By Dalia Deak
The Treasury Department published regulations on Monday that took aim at corporate inversions – and, they hit their mark. Two days later, the merger of pharmaceutical giants Pfizer and Allergan, the largest planned inversion in history of the pharmaceutical industry, fell through.
The temporary and proposed regulations put forth on Monday make it more difficult for U.S.-parented multinational groups to change their tax residence to a low-tax country. This practice, the Treasury noted, is typically not to grow the underlying business or pursue other commercial benefits that may arise, but primarily to reduce their taxes. Companies will often follow up corporate inversions with another tactic—earnings stripping. This is where the company will seek to further minimize U.S. taxes by paying deductible interest to the new foreign parent or its affiliates in the low-tax country.
Specifically, the regulations attempt to curb inversions and earnings stripping by doing the following:
- Limiting inversions by disregarding foreign parent stock attributable to certain prior inversions or acquisitions of US companies (under section 7874);
- Targeting transactions that increase related-party debt that does not finance new investment in the US (under section 385); and
- Allowing the IRS on audit to divide a purported debt instrument into part debt and part stock (under section 385).
Monday’s regulations also follow the overall trend in the Treasury’s attempt to curb the practice, with guidance published in September 2014 and November 2015 designed to make corporate inversion more difficult and less profitable.
President Obama, during the White House press briefing on Wednesday, commented on the Treasury’s regulations, praising the new regulations and indicating that these companies “effectively renounce their citizenship… declare that they’re based somewhere else, thereby getting all the rewards of being an American company without fulfilling the responsibilities to pay their taxes the way everyone else is supposed to pay them. “
The Pfizer/Allergan deal, which would have saved Pfizer an estimated $1B annually, was called off early on Wednesday with a press release from Pfizer specifically citing the new regulations as the cause. Previously, Pfizer and Allergan had determined that their deal would be able to pass based on previously proposed thresholds. However, the new regulations qualify as an “Adverse Tax Law Change” under the merger agreement, and the companies mutually agreed to terminate the merger as a result.