When Burger King announced its $12.5-billion purchase of Tim Hortons in August, speculation quickly ramped up about whether and, if so, when Congress would start closing the tax-inversion loophole and the extent to which that would chill the M&A market.
The speculators didn’t have to wait long, although it wasn’t Congress that moved. On September 22, the US Department of the Treasury and the Internal Revenue Service announced their intent to publish regulations that would both curb the incidence of inversion and reduce the associated tax benefits.
Canadian M&A lawyers aren’t happy. The loophole allows US and non US companies to combine in transactions that move the US corporation to a non-US jurisdiction where tax rates are lower. Typically, the US company and the non-US company would form a holding company in a low-tax jurisdiction, with the previous companies becoming subsidiaries of the holding company.
“I would not necessarily rank Canada as a predominant inversion target jurisdiction relative to others, but it is definitely on the radar and the inversion deal trend has generated a significant volume of work for us,” says Emmanuel Pressman in the Toronto office of Osler, Hoskin & Harcourt LLP.
But even where the targets are not Canadian or where Canada is not chosen as the new domicile, Canadian lawyers benefit. “So long as there are assets located in Canada, meaningful Canadian legal work flow will follow,” Pressman says.
Overall, of the deals outstanding when the intent to make the changes were announced, two (including one on which Torys LLP was Canadian counsel) have aborted and seven are proceeding (including Tim Hortons/Burger King). Some, however, may still change their minds about continuing.
“One of the difficulties in deciding whether to proceed is that the rules as formulated in the notice of September 22 are not final and could still change to catch a wider net of transactions,” says Corrado Cardarelli in Torys’ Toronto office. “However that may be, there’s definitely going to be a chilling effect.”
The first change, which will take retroactive effect to September 22, strikes at a key feature in a tax-inversion transaction, namely the requirement that shareholders in the US company cannot own more than 20 per cent of the combined company, a formula known as the “inversion fraction.”
The new rules make it harder to meet that fraction by disregarding some of the stock issued by the new parent if more than 50 per cent of its assets are passive or marketable securities. “The reason for this change is that many of the non-US merger candidates are companies with lots of cash and no real activity,” Cardarelli said.
The second change is aimed at US companies who have “slimmed down” in anticipation of an inversion, perhaps by paying extraordinary dividends or effecting sales that are not in the ordinary course of business. The reduced value of these companies means that their shareholder will be entitled to fewer shares in the new parent company, making the inversion fraction easier to meet. Under the new rules, however, the IRS will ignore the slimming transactions for the purpose of calculating the inversion fraction if the slimming occurred within 36 months of the inversion.
Other changes will affect future tax planning and tax benefits, even for inversions completed before September 22. These changes treat payments made from the subsidiaries of the US company directly to the new parent (through tax-planning techniques known as “hopscotch” and “decontrol” transactions) as having been received by the US company and therefore subject to the country’s 35-per-cent corporate tax, among the highest in the world.
“Obviously, there will still be opportunities for companies that are not merging with a foreign cashbox or haven’t slimmed down,” Cardarelli says.
Just not as many opportunities as there were before.