The Obama administration’s latest move to curb companies from shifting their headquarters overseas to dodge taxes marks the strongest such action to date, derailing the $150 billion proposed merger between Pfizer Inc. of New York and Allergan, the longtime Southern California-based drug maker that was bought by an Irish firm last year.
In issuing two new broad rules late Monday to deter so-called corporate inversions, the Treasury Department seemed to be targeting the Pfizer-Allergan deal and others like it.
One of the regulations makes tax inversions harder and potentially much less profitable for foreign companies that have been involved in multiple deals with U.S. companies over a three-year period, what Treasury officials called “serial inverters.” Allergan was bought in March of last year by Actavis, a one-time New Jersey-based firm that itself had merged in 2013 with an Ireland company.
“That rule appears to be directed at Pfizer-Allergan,” said Adam Rosenzweig, a law professor and expert in international taxes at Washington University School of Law in St. Louis. “If the sole purpose (of the merger) was tax-driven, this would probably stop the deal.”
Allergan, which was born out of a Los Angeles drugstore more than 65 years ago and became best known as the maker of Botox, was expected to complete its merger with Pfizer in the second half of this year.
But Wall Street signaled that the new rules put the deal in peril. Allergan’s stock plunged $43.20, or 15.6 percent, to $234.35 a share in afternoon trading Tuesday in New York. Pfizer’s stock rose 84 cents to $31.56 a share.
On Wednesday morning, Pfizer announced the deal had been called off by the two companies by “mutual agreement.”
“The decision was driven by the actions announced by the U.S. Department of Treasury on April 4, 2016, which the companies concluded qualified as an “Adverse Tax Law Change” under the merger agreement,” Pfizer said in a written statement.
Pfizer said it agreed to reimburse Allergan $150 million for expenses related to the deal, as required in the merger agreement.
The new federal rules on inversions, which would apply to deals not yet closed, are the third round of efforts by the Obama White House to deter companies from leaving for tax advantages abroad. The prior actions, however, were seen as largely ineffective and drew criticisms on the political campaign trail, where the issue has been a hot topic.
President Barack Obama, who two years ago promised to crack down on tax inversions, said Tuesday that the new regulations “build on steps that we’ve already taken to make the system fairer.” Obama has previously chastised corporations that exploit the tax system by generally buying small companies and then changing their address to another country to reduce their U.S. tax burden. While saying that the new rules would help curb the practice, the president called on Congress to close the loophole for good by reforming the tax system.
“Let’s stop rewarding companies that are shipping jobs overseas and profit overseas,” he said, “and start rewarding companies that create jobs right here at home and are good corporate citizens.”
The Treasury Department’s new rules surprised analysts in their breadth and potential for wide impact. The second of the two main regulations focuses on blocking a tactic known as “earnings stripping,” a practice that is not limited to corporate inversions. It involves a company lending money between a U.S. and foreign affiliate so that interest payments can be deducted from U.S. tax bills.
Analysts said the new rulings are substantial expansions to the Treasury Department’s administrative actions to clamp down on a practice that has been condemned by candidates of both parties and by many members of Congress. Still, Treasury Secretary Jacob J. Lew said in a statement that although the new rules should help slow the pace of such deals, “we know companies will continue to seek new and creative ways to relocate their tax residence to avoid paying taxes here at home.”
Companies and business groups have blamed the rise in tax inversions on the high U.S. corporate tax rates that they say give foreign companies a competitive edge. But also fundamental to the debate, analysts say, are questions about what constitutes an “American” company at a time when business and capital is global, said Rosenzweig. Is corporate domicile determined by where the company is legally incorporated, where most of the employees are located, or where principal research or operations take place, he asked.