Inversions: structuring your move

Much has been said about the merits and morals of corporate inversions. But what must a company consider when choosing a transaction structure?

Most of the ink spilt in recent times on this topic has focussed on US companies moving to so-called lower tax jurisdictions. The expected tax savings for US companies, as outlined in public disclosure documents, can be very attractive where a group has significant non-US operations or revenues that are expected to grow in the future. However, given the size and scale of operations of the companies involved make these transactions complex, they will only be pursued if there are compelling strategic reasons for doing so; not simply to generate a short-term bump to the bottom line through tax savings.

Ireland has been the final jurisdiction of choice in the majority of inversion transactions

Ireland, along with Switzerland, the Netherlands and the UK, is one of the jurisdictions usually considered by companies incorporated in the US and elsewhere considering an inversion or migration. To-date, it has been the final jurisdiction of choice in the majority of transactions. While a critical pillar of Ireland's brand is its tax-related benefits – including its 12.5% corporate tax rate – the deciding factor in locating a group's holding company here has never, in the authors' experience, been tax alone. This makes sense when you consider that the company must operate in the destination jurisdiction's legal regime for the foreseeable future. As a result, it is essential to carefully consider the corporate governance rules (including potential liability of directors, say-on-pay and board structure), whether its accounting standards will be required to change, capital management restrictions, and other non-tax issues in the proposed new jurisdiction. Companies should also consider their exit strategy. In the momentum of an inversion or migration, this is often forgotten. But a once-attractive jurisdiction can become less so over time, so checking how difficult it will be to leave if the need arises is essential before relocating there.

Inversion by insertion of a new holding company

Many jurisdictions (particularly those with a common law tradition) will have a procedure akin to a scheme of arrangement under Irish law. This allows shareholders to choose to swap their shares in the existing group holding company (Company) for shares in a new holding company incorporated in the same or another jurisdiction (NewCo). This swap can be effected by a cancellation of the existing shares in the Company and their re-issue to NewCo, or by transferring all the shareholders' securities in the Company to NewCo in consideration for NewCo issuing shares to the Company's former shareholders. This type of structure was used by a number of companies which moved their holding companies from Bermuda or the Cayman Islands to Ireland in 2008 and 2009 including Accenture, Covidien, Ingersoll-Rand and others.

Except in limited circumstances (described below), it is generally no longer possible for companies to leave the US tax net by simply inserting a new non-US holding company on top of the group. But, inversion may occur as a side-effect of another transaction. If a US company wishes to invert, a key consideration in structuring any M&A transaction will be the anti-inversion rule contained in section 7874 of the Internal Revenue Code. This rule does not apply if, after the merger:

1. the former shareholders of the US holding company own less than either 60% or 80% of the enlarged group (shareholding test), or

2. the enlarged group has 'substantial business activities' in the destination jurisdiction (substance test).

'Substantial business activities' exist where the group has at least 25% of employees, employee compensation, assets and income in the new jurisdiction. This is a difficult test for multinational companies to meet (although it was the basis of Liberty Global's acquisition of Virgin Media in 2013). As a result, recent inversions by US companies have relied on the shareholding test, using one of a number of structures.

Inversion by acquisition

Most recent discussions regarding inversions have focussed on this structure. It involves a new holding company being formed in the destination jurisdiction (New Holdco) to acquire both the target company and the company wishing to invert (Exiting Company). It is important to note that it is not necessary for the New Holdco and target to be located in the same jurisdiction. For example, in a transaction last year Endo Health Solutions (a US company) and Paladin Labs (a Canadian company) were acquired by a new Irish-incorporated holding company. In transactions of this type, the cash and securities consideration received by the former shareholders of the Exiting Company and target needs to be structured in a way that meets the shareholding test if a successful inversion is to be achieved. It should be noted, however, that material benefits may still accrue where the former shareholders of the Exiting Company own less than 80% of the enlarged group, with the result that the New Holdco is treated as a 'surrogate foreign corporation' by the IRS.

In addition to Endo/Paladin, other recent examples of inversions by acquisition are Medtronic/Covidien, Forest Labs/Actavis, Chiquita Brands/Fyffes and Eaton/Cooper Industries.

Inversion by spin-off/acquisition

A variant of inversion by acquisition was used by Tyco (Swiss incorporated) to spin-off its Flow Control business to be acquired by New Pentair – a Swiss-incorporated holding company that also acquired the US-incorporated Pentair. The effect of this was to merge Pentair and Tyco's Flow Control business, with Tyco shareholders receiving shares in the Pentair Group's new Swiss holding company.

While all of these structures could also be used by non-US companies wishing to exit their existing jurisdiction, European companies have additional options when choosing a methods to move jurisdiction.

