inversion pipeline is still strong. To counter the problem, the U.S. Treasury acted to make it much more difficult for U.S. companies to move their legal headquarters to lower-tax countries.
Whether the actual target of the new rules is inversions or tax reform, what happens next will impact us in an unexpected way.
Here is what we need to know to take maximum advantage...
To execute a tax inversion deal, a U.S. company must purchase a foreign company and the shareholders of the non-U.S. company must comprise at least 20% of the combined shareholders of the combined company. U.S. companies engaging in such transactions have been trying to avoid the developed world's highest corporate tax rate.
Recently these deals have been focused on the pharmaceutical and healthcare industries, and stocks in those industries took a dive after the Treasury released its new regulations on Monday. British pharmaceutical giant AstraZeneca Plc. (NYSE ADR: AZN), which had been the target of a failed inversion bid by U.S. drug maker Pfizer Inc. (NYSE: PFE), dropped 3.6%. AbbVie Inc. (NYSE: ABBV), which is involved in a $54 billion deal to buy Irish pharmaceutical giant Shire Plc. (Nasdaq ADR: SHPG), was down 1.9%. Covidien Plc. (NYSE: COV), an Irish company being bought by American medical device maker Medtronic Inc. (NYSE: MDT) was down 3%.
The Obama administration came out harder and faster than many expected. Realizing that it would be unable to get any action through a paralyzed Congress two months before mid-term elections, Treasury Secretary Jacob Lew called on his tax writers to draft regulations that will make tax inversion much harder and less profitable. The rules make several changes to current rules that are effective immediately for any deals that have not yet closed, which includes the Burger King deal.
First, Treasury closed a loophole that allowed a tax-free transfer of cash or property from a foreign subsidiary to the new foreign parent and moved to prevent companies from restructuring foreign units to access deferred earnings without paying taxes.
Second, Treasury banned so-called "hopscotch" loans that allow companies to avoid taxes on repatriated foreign earnings by making loans to a new foreign parent company created in a tax inversion deal.
Third, it attacked techniques that allowed companies to meet the condition that a U.S. business can invert only if the new company has foreign ownership above a 20% threshold. Previously, companies were able to finesse this requirement by reducing their size prior to completing the merger but the new rules prohibit them from doing so.
Fourth, the new rules prevent companies from engaging in "spinversions" whereby they invert themselves and effectively relocate to a lower cost jurisdiction by shifting assets to a foreign entity and then spinning it off to shareholders. Such a spin-off will now be counted as a U.S. company subject to U.S. corporate tax rates.
The new rules are of course meant to temper enthusiasm for tax inversion, but the "tax" problem is more complex. What's needed to stem the inversion flow is a more focused look at our overall corporate tax policies. It's all on the table, but here's what we're missing...
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.