The Latest Trend: Inversions via M&A

May 12, 2014

As of late, there has been an increased trend of US corporations reincorporating in foreign jurisdictions, including Ireland in particular, along with the Netherlands and Canada, by way of business combination transactions. These transactions are motivated in part by a desire to reduce global effective tax rates.

While a US company cannot avoid the application of the anti-inversion rules of Section 7874 of the Internal Revenue Code (the “Anti-Inversion Rules”) by merely reincorporating abroad, under certain circumstances, it is possible to mitigate the impact of these rules where a reincorporation is accomplished via a merger or similar transaction whereby the US company becomes a subsidiary of a foreign-based holding company.

Inversion transactions tend to involve the combination of a US public company with a foreign publicly traded merger partner. The form of the transaction varies significantly, but typically involves a merger with the US public company and an analogous transaction with the foreign merger partner, typically a scheme of arrangement or even an EU cross-border merger.

In their current form, the Anti-Inversion Rules apply differently, depending on certain ownership thresholds:

  • If the former shareholders of the US company own less than 60% of the new foreign holding company post-transaction, the Anti-Inversion Rules generally will not apply at all and the new foreign parent of the combined companies will be respected as a foreign corporation for US tax purposes.
  • If the former shareholders of the US public company own at least 60% but less than 80% of the new foreign holding company post-transaction, under the Anti-Inversion Rules, the new foreign parent will be respected as a foreign corporation for US tax purposes, but the use of US tax attributes of the US company to reduce US tax on certain transactions or restructurings related to the inversion will be denied. In addition, certain stock-based compensation held by insiders will be subject to a 15% excise tax.
  • Finally, if the former shareholders of the US company own 80% or more of the new foreign holding company post-transaction, the new foreign parent generally will be treated as though it were a US corporation for US tax purposes.

Regardless of these ownership thresholds, the Anti-Inversion Rules will not apply at all if the combined companies have substantial business activities in the country of organization of the new foreign parent. However, under the current regulatory articulation of this standard, this exception is available only in rare circumstances.

The potential favorable tax consequences from reincorporating a US company in a foreign jurisdiction include (i) eliminating the constraints the US controlled foreign corporation rules may impose on the US company’s ability to defer US taxation of its foreign profits, (ii) an ability, through leverage or other intercompany transactions, to reduce the US company’s US taxable income post-transaction, and (iii) greater flexibility in planning to minimize the effective tax rate on the combined group’s non-US operations. These favorable tax consequences must be weighed, however, against the immediate tax consequences of the inversion to the US shareholders of the US company (any gain realized in the transaction generally is taxable to them) and various post-transaction corporate governance considerations arising from the fact that the affairs of the new foreign parent company will not be governed by US corporate law.

While tax considerations may make an inversion by way of a merger attractive, US public companies considering such a transaction should weigh carefully the potential downsides of such a transaction, such as whether the new combined company will be able to utilize US style anti-takeover defenses in the context of a potential future takeover threat. For example, the United Kingdom (through a combination of the Companies Act 2006 and the City Code on Takeovers and Mergers) does not permit staggered boards of directors or other “frustrating actions” in response to a hostile bid, and even Canada, whose corporate law resembles US corporate law in many respects, does not permit a board of directors to indefinitely maintain a “poison pill” shareholder rights agreement in the face of a hostile bid. For a US public company with competitors larger than itself, it would be advisable to assess whether an inversion might expose the new foreign parent to the risk of a hostile bid from a larger competitor that would be difficult to defend against without the use of US style defensive measures.

It is unclear whether the ability to avoid the application of the Anti-Inversion Rules through an inversion taking the form of a merger with an existing foreign company will last for long. Proposals have been made to further broaden the scope of these rules in ways that would prevent many of the transactions currently under way from accomplishing their tax objectives. In light of these proposals, there may be an incentive for more US companies considering an inversion transaction via merger to move forward with their plans sooner rather than later so as to ensure that their transaction will be subject to the current version, not a more stringent version of the Anti-Inversion Rules.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Robert Fisher, an O'Melveny partner licensed to practice law in California, Luc Moritz, an O'Melveny partner licensed to practice law in California, Paul Scrivano, an O'Melveny partner licensed to practice law in New York and California, Sarah Young, an O'Melveny associate licensed to practice law in New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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