This commentary was originally sent to subscribers of Action Alerts PLUS at 09:00 on Nov. 20, 2015. Click here to learn about this dynamic market information service for active traders.
Last evening, the Treasury Department released its highly anticipated announcement regarding updated rules for corporate tax inversions. As we mentioned, investors had feared that these proposed actions (which in the middle of the week were unknown) could potentially derail Pfizer's (PFE) bid for Action Alerts PLUS portfolio holding Allergan (AGN). However, after reading through the release, we are confident that the deal has a green light to proceed.
The new actions released by Jack Lew build upon the Treasury's previous steps to deter corporate tax inversions. As background, the notice reinforces the "60%-80%" rule whereby combined corporations are subject to adverse tax consequences if the shareholders of the former U.S. parent end up owning at least 60% of the shares of the new foreign parent. If the continuing ownership stake of the shareholders of the former U.S. parent is greater than 80%, then the combined company will be considered a U.S. company, despite the foreign corporate address. If the continuing ownership is in the grey area of 60%-80%, then the company is respected as foreign, but faces unfavorable tax consequences that can nullify some of the benefits of the inversion. These rules had been previously laid out by the Treasury to help dissuade tax inversions.
In the new notice, Mr. Lew only focuses on the 60%-80% grey area and does not touch on any new actions involving deals under the 60% threshold -- good news for Allergan. Importantly, the release essentially aims to stop U.S. corporations from "cherry-picking" a tax-friendly country in which to locate their new tax residence. In some inversions, the combined company will look to choose a different foreign country than the foreign parent's current home-base in order to gain more favorable tax benefits. When doing this, the companies can find a way to circumvent the 80% threshold explained above to give the U.S. parent more ownership in reality, but are still not subject to tax consequences because the stock of the foreign parent issued to the shareholders of the existing foreign corporation (who is based in a "third country") was disregarded under the previous rules. The actions released last evening discourage this sneaky tactic, among others.
As we all know, Allergan (who is the "foreign parent" in the example above) is currently based in Ireland, a country with very favorable tax benefits. Thus, a combined Pfizer-Allergan entity ("Allergizer" as we could call it) would likely not search for a third country as a new tax residence, and therefore would not have to worry about Mr. Lew's targeted guidance towards these types of transactions.
All in, it almost seems as if the rules were perfectly worded so that Allergan and Pfizer could actually complete a deal if they decide to do so. As for the 60% threshold, we are confident that the companies would be able to structure the deal in such a way that Pfizer would own 59% or less of the combined entity. There is also the possibility for Allergan to acquire Pfizer in a so-called "take under" (wherein AGN shareholders would effectively still receive a premium, as Pfizer would sell itself at a discount), which would be another way to achieve optimal benefits for the new company.
We will continue to monitor any news regarding the deal and would not be surprised to see something announced in the near future. We will be back with more updates as they become available.