By Arthur Graber, PharmD, Post-Doctoral Fellow at Bayer HealthCare

Have you been seeing more in the news recently about pharma mergers and tax-inversion deals?  This article will de-mystify and explain some of the background and rationale behind this recent phenomenon. 

Like most U.S. corporations, over the last 30 years many pharmaceutical companies have employed various strategies to reduce their tax burden to increase overall profitability and deliver earnings that are in line with shareholder expectations.  One of these tax strategies is known as “corporate tax inversion.”

A corporate inversion is a method that has been employed by U.S. based multinational companies to restructure operations in a manner that allows them to avoid or minimize certain U.S. taxes. Essentially, the corporation relocates its headquarters to a lower-tax nation, while still retaining its material operations in its higher-tax country of origin.  U.S.-based companies typically pay tax rate percentages in the mid-20s, while an inversion deal can reduce tax rate percentages to the teens or even lower.

Several U.S. pharmaceutical companies have been trying to acquire or merge with foreign pharma companies in so-called inversion deals designed to take advantage of lower tax rates in other countries.  A  Wall Street Journal article recently listed the following four examples:

• Shire PLC was in discussion with U.S. drug maker AbbVie Inc. about a potential $53.6 billion takeover.
• Mylan Inc. agreed to buy pharmaceutical assets from AbbVie's former parent, Abbott Laboratories, in a $5.3 billion deal that would create a new entity organized in the Netherlands.
• Salix Pharmaceuticals Ltd., of Raleigh, N.C., said it was buying the Cosmo Technologies unit of an Italian company and would domicile the combined company in Ireland.
• Medtronic Inc. agreed to pay $42.9 billion to buy Irish medical-device maker Covidien PLC.

Although there is a tax advantage for corporate inversion, an inverted company is subject to potential adverse tax consequences if, after the transaction they do not meet specific conditions. On September 22, 2014, the U.S. Treasury Department enacted several regulations that have made inversion abroad more difficult and reduce benefits to companies who have already done so. Specifically, the notice eliminated certain strategies that inverted companies currently use to access the overseas earnings of foreign subsidiaries of the U.S. company that inverts without paying U.S. tax.  

These changes are intended to:

• Prevent inverted companies from accessing a foreign subsidiary’s earnings while deferring U.S. tax through the use of creative loans, which are known as “hopscotch” loans
• Prevent inverted companies from restructuring a foreign subsidiary in order to access the subsidiary’s earnings tax-free Close a loophole to prevent an inverted companies from transferring cash or property from a CFC to the new parent to completely avoid U.S. tax
• Make it more difficult for U.S. entities to invert by strengthening the requirement that the former owners of the U.S. entity own less than 80 percent of the new combined entity.

Cross-border mergers can make the U.S. economy stronger and encourage foreign investment to flow into the United States; however the U.S. government feels that these transactions should be driven by genuine business strategies, not a desire to avoid U.S. taxes.

For more information on the specific changes and their effects, see: http://blogs.wsj.com/washwire/2014/09/22/treasury-fact-sheet-the-new-rules-on-tax-inversions/