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Thursday, 23 October 2014

Wartime marriages

Tax-arbitrage M&A requires a deep discount

Tax-arbitrage M&A requires a deep discount. U.S. companies seeking to relocate by mergers in a bid to slash how much they remit to Uncle Sam were a big part of the $1.8 trillion first-half deal boom. The benefits of such ill-conceived combinations will be fleeting, though. The more so-called inversions there are, the more likely the law is to change.

The healthcare sector, where the effort to find a new domicile is most prevalent, already has clocked in with $319 billion of announced transactions, exceeding the full-year record of $275 billion in 2007. That sum doesn’t even include Pfizer’s $119 billion attempt to buy AstraZeneca, which aroused the interest of U.S. lawmakers.

Studies suggest that even the best-intentioned mergers, especially cross-border examples, often destroy value. Some recent ones, including Medtronic’s plan to acquire Covidien and its Dublin headquarters, can’t generate enough cost savings – or strategic logic – to offset the hefty premiums involved. That means the ostensible tax savings are the only advantage – and sometimes those aren’t even entirely clear.

If lawmakers were, say, to reduce U.S. corporate tax rates from 35 percent to 25 percent, exclude profits earned overseas from U.S. tax, and allow funds to be brought home at a 10 percent tax rate, many of the benefits of inverting would erode. Such legislation also would probably be drafted to be revenue neutral, thus making it harder to hide earnings overseas.

Other small changes could make a difference, too. One inversion technique is for the U.S. operation to borrow from its newly owned overseas counterpart. The interest payments are tax deductible in the United States and get booked as profit in a lower-tax jurisdiction. A company can offset half its earnings this way, perhaps shaving 10 percentage points from its tax rate. Cut the allowable proportion to a quarter, and it’s a less valuable tool.

Such arrangements complicate deals, too. New subsidiaries have to be set up to hold intellectual property and other assets in favorable domiciles. The legal structures involved can take years to implement. Expectations, meanwhile, are growing that some kind of U.S. corporate tax reform will pass within three years. It would swiftly invert the power of inversions.

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Context News

In the first half of 2014, there were $1.8 trillion of announced M&A transactions worldwide, the highest level since 2007, according to preliminary figures from Thomson Reuters on June 30. There were $319 billion of deals in the healthcare sector, which surpasses the record $275 billion for all of 2007.

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