Investing Implications of Inversions

Should your clients be investing in companies that have recently undergone a corporate inversion? Tax specialist and political analyst Andy Friedman says only if the merger between the two entities makes sense. “Investors should evaluate inversions as they would any other merger: from a business perspective first and a tax perspective second,” writes Friedman of The Washington Update fame in a recent paper, “Corporate Inversions: A Primer.”

A corporate inversion typically involves a U.S. parent company merging with a smaller company overseas, Friedman says. By combining the two companies’ operations, the U.S. company moves its headquarters to that of the overseas company, and, as a result, the parent company ceases to be a U.S. taxpayer.

Investors “should consider how well the business objectives and executive oversight of the two companies are likely to mesh, and whether there is synergistic value and cost savings to be derived by combining the two companies’ operations,” he says. “If the results of this analysis are favorable, then the tax savings are icing on the cake.”

The name “inversion,” Friedman continues, comes from turning the company upside down, with the smaller offshore unit becoming the new parent. However, the company must continue to pay U.S. tax on its operations in the U.S. “For instance, if Burger King’s merger with Tim Hortons goes through, Burger King still must pay U.S. tax on the profits generated by its U.S. locations,” Friedman says.

But by moving its headquarters overseas, a business avoids U.S. tax on its foreign income, Friedman points out.

Inversions also impose a “significant hidden cost on investors,” he says. “Under an inversion transaction as typically structured, shareholders of the U.S. company are required to recognize taxable capital gains on their shareholdings—equal to the difference between the market value of their stock and their basis—when they exchange their existing shares for shares in the new offshore parent.”