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US Tax Inversion Planners Respond To Treasury Measures

Wednesday, October 8, 2014

The non-legislative measures put forward by the Treasury Department on September 22, to deter multinationals from using corporate inversions to move their tax residence abroad and move away from the high United States tax rate, have so far produced a mixed bag of results.

The measures are aimed at preventing the methods by which inverted companies access a foreign subsidiary's unrepatriated earnings while continuing to defer US tax, and, in particular, at stopping "hopscotch" lending, whereby low-interest loans skip over that subsidiary's US parent to go directly to a foreign company. The measures also included strengthening the methodology for calculating whether a company's former owners of the US entity owns less than 80 percent of the new combined foreign entity, as is required to qualify as a tax inversion.

However, while Treasury has succeeded, for example, in making Medtronic Inc's USD42.9bn deal to acquire Dublin-based Covidien Plc, and move its tax residence to Ireland, more expensive, it has not stopped the transaction.

Medtronic announced on October 3 that it now "intends to use approximately USD16bn in external financing to complete the acquisition of Covidien," and that it still "expects the transaction to close in late 2014 or early 2015."

As financing for the transaction will be secured from the capital markets, rather than from the USD13.5bn cash reserves held by its foreign subsidiaries, the company has confirmed that, going forward, its ratio of gross debt-to-earnings will be worse than under its previous plans. This could also have some effect on the group's credit rating.

However, Medtronic has also emphasized that, despite the additional expense of the new financing, the previously expressed strategic benefits of the transaction for Medtronic remain clear; the deal will expand its portfolio of innovative products and services, and drive more value and efficiency in its healthcare products, with a presence in more than 150 countries.

Another US healthcare corporation, Salix Pharmaceuticals, has announced that it will pull out of its planned inversion with the Irish subsidiary of Italian company Cosmo Pharmaceuticals SpA, despite having to pay a USD25m termination fee.

Salix stated that it had "believed the combination would generate significant value for our stockholders through the addition of key products to our development pipeline and a more efficient corporate structure that would enhance our profitability. Since then, however, the changed political environment has created more uncertainty regarding the potential benefits we expected to achieve."

There has been no indication, as yet, as to the measures' impact on another high-profile inversion involving Mylan Inc's agreed acquisition of some of Abbott Laboratories's non-US businesses and a move of its tax residence to the Netherlands.

It has been pointed out, however, that Mylan does not have the large foreign cash reserves that are a factor in other deals. Mylan had said the transaction would have significant benefits in diversifying the company's business, strengthening it in its largest markets outside of the US, and providing new opportunities for growth. It has also indicated that its tax rate can be expected to be lowered "to around 20-21 percent in the first full year, and to the high teens thereafter, enhancing the company's competitiveness."

In a further separate development, Civeo Corporation has announced that, after an assessment of structural alternatives for the company, it has decided to continue as a corporation and execute a "self-directed redomiciling" of the company to Canada, rather than, as had been expected, convert to a real estate investment trust (REIT).

Civio, which mainly provides temporary and long-term housing for workers in Canada and Australia, said that it more than qualifies for a redomiciling under the US tax code, with "substantial business activity" in the relevant jurisdiction, Canada. The Treasury's recent actions to rein in inversions cannot be expected to affect those plans, which the company expects to complete over the next six to nine months.

Domiciling the company in Canada is expected to achieve a tax rate of approximately 25-26 percent, 4-5 percent lower than the expected rate under a REIT structure, under which it would have suffered high initial costs and increased borrowings.

REITS have been touted as an alternative to inversions. They do not pay corporate tax as long as at least 75 percent of their total assets are "real estate assets" and/or cash; at least 75 percent of gross income come from real estate-related sources; and at least 90 percent of their taxable income is distributed to shareholders annually in the form of dividends.

The possibility of using a REIT to reduce a company's tax rate has increased since the Internal Revenue Service began, over the last year, to accept more non-traditional real estate assets as qualifying for inclusion in such trusts.