Corporate inversions have constituted an active and successful part of the M&A market in 2013 and early 2014, as acquirors have typically traded up on the date of announcement. However, there is now a new urgency for U.S. corporations seeking to invert to identify merger partners and complete their transactions.
In an inversion transaction, a foreign corporation is interposed between a U.S. corporation and its shareholders, typically to allow the U.S. corporation to distribute the untaxed earnings of its foreign subsidiaries to the shareholders of the new foreign parent, or to reduce its future tax liability through deductible payments to the new foreign parent, each without U.S. tax. For example, in Endo Health Solutions’ 2013 acquisition of Paladin Labs, shareholders of Endo and Paladin exchanged their shares for those of a new holding company incorporated in Ireland, which will own the two companies as subsidiaries. This will allow Endo to reduce its effective tax rate from 28 percent to 20 percent, resulting in $50 million in annual tax savings.
Under the existing tax laws, tax-efficient inversions are possible only if the former shareholders of the U.S. corporation own no more than 80 percent of the combined company after the merger or acquisition.
In March 2014, however, the Treasury Department proposed to amend the anti-inversion rules, effective January 1, 2015, to permit tax efficient inversions only if the former shareholders of the U.S. corporation own no more than 50 percent of the combined company after the merger or acquisition – a change that would significantly reduce the possibility for corporate inversion transactions.
The prospects for the enactment of this proposed legislation in the current year are uncertain at best. But the completion of any inversion transactions by December 31, 2014, would avoid the application of the proposed amendment and any similar amendments that Treasury re-proposes in 2015 or later with the same effective date of January 1, 2015. As a result, inversion transaction activity may well accelerate as we approach the end of the year.
For this reason, U.S. corporations seeking to invert should identify potential merger partners and work to complete a transaction before the inversion rules are tightened.