What Are Inversion Deals?

Pharmaceutical investors may have first heard the term ‘inversion deal’ in reference to Pfizer (NYSE:PFE) and Allergan’s (NYSE:AGN) attempted merger last year. The plan was to move Pfizer’s headquarters to Ireland, Allergan’s home base, in order to avoid paying higher corporate taxes.
That deal fell through, thanks to controversial  legislation introduced by the US federal government. “We followed the rules that congress had set for companies looking to move to a foreign domicile,” Allergan’s CEO, Brent Saunders, told CNBC at the time. “For the rules to be changed after the game has started to be played is a bit unAmerican.”
But changed they were—which may have left some investors wondering: where do inversion deals stand now?

What are inversion deals?

First things first: what are inversion deals, exactly? It’s a sort of financial engineering, wherein a multinational company buys a rival in another country—one with lighter taxation. The company then reincorporates.
So why do American companies do it with such alacrity? Put simply, the states has some of the highest corporate tax rates in the developed world, with companies paying 35 percent tax on their domestic earnings. They also pay tax on income from foreign subsidiaries that comes back to America—which means those profits are effectively taxed twice.
But inversion deals don’t mean the company packs up and heads abroad. While some board meetings must take place overseas, the original headquarters often remains in use, and indeed, the locus of operations.
In other words, inversion deals often amount to nothing more than a move on paper. And as the White House’s official blog explains, this allows companies some continued benefits— “including access to US markets, rule of law, patent and intellectual property enforcement, support for research and development and—not least—American workers.”
“Big corporations are playing by a different set of rules,” Obama said in April 2016. “[…] So I am very pleased that the Treasury Department has taken new action to prevent more corporations from taking advantage of one of the most insidious tax loopholes out there, and fleeing the country just to get out of paying their taxes.”

The legal status of inversion deals

What was that new action? On April 4, 2016, the Treasury Department limited ‘earnings stripping.’ This term refers to how foreign-based companies move profits out of the states, thereby avoiding paying US taxes.
It’s accomplished by having an American affiliate pay interest on a loan from another affiliate, in another country—usually one with lower taxes. As such, the American affiliate’s profits appear reduced, while the recipient affiliate pays minimal tax on those interest payments.
In April 2016, the Treasury Department recharacterized some of these interest payments as dividends that cannot be deducted from a company’s overall earnings.
The Treasury Department also took steps to limit serial inversions or the process by which American companies follow each other in ‘moving’ abroad.
But inversion deals haven’t been outlawed completely—despite Former President Obama’s best attempts. Throughout his time in office, he repeatedly called on Congress to eliminate the loophole altogether.

Inversion deals under Trump

Trump has been lobbied to change the policy of the Obama administration on inversion deals, but the President-Elect was a vocal opponent of inversion deals while on the campaign trail.
Trump campaigned that American companies would have no reason to move abroad if tax structures were changed at home. As such, he advocated for majorly cutting the US corporate tax rate … all the way to 15 percent.
Since losing the fight for healthcare reform, Trump’s administration has lost some momentum from companies and the market. Especially the assumption he and Speaker of the House Paul Ryan won’t be able to achieve Tax Reform in the US. It is possible Trump might change on this matter to gain back the goodwill of companies.
“The market’s patience is wearing thin,” Vasileios Gkionakis, head of global FX strategy at Unicredit, told CNBC. “It definitely doubts the U.S. administration’s ability to push forward (with) this so much talked and discussed agenda including the fiscal stimulus, tax deregulation, tax cuts,” Gkionakis said.
He has also announced plans to provide a one-time tax incentive to American companies: bring home profits stashed abroad, and pay just ten percent tax. Johnson & Johnson (NYSE:JNJ), Amgen (NASDAQ:AMGN) and Gilead Sciences (NASDAQ:GILD) are just a few of the companies that could take up that offer—as Bloomberg reported, they are among those American businesses with the greatest holdings in overseas cash.
 
This is an updated version of an article originally published on Investing News Network on January 23, 2017.
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Securities Disclosure: I, Bryan Mc Govern, hold no direct investment interest in any company mentioned in this article.