AS THE US took tougher steps on Monday to limit the tax-cutting power of corporate inversions, analysts said the new rules m ight put a planned $160bn merger between Pfizer and Allergan in jeopardy.
The US treasury department said on Monday the rules would limit companies’ ability to participate in inversion transactions if they had already conducted them within the past 36 months. Allergan has been involved in several mergers in that time frame. In a corporate inversion, a US company merges with a smaller foreign firm and then transfers the new company’s tax address offshore.
Pfizer and Allergan were reviewing the treasury department’s announcement on Monday night, according to a joint statement from the companies. “Prior to completing the review, we won’t speculate on any potential impact,” the companies said.
The deal would probably fall apart, Citigroup analysts wrote in a note to investors.
“Pfizer will likely have difficulty extracting the primary benefit associated with the transaction,” said the analysts, Liav Abraham and Andrew Baum. The treasury rules provide “sufficient cause for the proposed transaction not to move forward”, they said.
Shares of Allergan fell 22% in trading before US markets opened yesterday, while Pfizer rose 2.5%.
At issue is the treasury’s plan to change how it calculates whether a cross-border merger is subject to anti-inversion penalties, which would limit much of an inversion’s tax benefits in cases where US shareholders wind up with 60% or more of the new firm.
As announced, the Pfizer-Allergan merger does not meet that standard; Pfizer shareholders would wind up with 56%, which puts the deal beyond the reach of the treasury rules. However, if the rule means that some of Allergan’s merger-driven growth since 2012 was not allowable, the ownership ratio would swing more towards Pfizer in the treasury’s analysis and the planned transaction would be rendered less beneficial for tax purposes.
“The real question is whether Pfizer reads (Monday’s regulations) as reason enough to not continue to pursue the deal,” wrote Umer Raffat, a senior analyst with Evercore ISI.
It is unclear whether the treasury department has the authority to enforce that change, although Mr Raffat wrote that he th ought the agency could change the way it interprets ownership percentages.
Also on Monday, the treasury announced new rules that would make it more difficult to engage in a tax strategy known as “earnings stripping”, which enables US subsidiaries of multinational companies to reduce their tax bills by issuing debt to their foreign parents. Under those rules, which would apply to related-party transactions after yesterday, certain securities of at least $50m that were previously considered debt will be at least partially treated as stock. That would make it more difficult for foreign companies to load their US units with related-party debt, according to a treasury news release.
“For years, companies have been taking advantage of a system that allows them to move their tax residences overseas to avoid US taxes without making significant changes in their business operations,” Treasury Secretary Jacob J Lew said. “We will continue to explore additional ways to limit inversions.”
Mr Lew called on Congress to adopt legislation aimed at inversions, as did White House Press Secretary Josh Earnest.
Analysts were scouring the treasury’s proposals on Monday evening for clues as to whether they would affect Pfizer-Allergan, which is scheduled to close later this year.
Allergan, which has a legal address in Dublin, began as Watson Pharmaceuticals, a small, New Jersey-based maker of generic drugs. In 2012, it bought Iceland’s Actavis and took that company’s name. The next year, it bought Warner Chilcott, and used the transaction to move its tax address abroad, while keeping its operating headquarters in the US. More deals followed, for Forest Laboratories, and Allergan. The resulting company took Allergan’s name last year.
Mr Lew told reporters on Monday: “Some companies are serial inverters.” He did not name names.
Under existing rules, when a US company merges with a foreign firm, US shareholders must own less than 80% of the new firm for it to be considered a foreign company for tax purposes. If the treasury disregarded the portion of Allergan’s growth attributable to previous inversions, its merger with Pfizer might not qualify, said Henrietta Treyz, an analyst at Height Securities.
“So the question for Pfizer is, can you still get over that threshold, and do you still want to do it?” Ms Treyz said.
Mark Schoenebaum, an analyst at Evercore ISI in New York, said the effect of the new rules would not be fully clear until Pfizer commented on the rule changes.
Inversions have become a political flash point, with presidential candidates, including Democrat Hillary Clinton and Republican Donald Trump promising to discourage
Democrats in Congress, welcomed the treasury’s announcement. Republicans have called for tackling inversions in the larger context of international tax reform, which would include lowering the 35% corporate income tax in the US that is among the world’s highest.