A public limited company in any EU jurisdiction can convert into a European company (Societas Europaea or SE), or a SE can be formed by a merger of European companies. A SE is able to transfer its registered office between EU member states, subject to complying with certain procedural conditions and obtaining necessary shareholder consents, and continues as the same legal entity throughout this procedure. This is how James Hardie Industries converted a Dutch company into a SE, and then moved that SE's corporate domicile to Ireland in 2009.

Another option is to use the EU cross-border merger procedure implemented across Europe in 2008 to merge companies by way of absorption, acquisition or the formation of a new company. To date, this structure has been used mainly for intra-group transactions involving Irish companies. But it is only a matter of time before it is put to more innovative uses in migrations or arm's length transactions with third parties.

Subsequent to the Tyco/Pentair transaction described above, Pentair decided to move its holding company's place of incorporation from Switzerland to Ireland. Switzerland is not in the EU, so the EU structures were not available. Instead, the transaction was effected under a merger agreement between Pentair Switzerland and Pentair Ireland, with all of the assets and liabilities of Pentair-Switzerland transferring to the Irish company when the merger became effective.

The first, fourth and fifth transaction structures described above are, in terms of planning and execution mechanics, usually akin to complex intra-group reorganisations. This is not to under-estimate the legal and logistical issues that arise when listed companies with external debt funders and extensive third party contractual obligations seek to migrate their holding company to another jurisdiction.

However, inversion by acquisition or spin-off /acquisition transactions introduce third party negotiations and the need to complete an M&A transaction. The detailed planning of these transaction from the outset is absolutely essential and deserves particular attention.

A particular challenge that arises when a new holding company is acquiring an Exiting Company and the target is that the two acquisitions will be subject to different regulatory regimes but will be required to close (insofar as possible) at the same time. This is to avoid a situation where the New HoldCo completes the acquisition of only half of the enlarged group. A solution has been devised for transactions involving a US-incorporated Exiting Company and an Irish-incorporated target and New HoldCo. In these deals, a US-incorporated subsidiary of New HoldCo is set up, into which the Exiting Company merges, while the target's acquisition is effected by a scheme of arrangement under Irish law. As a scheme of arrangement becomes effective when an order of the High Court of Ireland is registered in Dublin, this process gives considerable flexibility in timing the completion of the Irish acquisition to coincide with the US merger becoming effective.

Experience indicates that legal and accounting issues are as important as tax considerations in informing a company’s decision to relocate

To the extent that shareholder votes are needed to approve or facilitate the transactions involved in an inversion by acquisition, it is desirable to schedule shareholder meetings, to the extent possible, on the same or similar date. This is to avoid the risk of a change in market or shareholder sentiment resulting in inconsistent voting outcomes. This will require co-ordination in drafting and publishing the disclosure documents each company is required to send to its shareholders. In inversions by acquisition or spin-off/acquisition, a US-incorporated Exiting Company with listed securities will have to comply with the requirements of the exchange(s) on which it is listed, as well as SEC requirements, both in respect of the acquisition transaction and the listing and registration of the securities in the New HoldCo. Similar regulatory considerations will apply to non-US Exiting Companies. On the other side of the transaction, a different regulatory regime will apply. For example, in the case of an Irish-incorporated listed target, it is likely that the Irish Takeover Rules will regulate the acquisition of the target. Reconciling the requirements of both regulatory regimes can take some work, and some flexibility on the part of regulators will be of assistance. Identifying where this forbearance is required, and making appropriate submissions to regulators as early as possible will ensure a smoother path to completion.

These structuring issues, combined with the usual matters that arise on cross-border transactions involving multinational companies (including antitrust and other consents or clearances around the world) can mean an inversion takes a number of months to complete. The commercial risks of having a transaction in the market for a significant period of time make it critical to have a robust transaction agreement in place from the outset to protect both parties. In particular, the conditions permitting each party to terminate the transaction, and the consequences of such termination including break fees or other penalties, may need to be approved by regulatory bodies, as well as being commercially acceptable to the directors of the participating companies.

It's clear that the issues that arise in designing and implementing migration or inversion transactions are complex. Given the exact circumstances of each transaction will differ, innovation and flexibility are often required to identify a commercially acceptable and legally robust structure. However, this is true of all significant transactions entered into by large companies. While the political commentary on migrations and inversions has highlighted tax concerns above all else, experience indicates that other legal and accounting issues are of as much, and sometimes more, importance to companies in deciding to leave or relocate to a particular jurisdiction. The key question for companies in considering whether and how to pursue transactions of this nature is whether it makes strategic sense for the group's business as a whole.

By Arthur Cox partners Maura McLaughlin and Conor Hurley in Dublin