Ajay Gupta
2/9/2016
“I will build a great, great wall on our southern border. And I will have Mexico pay for that wall," Republican presidential hopeful and front-runner Donald J. Trump said in his announcement speech last June.
Turns out the inevitable Democratic nominee, Hillary Clinton, would also build a great, great wall. Unlike Trump’s wall, hers would not deter foreign individuals lacking proper documentation from coming into the country. Instead, it would dissuade U.S. corporations stuck with domestic charters from leaving. And she would have U.S. investors and workers pay for that wall.
Reacting to the news that U.S. drug giant Pfizer Inc. would combine with the Irish manufacturer of Botox, Allergan PLC, in a $160 billion deal and invert to Ireland, Clinton unveiled a plan to stop “inversions and transactions like Pfizer’s.”
Among the steps she outlined was an “exit tax” on the deferred offshore earnings of departing U.S. multinational corporations. Presumably, the tax would be imposed at the full 35 percent corporate rate on all such deferred offshore earnings of any U.S. corporation that merges with or is acquired by a foreign company, whether in a friendly or hostile deal, and regardless of the U.S. corporation’s shareholders’ percentage ownership interest in the surviving foreign corporation.
In addition, unless that percentage is less than 50 percent, she would disregard the attempted expatriation by continuing to treat the surviving corporation as a domestic one.
After inversion activity began resurging four years ago, the IRS responded in 2014 with a noticethreatening regulations under section 7874 that would make it difficult for an inverting U.S. corporation to access its deferred offshore earnings for onshore use. A 2015 notice indicated that the regulations would have more bite than may have been previously understood.
The 2014 notice was widely seen as being responsible for scuttling a $55 billion deal in which U.S. drugmaker AbbVie Inc. would have acquired Jersey-registered, Irish-headquartered Shire PLC and inverted to the United Kingdom. Instead, Shire began pursuing U.S. specialty drugmaker Baxalta Inc., which was separated from Baxter International last July. In January, Shire agreed to buy Baxalta in a $32 billion transaction, following which Baxalta holders will have a 34 percent stake in the combined company.
The IRS’s 2014 anti-inversion notice turned the anticipated market consolidation featuring Shire upside down. The company ended up buying a U.S. drugmaker—Baxalta—instead of being acquired by one—AbbVie. Clearly, as that tale demonstrates, the regulatory impediments in accessing overseas cash will restrain U.S. corporations’ ability to buy up foreign companies.
But Clinton’s proposed exit tax would make things much worse. It would render U.S. corporations less desirable even as acquisition targets. Had Clinton’s exit tax been in effect for the Shire-Baxalta deal, the combined entity would have faced a 35 percent tax on all of Baxalta’s considerabledeferred offshore earnings. Shire may well have looked elsewhere for a suitable acquisition target. The losers under Clinton’s exit tax would be investors in U.S. multinational corporations, who would find their investments declining in value to reflect their diminished attractiveness to foreign buyers.
In both the Pfizer transaction and the $14 billion deal between Johnson Controls Inc. and Tyco International PLC, in which the former will invert to Ireland, planners were careful to keep the combined entity’s ownership by the shareholders of the expatriating U.S. corporation just below 60 percent, the threshold at which the restrictions in section 7874 and the IRS’s threatened new regulations begin applying.
Clinton’s proposal to move the threshold percentage to 50 percent would make that careful planning moot. Under that proposal, no expatriating U.S. corporation could be the acquirer in a cross-border transaction.
The IRS’s anti-inversion regulatory pronouncements stack the deck in the global mergers and acquisitions market in favor of well-capitalized foreign acquirers that can meet onshore expenditure requirements with their own resources. Clinton would deepen that bias. The losers would be U.S. workers whose jobs would be vulnerable to the whims of foreign buyers.
In the international corporate taxation regime that Clinton would fashion, query whether a tax lawyer advising a U.S. start-up with a business plan contemplating significant foreign-source earnings could avoid malpractice without at least suggesting locating the corporate charter in the Cayman Islands, Ireland, or other tax-favored jurisdiction. If U.S. businesses invert before they incorporate or build up substantial offshore earnings, the wall that Clinton seeks to erect around U.S. multinational corporations would have little to show for itself except the deepening toll it will extract in the returns generated by U.S. investors and wages earned by U.S. workers.
[A related article appears in this week’s Tax Notes International.]