Obama Claims Trophy With Collapse Of Pfizer-Allergan Merger, But Inversions Debate Continues

In its yearslong fight over corporate inversions, the Obama administration finally has a trophy. The U.S. Treasury Department issued new rules Monday aimed at stopping changes to corporate citizenship through mergers to gain a lower tax rate, and pharmaceutical giant Pfizer did just that by abandoning a planned deal with Allergan.

Though the Treasury framed the change in tax regulations as an administrative matter, President Barack Obama made clear that the issue has a larger political meaning that fits into a national debate that is growing more skeptical of corporate power and concentration by the day. American companies, Obama said, can’t ignore the public’s ire.

“They effectively renounce their citizenship. They declare that they’re based somewhere else,” Obama said Tuesday. “It sticks the rest of us with the tab, and it makes hard-working Americans feel like the deck is stacked against them.”

In a volatile election year in the United States, a need to stop inversions has united most of the major candidates for president.

Former Secretary of State Hillary Clinton has proposed using a “common-sense 50 percent threshold” for foreign shareholder ownership of a company before it can shed its U.S. corporate citizenship. In an inversion, shareholdings may not change even as a company swaps its U.S. domicile for a foreign one for tax purposes.

New York real estate developer Donald Trump has called for cutting the corporate tax rate to make inversions less appealing. He has said he’d also seek a one-time 10 percent tax on overseas profits of U.S. corporations in order to bankroll the tax rate change. “Since we are making America’s corporate tax rate globally competitive, it is only fair that corporations help make that move fiscally responsible,” Trump states in his plan.

In Washington, the consensus around stopping inversions has been less clear.

The Republican-dominated Congress has repeatedly declined to pass legislation on inversions amid a debate about a broader corporate tax reform. The Obama administration agrees in principle on the need for overhauling the federal tax code, but has pressed ahead with administrative actions to slow the inversion trend. Previous administrative steps haven’t been effective.

Economist Douglas Holtz-Eakin, head of the conservative advocacy group American Action Forum, argued that Treasury should put more effort into the legislative avenue. “The U.S. needs a new tax code that provides incentives to locate, invest, and expand in this country, and Treasury and the White House are failing the leadership challenge of delivering genuine international tax reform,” he said.

In a roundabout way, the Financial Accountability and Corporate Transparency Coalition, a group of activists who oppose inversions and other corporate tax dodges, agreed with Holtz-Eakin, at least partly. The group lauded Treasury for the measures, which include provisions to stop a profit-shifting technique known as earnings stripping. But it said Congress should still act to redefine what true foreign ownership is along the lines Clinton has proposed.

“These moves by Treasury will surely limit the attractiveness of inversions and the related benefits of earnings stripping, but Congress must still act,” said Clark Gascoigne, interim executive director of the group.

The administration argued in the past few days that the new rules weren’t aimed at the pending Pfizer-Allergan merger, which would have been the largest inversion-type transaction ever in the pharmaceutical industry. White House spokesman Josh Earnest said the regulations had been in the works for some time, but added coyly that the administration would be “pleased” if inversions fell through as a result.

Brian Gardner, an analyst with Keefe, Bruyette & Woods, said the biggest impact going forward could be on the investment banks that reap lucrative fees from facilitating inversion agreements between U.S. companies and overseas competitors.

“Within the financial space, the clearest impact is on the M&A [merger and acquisition] advisers as we think the earnings-stripping provision may have more teeth than previous Treasury initiatives that have failed to stop inversion deal flow,” Gardner said.

The Treasury’s rules took a dual aim at the proposed Pfizer-Allergan merger. The first part of the rules effectively raised the tax bill of “serial inverters” — which include Allergan, an Irish-domiciled company built through cross-border acquisitions.

A second part took aim at “earnings stripping,” an element of inversion transactions that lets multinational giants reduce their effective U.S. tax rates. Companies based in lower-tax jurisdictions can lend money to U.S. subsidiaries, and then deduct the interest paid from their taxable U.S. income, effectively pulling money earned in the United States into lower-tax jurisdictions as interest payments.

The measure on earnings stripping drew a strong reaction from representatives of foreign investors in the United States, who frequently lend money to U.S. subsidiaries. Nancy McLernon, head of the Organization for International Investment, which represents multinationals such as Nestle, Deutsche Telekom and Unilever, said spending wholly unrelated to inversions could be affected by the new rules.

“This is a misguided approach that could have a freezing effect on attracting global employers and will damage U.S. competitiveness, which may very well be measured in lost jobs, wages and GDP,” McLernon said.