Why Pfizer-Allergan inversion criticism is misplaced

Author: Tom Young | Published: 1 Dec 2015
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The record-breaking $152 billion merger between US pharmaceutical company Pfizer and the Irish headquartered Allergan has attracted fierce criticism – and promises of future legislative reform.

But the attention on its so-called inversion structure misses the point, according to M&A and tax lawyers, who believe the focus should be on US authorities’ deceptive use of guidance.

Announced on November 23, the deal will see Pfizer buy Botox maker Allergan and move its tax base to Ireland. As a result of the move, Pfizer expects to cut its tax rate to 18% from its roughly 25% current rate, due to Ireland’s lower corporate rate.

The merger has rekindled political interest in inversions after their popularity last summer, and coincides with the latest set of US Treasury and Internal Revenue Service (IRS) guidance on November 19, which further restricts corporates’ ability to carry out inversions.

But despite continued efforts by the US authorities, an inability to pass primary legislation either outlawing the structure or lowering the country’s corporate tax rate due to Congressional deadlock means inversions will remain appealing – and possible.

“Inversion activity will continue,” said Sara Luder, head of Slaughter and May’s tax practice in London. “The US needs to reform its corporate tax system but until it does there will be continuing interest in this,” she added.


  • The record-breaking $152 billion merger between Pfizer and Allergan has attracted fierce criticism and promises of future legislative reform;
  • The deal employs the inversion structure, with Pfizer moving its headquarters to the lower corporate tax jurisdiction of Ireland, Allergan’s headquarters;
  • But counsel in Europe believe more focus should be paid to recent US guidance on inversions, which is effectively replacing primary legislation;
  • Recent guidance, such as November 20’s restrictions on third country inversions look set to further hamper deals;
  • But inversions are expected to continue, at least until restrictive US corporate tax rate is lowered.

A true inversion?

In some respects, the Pfizer-Allergan merger doesn’t fit traditional classifications of inversions anyway. According to US Treasury definitions, an inverted company is subject to restrictions ‘…if the shareholders of the old US parent end up owning at least 60% of the shares of the new foreign parent.’ Former Pfizer stockholders are expected to hold around 56% of the combined company.

This hasn’t prevented public criticism of the deal, with almost all leading US Presidential candidates voicing opposition to the tie-up.

But the IRS and Treasury are hamstrung. Under current law, US companies that invert through a merger are still treated as domestic for tax purposes if the former US company’s shareholders own over 80% of the combined company. The administration wants to reduce this to 50%, but that requires legislation that is deemed impossible in an unworkable Congress.

Pfizer's New York offices
Leaving the US:
Pfizer's New York offices

Instead, a growing raft of guidance aimed at stifling the structure has been released. Restrictions published in September 2014 during the proposed $55 billion AbbVie-Shire merger is viewed by many as the most severe, with some surprised that they didn’t succeed in stopping inversions altogether.

They included a prohibition on hopscotch loans that allowed companies to access foreign cash without paying US taxes, and a limit to so-called spin-versions, in which US companies spin off units into a foreign company. The proposals were so severe that they ultimately led to the cancellation of the Abbvie-Shire deal.

Gillian Fairfield, partner at Herbert Smith Freehills who advised AbbVie on the proposed deal, believes that Congressional log-jam is blocking the possibility of primary legislation to change the tax code. “So authorities have pursued this route of issuing often highly complex regulations from the Treasury Department, snipping off limbs of the inversion transaction without killing the transaction itself."

Third country

The guidance published on November 20 this year makes further inroads into options available to dealmakers considering inversions – though they would not have caught Pfizer-Allergan.

Of chief concern is the third-country proposal which sees the IRS and Treasury attempting to prohibit transactions where a US and foreign target combine to form a foreign parent that is outside the target company’s headquartered jurisdiction.

Some believe the guidance will have profound effects on dealmaking. “Before this guidance, if Pfizer had been merging with AstraZeneca they could have just had a Dutch holding company. You can’t forum shop anymore,” said Stephen Cooke, head of Slaughter and May’s M&A practice in London.

Pfizer’s Allergan merger would comply with the guidance because Allergan is headquartered in Ireland anyway. But Sara Luder believes the changes will impact the market.

“It is interesting for M&A because it means parties can’t go hunting anywhere for a new target and then decide where to locate the Topco. Those two points have now become linked,” she said. Fairfield is more relaxed about the changes. “I don’t think it is a huge loss,” she said.

Binding guidance?

Perhaps most importantly, the IRS and Treasury appear to be using the guidance in lieu of legislation, and deterring parties from the inversion structure as a result.  “Everyone has been waiting for the legislation [as a result of the guidance] and it never materialises,” said Isaac Zailer, global head of tax at Herbert Smith Freehills in London.

Zailer hears from US colleagues that using guidance in this manner is not unique to tax legislation in the US. But it is being used as a tool to shape behaviour, even before the making of primary or secondary legislation, and even where new binding rules fail to materialise.

“Although the US authorities fail to follow through ‎with actual legislation, and against the background that all the guidance does is set out the view‎ of the Treasury, it is nevertheless impacting peoples’ behaviour,” said Zailer. “They are working under the belief that there will soon be new rules that are binding,” he added.

"They are working under the belief that there will soon be new rules that are binding"

According to Zailer and Fairfield, the IRS has dealmakers in a bind. Any attempt to challenge this guidance would be reliant on completing on a deal that the suggested legislation is aimed at destroying. “It’s unlikely that anyone would launch a deal on the basis of zesty confidence in an ability to challenge the regulations after the fact,” said Fairfield.

Because of this, Pfizer’s announcement of its deal now has surprised some. “These certainly are shifting sands on which to announce a significant inversion deal,” said Fairfield, noting the threat of future legislation. 

This goes some way in explaining the deal’s large break fees, which stand at $3 billion if one of the companies’ boards changes its mind before March 2016 and $3.5 billion after that. The Abbvie break-up fee was $1.64 billion.

Still worth the trouble

Despite these growing restrictions, inversions still hold two key benefits which remain untouched by the changes. Firstly, revenue not generated from US businesses doesn’t need to pass the US post inversion. Instead post inversion corporates will acquire new non-US business into the non-US side of the group, and will then transfer their existing non-US business from the ownership of what is now an intermediate holding company (the former US parent) into the non-US side. “That has not been stopped,” said Zailer.

And companies can still undertake so-called earnings stripping. This involves gearing up the transaction such that the US company is borrowing from the UK company (for instance). The interest on that borrowing is going to be deductible in the US at 35% and only 20%, or even lower, in the UK. “So you have some tax arbitrage there,” said Zailer. While there are anti-avoidance rules which limit stripping in some cases, the practice can only be stopped by primary legislation because the cost of borrowing is deductible as a matter of primary legislation, he added. And such legislation, in the current climate, is almost unthinkable. 

Tear sheet

The transaction was announced on November 23. Wachtell Lipton Rosen & Katz, Skadden Arps Slate Meagher & Flom, Clifford Chance, Morgan Lewis & Bockius and A&L Goodbody are advising Pfizer. Allergan is represented by  Cleary Gottlieb Steen & Hamilton, Latham & Watkins and Arthur Cox. The firms involved were unable to comment on the transaction. 

The merger agreement can be found here