Market reacts to Pfizer-Allergan block

Author: Edward Price | Published: 13 Apr 2016
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On April 4, US Treasury announced new temporary and proposed regulations governing inversions. Two days later, pharmaceutical giant Pfizer abandoned its attempt to buy Irish-based company Allergan, leaving counsel to sift through the rubble of the deal for clues as to the future of inversions.

Inversions allow companies to shift their headquarters for tax purposes. Pfizer was to purchase Allergan for $160 billion, with the aim of moving the headquarters of the resultant new firm, for tax purposes, to Ireland. Instead, Pfizer now owes Allergan a $400 million break fee.

The current US administration has long frowned on the practice of inversions – without resounding success. The Treasury has twice attempted to tackle the practice, to little effect. As a result, nobody saw the April 4 move coming.

“I think it is safe to say that people were very surprised at the regulation package that the US Treasury issued,” said Bernie Pistillo, partner at Morrison & Foerster.

The surprise was twofold. One source of bewilderment was the contents of the package. Counsel simply didn’t anticipate it. But a second more potent shock stemmed from how there was absolutely no inkling in advance that a package was coming. Taken together, it’s clear that both bombshells were intended.


  • Counsel were surprised by Treasury’s move to block the Pfizer-Allergan deal;
  • Under the new regulations, much of any combined group would have been subject to US tax;
  • The new regulations will likely make it much more difficult for a US company to invert, and reduce the number of potential foreign targets;
  • Nonetheless, the demand for inversions is likely to continue until the US looks to modernise its tax regime.

“It was a true stealth effort. I think it is pretty clear that the government wanted there to be no advance warning of this, so as to minimise the risk of any particular transaction being accelerated,” said Pistillo.

“The timing was a surprise,” said Sara Luder, head of Slaughter & May’s tax practice in London.

Bernie J. Pistillo, partner at Morrison Foerster.
Bernie Pistillo, 
Morrison & Foerster
Perhaps that surprise is understandable. The US Treasury first announced it was looking at earnings stripping rules in 2014. According to Luder, the fact it didn’t take steps earlier was thought, by some, to indicate the Treasury was struggling to find a way of tackling the issue without primary tax legislation. And because that primary tax legislation was something the US is unable to produce as a result of an obstructive Congress, any effective tackling of inversions seemed dead in the water.

“We know companies will continue to seek new and creative ways to relocate their tax residence to avoid paying taxes here at home,” said Treasury secretary Jacob Lew at the announcement.

“Today, we are announcing additional actions to further rein in inversions and reduce the ability of companies to avoid taxes through earnings stripping,” Lew said, who also stressed the need for Congressional action, indicating the limits to Treasury’s ability to act alone.


Counsel have identified two rules that stand out.

First, the new serial inverter rule, under which the stock of a foreign merger partner that was issued in connection with the acquisition of a US entity within the last 36 months will be disregarded for purposes of determining whether the relevant 60% inversion threshold has been met.

“The three-year add-back change was also a surprise - it is surprising to see a government take a step that was so clearly targeting a particular transaction,” said Luder.

“In the Pfizer deal, the serial inverter rule was directly applicable because Allergan had previously been the party to three different inversion transactions within the past three years,” said Pistillo.

Second, lawyers have noted the earnings-stripping or debt-equity rules, which will operate to reclassify certain related-party debt instruments as equity and disallow an interest deduction. This strategy has been key to reducing the US tax burden of the former US group parent in many expatriation transactions.

Under the new regulations, a significant percentage of the Allergan shareholding would have been disregarded, resulting in much of the combined group being held by former shareholders of Pfizer. And therein lies the rub.

“The likely result would be that the combined group would be treated as a US corporation for all US tax purposes,” said Pistillo.

Even had this rule not applied, according to Pistillo, the new limitations on earnings stripping resulting from the new debt-equity regulations would have made the transaction much less attractive to the companies.


All of the above begs an important question: is the US Treasury acting within its rights? Some commentators suspect the regulations are in fact outside its, and the IRS’, authority.

“There are strong arguments to be made in favour of this conclusion, even with respect to a number of the inversion regulations that were issued prior to April 2016,” said Pistillo.

But even if the current round of guidance does stretch the Treasury’s mandate a little thin, nobody would want to take so large a risk as to test that theory with an actual merger.

“In the context of a major public transaction such as the Pfizer deal, executives would never want to proceed with a transaction and rely on the ability to challenge these regulations in court,” said Pistillo.

In other words, likely giving activist shareholders angst, the mere issuance of these regulations was enough to tank the deal.


The new regulations will make it much more difficult for a US company to invert with a repeat offender. They will also greatly reduce the attractiveness, and availability, of standard earnings stripping transactions post-inversion. But even these rules are unlikely to stop every inversion transaction.

“For many companies looking to expatriate, the driver is the ability to remove its foreign affiliates from the US-controlled foreign corporation regime, and to access trapped cash that has not been subject to US taxation,” said Pistillo.

According to Pistillo, the US is moving towards international tax reform, and looking at the taxation of un-repatriated offshore earnings as a means of paying for those reform efforts.

"It was a true stealth effort"

As such, many US multinationals may be increasingly tempted to exit the national tax net before their offshore earnings are repatriated and taxed, even at a preferential rate. The demand for inversions won’t necessarily drop as their prospective ease falls.

“The demand for inversions is likely to continue until the US looks to modernise its tax regime,” said Luder. He takes a global view, seeing the rest of the world as moving towards a territorial regime in which profits are taxed only where they are earned. The US, in contrast, continues to claim taxing rights over a US group's worldwide profits.

“While this remains the case US groups will continue to find inversions attractive - even with the earnings stripping changes,” said Luder. That said, it takes two to tango and the Treasury rules will have an impact overseas as well as at home. “The three year lookback rule will mean that there are fewer potential foreign targets,” Luder said.

See also

Why Pfizer-Allergan inversion criticism is misplaced

Pfizer-Allergan reignites US inversion debate

Mergers and acquisitions report 2016