New Rules On Inversions Could Kill The Allergan-Pfizer Merger

Pfizer is now based in New York City, but the drug giant's domicile would be moved to Ireland under the terms of its proposed merger with Allergan.

Mark Lennihan/AP

U.S. companies will find it much harder to reduce their taxes by merging with foreign firms under new rules introduced by the Obama Administration, and that's already throwing the fate of one big deal in doubt.

Shares of Allergan were down sharply Tuesday, as investors questioned whether its $150 billion merger with pharmaceutical giant Pfizer will still take place.

The Treasury Department on Monday introduced rules aimed at reducing the incentives for companies to carry out inversions. That's a controversial practice in which a U.S. company merges with a firm in a foreign country, such as Ireland, and moves its headquarters there to take advantage of that nation's lower tax rate.

In most cases, the move is something of a legal fig leaf, because the company continues to operate in the U.S. in much the same manner as before.

President Obama today called inversions "one of the most insidious tax loopholes out there." He said they allow companies to remain in the U.S., taking advantage of its infrastructure and legal system, adding:

"But they effectively renounce their citizenship. They declare that they're based somewhere else, thereby getting all the reward of being an American company without fulfilling the responsibilities of paying their taxes the way everybody else is supposed to pay them."

Critics say inversions have become more common because the U.S. corporate tax rate is higher than any other developed country's, at least on paper. Unlike other countries, the U.S. also requires its companies to pay taxes on income they earn anywhere in the world.

The new rules would restrict inversions in two ways.

First, they would address the practice of income-stripping, in which a foreign company lends money to its U.S. subsidiary, enabling it to deduct the interest it pays on the debt and therefore cut its tax bill. The government now has more discretion to block such deductions.

Second, the rules would change how Treasury Department measures the size of foreign companies, in a way that would directly affect Allergan.

The U.S. already restricts inversions in which U.S. shareholders own too large a part of the combined company. The new rules say acquisitions made by the foreign company within the past three years can't be included in determining its size. So now Allergan would be considered too small a part of the newly merged company, and it could no longer reap the benefits of an inversion.

Pfizer and Allergan have remained tight-lipped about the impact of the new rules, saying in a joint statement:

"We are conducting a review of the U.S. Department of Treasury's actions announced today. Prior to completing the review, we won't speculate on any potential impact."

But analysts are already speculating about the impact.

"It's going to be a major impediment. They're pretty much taking all of the juice out of inversions," Robert Willens, a New York-based tax analyst, told The Wall Street Journal. "They've addressed literally every benefit that one attempted to gain from an inversion and shut them all down systematically."

U.S. officials say the rules will slow but not stop corporate inversions, which remain attractive for companies hoping to cut their taxes.

"These actions took away some of the economic benefits of inverting and helped slow the pace of these transactions, but we know companies will continue to seek new and creative ways to relocate their tax residence to avoid paying taxes here at home," Treasury Secretary Jacob Lew said in the department's statement released Monday.