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Tax rule changes put to quick test as Burger King 'inversion' advances

Burger King Worldwide’s deal to buy Tim Hortons and move its address to Canada will proceed, a day after the U.S. Treasury Department announced plans to crack down on corporate inversions.

Scott Bonikowsky, a Tim Hortons spokesman, said the deal is “moving forward as planned” and is driven by long-term growth and not tax benefits. The actions to curb inversions announced Monday by Treasury Secretary Jack Lew are getting an immediate test as eight U.S. companies with pending deals decide whether to continue moving forward.

“These rules do not strike anything like a mortal blow to the pending deals,” Robert Willens, a corporate tax consultant in New York, wrote to clients Tuesday as he assessed the likelihood that Medtronic and AbbVie will complete their pending mergers. “Such deals should proceed to completion without missing a beat.”

Companies with unannounced deals may be reconsidering their plans, particularly if the benefits would stem from access to U.S. companies’ foreign earnings.

“It potentially changes in a meaningful way the financial calculus that merger partners are going to undergo as they look at inversion,” Neil Barr, co-head of the tax department at Davis, Polk & Wardwell in New York, said in an interview Tuesday. “The needle appears to have moved pretty meaningfully.”

Lew’s goal was to have companies reconsider inversion deals they’re already working on. He also left open the prospect of future action aimed at earnings stripping, the post-inversion transactions that companies use to reduce taxes on U.S. income.

“This action will significantly diminish the ability of inverted companies to escape U.S. taxation,” Lew told reporters on a conference call Monday. “For some companies considering deals, today’s action will mean that inversions no longer make economic sense.”

A wave of inversions caught lawmakers’ attention this year when large U.S. companies including Pfizer and Walgreen explored transactions and Medtronic, AbbVie and Burger King moved forward with deals.

Not retroactive

The new rules, which will apply to transactions that close starting Monday, include a prohibition on “hopscotch” loans that let companies access foreign cash without paying U.S. taxes. They also curb actions that companies can use to make such transactions qualify for favorable tax treatment.

The changes will have the biggest effect on the eight U.S. companies with pending inversions, including Medtronic and AbbVie, which plan the two largest such deals in U.S. history.

In its purchase of Covidien, Medtronic plans to lend some of its untaxed profits outside the United States to its new Irish parent company. That transaction may be penalized by the hopscotch rule.

Treasury’s actions may raise Medtronic’s cost of financing without imperiling its deal or AbbVie’s, Willens said.

Treasury stopped short of making the rules retroactive to deals that have been completed. Companies already reaping the benefits of a foreign tax address will face minimal changes except for the risk of a second round of Treasury rules affecting maneuvers known as earnings stripping.

Writing regulations aimed at earnings stripping, which analysts had expected could be part of the first wave of Treasury action, can be a difficult exercise. The government will be trying to curb abusive transactions without hurting all foreign-based companies operating in the U.S.

Henrietta Treyz, an analyst at Height Securities, said Treasury is leaving open the possibility of future action to maintain pressure on companies.

Obama and Lew have urged Congress to pass a bill that would curtail inversions. When Congress left Washington for campaign season without acting, the administration did.

“While the administration’s actions are an important step, only Congress can fully close the tax inversion loophole,” Sen. Carl Levin, a Michigan Democrat, said in a statement. “Congress should act promptly when we return to eliminate this tax dodge.”

Treasury will release the formal regulations later. In keeping with past practice, the announcement served as a detailed notice of the government’s plans.

‘Plug a leaky boat’

The changes may cause complications for companies including Medtronic that are counting on the benefits of tax-free access to foreign cash. Another deal involving Horizon Pharma closed on Sept. 19.

Medtronic said in a statement Monday, “We are studying Treasury’s actions. We will release our perspective on any potential impact on our pending acquisition of Covidien following our complete review.”

Kenric Tyghe, a Toronto-based analyst with Raymond James, said it’s unlikely the changes proposed in the U.S. would affect the Burger King-Tim Hortons deal.

David Woollcombe, a Toronto-based partner at McCarthy Tetrault, said he doesn’t see the regulations having much effect on deals or potential deals that are driven by a strong strategic rationale, as opposed to tax arbitrage.

The changes proposed will apply to pending and future deals and will likely diminish the tax advantage that U.S. companies have sought from an inversion, he added.

“They are trying hard to plug a leaky boat with a series of stopgap measures, as the prospect of meaningful U.S. tax reform in the short term is very low,” Woollcombe said in an email. “The Democrats need to be able to point to some action having been taken in advance of the mid-term elections as inversions have become a political lightning rod.”