Monitoring international tax proposals for impact on transactions

Private equity groups often count on a target’s post-transaction growth to drive profits. One of the most frustrating scenarios is to achieve that growth but suffer an unforeseen setback due to a tax liability resulting from changes in tax rules.

2014 provided several examples of rule changes that can impact transactions. In the early part of the year, President Obama’s budget proposal included provisions aimed at restricting “corporate inversion” transactions that result in the expatriation of U.S. corporations for the purpose of reducing long-term U.S. income tax. An inversion transaction involves the merger or acquisition of a U.S. business by a foreign acquirer where the former U.S. owners of the target retain a significant interest.

Obama’s proposals didn’t become law, but businesses and investors were forced to examine the potential impact they could have on transactions. Later in the year, the IRS took regulatory action to further curb inversion transactions. Those regulations are still being drafted, but businesses are on notice that regulations will be effective from the day that they were announced as rules in September 2014.

The forthcoming final anti-inversion regulations have injected significant uncertainty regarding the U.S. tax outcome of cross-border mergers and acquisitions involving U.S. targets. An insurance industry representative commented that the IRS-proposed regulations will have a “chilling effect on routine, non-abusive mergers and acquisitions.”

Proposed tax changes may even inadvertently favor one transaction form over another. The anti-inversion rules make it difficult for former U.S. owners to retain an equity interest in an acquisition by, or in combination with, a non-U.S. company. In effect, these rules make an outright takeover by a foreign acquirer a tax-advantaged transaction! Of course, just like last year’s proposals, the first hurdle this change would face is gaining Congressional approval.