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Jan 2015
14
January 14, 2015

Myths and Truths Regarding Inversion Transactions


Inversion transactions have received significant attention recently from the press and officials in Washington, D.C. Much of this discussion has occurred because of the growing number of such transactions being consummated or discussed by multi-national companies, including household names such as Burger King.

Many of the recently proposed or completed inversion transactions have occurred in the pharmaceutical industry, but the procedure is available to all companies and numerous corporations across many sectors have utilized it. The recent surge in these transactions has been reported as corporations allegedly wanting to beat any new or more restrictive legislation. Inversion transactions have been occurring for decades among non-pharmaceutical companies, but the current political and international tax oversight efforts have focused public attention on these transactions.

So what is an inversion transaction?  It is nothing more than an acquisition or merger where a U.S. company is combined with a foreign corporation and the foreign corporation becomes the successor, surviving or parent company. These transactions were dubbed inversion transactions by the U.S. Department of the Treasury over concerns about the flight of America’s corporate tax base to other nations.

For background, U.S. corporations are taxable on their worldwide income with deferral for active business income of foreign subsidiaries. In response to the concern of “base erosion” and “profit shifting” (BEPS), Congress enacted legislation to curb inversion transactions that were entered into for the primary or significant purpose of reducing a U.S. company’s exposure to the U.S. corporate income tax. Many of the transactions that were being cited as not having a proper business purpose resulted in a U.S. corporation being expatriated into a foreign corporation, where only the U.S. activities would be subject to the U.S. corporate tax.

Is an inversion transaction legal? Yes, but any inversion transaction will be subjected to all of the regulatory requirements of any other transaction, including U.S. tax laws. A transaction that is deemed to be an inversion will invoke some tax rules meant to eliminate or mitigate the reduction of earnings to the U.S. corporate income tax. Recent rules issued by the Treasury Department are an attempt to close some of the holes in the 2003 rules that are commonly called anti-inversion rules.

Basically, an inversion whereby the owners of a U.S. corporation continue to own more than 60 percent of the interests in the surviving or succeeding foreign corporation will have restrictions of the use of losses against income otherwise subject to U.S. corporate income tax. If the owners continue to own more than 80 percent of the surviving or succeeding corporation’s stock, the foreign corporation will still be treated as a U.S. corporation subject to the U.S. corporate income tax on its worldwide income.

The rules dictating whether a transaction is an inversion involve complex mathematical tests. A transaction that does not have the intention to be an inversion could accidentally fall into this trap. It is important to consider the ramifications of any type of acquisition or merger with a foreign corporation, including the possible application of the anti-inversion rules. Cross-border transactions involve complex tax considerations and the anti-inversion rules add to that complexity.

Until and unless federal tax reform fixes the underlying problems that encourage U.S. companies to reduce their exposure to the current corporate tax, any announcement of a transaction where a foreign corporation will be the survivor in a cross-border transaction will receive criticism and scrutiny from Washington D.C., and may even draw fire from activist shareholders.

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