Multinationals now have had a few months to regroup and contemplate the practical impact of the new regulatory environment for inversions.
The US Treasury Department’s proposed new regulations (Notice 2014-52) aim to limit the tax benefits of these inversions, which involve an American company relocating its tax domicile to a lower rate jurisdiction via a takeover of a foreign entity.
Yet last month’s announcement by US-based broadband media technology company, Arris Group, and UK-based set-top box manufacturer, Pace, indicates that multinationals now appear ready to reengage in these transactions.
The Arris/Pace deal will redomicile the combined company in the UK, but the company will be run operationally in Arris’ hometown of Suwanee, Georgia. It is not certain how the touted non-tax synergies of the Arris/Pace deal will play out. But by redomiciling in the UK, Arris will, according to its own management, reduce (modestly) its non-GAPP tax rate to approximately 26%-28%.
We will not know, however, until a few more deals are announced (including the potential revival of the scuttled Monsanto/Syngenta deal) whether the proposed rules and market forces will work to permanently reduce tax-motivated inversion activity, or whether they will trigger the discovery of even newer ways to avoid taxes.
In the near-term, the proposed rules certainly make it more difficult for companies to execute tax-efficient inversions. For example, the new rules restrict the ability of the parties to artificially resize themselves before an inversion, and to engage in “creative repatriation” after an inversion.
Inversion activity, however, might wane due to a variety of other factors. First, the transactions themselves are taxable to the US company’s shareholders, a seldom-discussed incremental deterrent to inversions, especially if they may already be uncomfortable with the prospect of being diluted.
If they receive exclusively foreign company stock as consideration in the merger, they need to release other cash just to pay the taxes due. And while the dealmakers might include some kind of gross-up, this benefit will be allocated just for the insiders, which by itself may be a friction to the deal getting done.
It is also possible that US companies eventually may realise that they are better off reinvesting their overseas cash in their overseas subsidiaries, to exploit the market opportunities of a fully-developed overseas jurisdiction, such as the UK.
This thought must have occurred to UK lawmakers as they considered the costs and benefits of lowering their tax rates and converting to a territorial system of taxation. One “cost” for example, is that companies in a territorial system have the extra incentive to shift portable income-producing assets like intellectual property to even lower tax rate jurisdictions. As the global stakes increase in regulatory competition, the benefits of well-developed US state (even Delaware) corporate law may not keep US companies from fleeing, either on paper or by actually shifting their operations overseas.
An inversion is merely one tool that a company can use to lower its taxes. Companies have proven to be extremely adept at discovering new deal technologies to exploit the distorted incentives of previous iterations of the law. A new regulatory environment may squelch inversions, but not the ingenuity of the market to harness new distortions in its relentless pursuit to lower taxes and reduce regulatory costs.
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of The Economist Intelligence Unit Limited (EIU) or any other member of The Economist Group. The Economist Group (including the EIU) cannot accept any responsibility or liability for reliance by any person on this article or any of the information, opinions or conclusions set out in the article.
