New US tax-inversion rules may threaten Pfizer, Allergan merger

Shares in Allergan fell as much as 22 percent after the US Treasury Department issued new regulations designed to curb tax-inversion deals, potentially jeopardising the company's planned $160-billion merger with Pfizer. In response to the news, the drugmakers said "we are conducting a review of the...actions," adding "prior to completing the review, we won't speculate on any potential impact."

The US Treasury Department indicated that it hopes to "limit inversions by disregarding foreign parent stock attributable to recent inversions or acquisitions of US companies." Specifically, the rules would limit a company's ability to participate in inversion transactions if they've undertaken one within the past 36 months. Allergan, under its previous name of Actavis, has been involved in several mergers in that time frame, including recent deals with Warner Chilcott and Forest Laboratories. Last year, Actavis completed the purchase of Allergan, later adopting the acquired company's name.

"For years, companies have been taking advantage of a system that allows them to move their tax residences overseas to avoid US taxes without making significant changes in their business operations," noted Treasury Secretary Jacob J. Lew. "Some companies are serial inverters," Lew remarked, adding"this will have an important effect, but we cannot stop these transactions without new legislation [from Congress]."

Under Pfizer and Allergan's proposed merger, the companies have indicated that former Pfizer stockholders will hold approximately 56 percent of the joint drugmaker, with Allergan shareholders owning around 44 percent. The drugmakers also said that upon closing of the transaction, the merged company is expected to maintain Allergan's Irish legal domicile.

Commenting on the news, Citigroup analysts Liav Abraham and Andrew Baum suggested that the deal will probably fall apart. "Pfizer will likely have difficulty extracting the primary benefit associated with the transaction," Abraham and Baum noted, adding that the new regulations provide "sufficient cause for the proposed transaction not to move forward." However, Evercore ISI analyst Umer Raffat remarked "the real question is whether Pfizer reads today's regs as reason enough to not continue to pursue the deal."

Under existing rules, when a US company merges with a foreign firm, US shareholders must own less than 80 percent of the new entity for it to be considered a foreign company for tax purposes. Height Securities analyst Henrietta Treyz said if the US Treasury Department disregarded the portion of Allergan's growth attributable to prior inversions, its merger with Pfizer might not qualify. Treyz commented "so the question for Pfizer is, can you still get over that threshold and do you still want to do it?"

As part of the merger agreement between Pfizer and Allergan, either party may terminate the deal if an adverse change US legislation would cause the combined company to be treated as a US company for federal income tax purposes. The terminating party would have to pay the other drugmaker up to $400 million for its expenses. Shortly after the transaction was announced, some US politicians criticised the deal over Pfizer's plans to relocate its tax address to Ireland.

For further analysis, see The Q&A – Why Pfizer's $160-billion merger with Allergan may not happen.

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