The Promise — and Perils — of Inversion Deals

Why everyone’s talking about these cross-border mergers

Corporate inversions have become the dominant means of making cross-border mergers — representing the majority of U.S. outbound deals announced in 2014. The basic premise of this type of transaction is that a buyer in the United States reduces its global tax exposure by finding a seller in another country with a lower corporate tax rate. Then the buyer “domiciles” itself in the seller’s country, either setting up new offices or taking over the seller’s facilities.

If your company is considering a cross-border merger, inversion methods could help you achieve strategic objectives while lowering your tax exposure. However, inversion deals are controversial enough that President Obama and many congressional leaders have spoken out against them.

Growing wave . . . of controversy

As of June 30, inversions accounted for 66% of 2014’s proposed U.S. outbound deals, according to Thomson Reuters. That’s up from just 1% in 2011. Many recent deals have been made between pharmaceutical manufacturers, but other buyers include media companies and manufacturers.

The merits of inversion deals have been debated for years. But the practice came to the attention of the general public when Burger King proposed an $11 billion acquisition of Canada-based Tim Hortons, a coffee-and-doughnut chain, this past summer. As part of the deal, Miami-based Burger King would move its corporate headquarters to Canada, which offers a lower corporate tax rate. Burger King management claimed that the move wasn’t a tax ploy but instead was designed to improve the chances that Canadian regulators would approve the deal.

Big savings

A primary allure of inversions is potential cost savings due to reduced tax exposure. Once domiciled in a new country, companies don’t have to pay the U.S. statutory tax rate of 35% on foreign earnings. What’s more, they can use cash from foreign sales without being subject to the high repatriation tax they’d pay as a U.S.-domiciled company. When Cleveland-based Eaton Corp. acquired Ireland’s Cooper Industries and relocated its headquarters to Ireland, Eaton stated that it expected to save $160 million a year.

There are other strategic reasons to do an inversion deal. As in Burger King’s case, an acquiring company may relocate to reduce its chances of coming afoul of antitrust laws. And occasionally, an inversion represents the culmination of a long-term strategic shift. If a buyer’s customer base is already primarily in its target company’s country or economic region, it can make sense to relocate via merger.

Government pushback

To avoid losing tax dollars, the IRS has proposed a rule that would require corporate buyers to already have at least 25% of their assets, income and employees in the country to which they’re moving. Also, foreign-owned sellers would have to be worth at least 20% of the value of their purchaser. (This latter provision is intended to end the practice of U.S. businesses merging with shell companies in so-called tax shelters such as Bermuda.)

Some legislators have called for an increase in these percentages, but others have proposed instead cutting U.S. corporate and repatriation tax rates to level the playing field. Considering that U.S. nonfinancial companies held nearly $950 billion of cash overseas at the end of 2013, avoiding the repatriation tax alone could be enough incentive to justify the headaches of moving headquarters across borders.

In September, the Treasury Department announced new regulations intended to reduce the tax appeal of inversion deals. They would strengthen requirements that U.S. companies own less than 80% of the combined company to benefit from the other country’s lower tax rates.

Weighing your options

Given the risks involved in inversion deals, such transactions aren’t for every business buyer. But for certain companies — for example, those that earn large amounts overseas and face substantial tax burdens for repatriated earnings — an inversion deal could be worth the challenges involved.

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