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US inversions: AWOL or desertion?

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The political rhetoric in the US is hotting up. President Obama has recently called companies that pursue inversions ‘corporate deserters’.

In the UK, the aborted Pfizer/AstraZeneca deal and AbbVie’s offer for Shire have attracted significant press comment of late; they both join a growing list of approaches by US firms for overseas merger partners, where one eye (at least) has been on a reduced effective tax rate for the combined group.

During the 2000s, the UK endured its own corporate exodus, with groups escaping from an uncompetitive UK tax system. However, for us it was less a case of desertion and more one of absence without leave. The UK’s response was a series of reforms designed to make the UK’s system a more attractive (territorial) one. And, encouragingly, a raft of companies has subsequently come back to the UK.

The current US tax system resembles, in some respects, the pre-reform UK regime: a worldwide tax system that, at best, subjects non-US profits to US tax when repatriated. Some of the most successful US multinationals have reacted by retaining vast amounts of cash in their offshore subsidiaries – the problem of ‘trapped cash’.

A US inversion transaction – whereby a non-US holding company replaces a US company as the parent of the group – facilitates planning to reduce US taxes, including by gearing up US operations, moving non-US businesses 'out from under' the US and other inter-company arrangements. Sounds familiar?

To date, the IRS has responded with a series of anti-avoidance measures. Although ‘self-inversions’ are now all but impossible for US multinationals (Aon made it just in time), the focus has moved to ‘merger inversions’, with a value that clears the hurdle prohibiting 80% or more of the combined business from remaining in the hands of the US corporation’s former shareholders. Indeed, the stock of suitable merger partners, which has been a practical constraint on inversions, may potentially be increased through so-called ‘spinversions’ (Mylan/Abbott).

Where will this all end? President Obama’s budget proposals, if enacted, would shrink the 80% threshold down to 50% (potentially with retrospective effect). Irrespective of the likelihood of these proposals being enacted, it will be interesting to observe their behavioural impact – the law of unintended consequences can be powerful. Ultimately, it remains to be seen whether  as in the UK  the current appeals to 'patriotism' give way to competitive reform of the US tax system.

By Jonathan Cooklin and Dominic Foulkes, Davis Polk. Email: &