Inversion deal crackdown hurts U.S. and European health care stocks

Health care stocks fell Tuesday in the U.S. and Europe after the U.S. government put out rules Monday designed at blocking cross-border, tax-reducing “inversion” deals.

The deals have been led by U.S. companies seeking to avoid the developed world’s highest corporate tax rate by buying foreign businesses and moving their tax address abroad. The U.S. Treasury rules seek to slow or halt those transactions, or at least make them less profitable as a way of keeping the companies headquartered in the U.S.

Pfizer, which this year tried to buy AstraZeneca and move abroad, fell less than 1 percent to $30.05 at the close in New York. AstraZeneca declined 3.6 percent to 4,414 pence in London.

“Clearly the prospects for an inversion transaction are now less likely,” Alex Arfaei, a New York-based analyst at BMO Capital Markets, said of Pfizer in a note to clients.

To execute a so-called tax inversion, U.S. companies need to buy a foreign operation, and the shareholders of the non-U.S. company need to make up at least 20 percent of the combined operation. Shares also fell in companies that would benefit from the moves or already have struck but not completed deals to do so.

Treasury Secretary Jacob J. Lew announced rules on Monday that could affect pending deals such as one involving AbbVie, an Illinois-based pharmaceutical company that is in the process of acquiring its smaller British rival, Shire, or the Minneapolis medical device maker Medtronic, which is acquiring Covidien in Ireland.

The new rules use existing Treasury regulations to crack down on complicated transactions such as internal loans, stock purchases and sales that such inverted companies use to substantially reduce the tax they owe in the United States. They would short-circuit so-called hopscotch loans — when an American parent company uses its foreign subsidiary’s earnings without paying U.S. taxes — making the loans count as American property.

The rules also prevent inverted companies from taking advantage of a strategy known as decontrolling, when an inverted company essentially has its foreign entity buy enough stock from the American parent that it has access to earnings from the overseas branch without ever paying U.S. taxes on them. They could still make the stock purchases, but the tax benefit would vanish. And inverted companies could no longer transfer cash or property from an overseas entity to the new foreign parent company without paying taxes in the United States.

In addition, Treasury plans to tighten an existing requirement that an inversion can take place only if the former owners of the American company own less than 80 percent of the resulting firm and if the foreign entity is valued at more than 20 percent.

Still, some Democrats, including those who have been the harshest critics of corporate inversions, said the actions were far too limited to substantially reduce the practice. Sen. Charles Schumer of New York said the Obama administration had been hemmed in by the limits to its legal authority, yielding a set of rules that most likely will hold up in court but have little substantive effect.

Schumer, for example, has proposed adjusting the ownership threshold to 50-50.

“Certainly they made a good effort, but what this administrative action shows is that the only real way to stop inversions is legislative,” Schumer said in an interview.

In particular, he said Congress must pass legislation that stops a practice known as “earnings stripping.” That is when a parent company loads up a U.S. subsidiary with debt, which can be deducted for tax purposes, rather than treating it as equity, which is not eligible for deductions.

Pharmaceutical companies have led the way in a period of tax inversion deals. Eight inversion deals are pending, five of which are drug or medical device deals, according to data compiled by Bloomberg. Three more such deals were completed this year in the industry.

AbbVie, based in North Chicago, Ill., has agreed to buy Shire and move to the U.K. Its shares fell 2 percent to $57.56 in New York, while Shire dropped 2.5 percent. Medtronic, which plans to buy Covidien and move its legal address to Ireland from Minneapolis, fell 2.9 percent to $64.08. Covidien shares fell 2.5 percent to $88.11.

Smith & Nephew, a British maker of artificial hips and knees that had been a potential target for Stryker of Kalamazoo, Mich., fell 2.8 percent. Mylan, which has a deal to acquire Abbott Laboratories’ generic drugs unit, rose less than 1 percent to $46.61.

A spokesman for U.K.-based Shire said he had no comment. A spokeswoman for AbbVie didn’t respond to requests for comment.

Medtronic may become one of the biggest losers.

“Our initial read of the Treasury Notice leads us to believe that there could potentially be negative tax consequences for Medtronic,” said Glenn Novarro, an analyst at RBC Capital Markets, in a note to clients.

Conversely, as the rules are not retroactive and will not apply to deals that are already completed, a likely winner is Horizon Pharma, which just last week completed its address change from Illinois to low-tax Ireland.

This story was originally published September 23, 2014 at 7:18 PM with the headline "Inversion deal crackdown hurts U.S. and European health care stocks."