Treasury's crackdown on inversion could scupper Medtronic-Covidien deal

Treasury Secretary Jacob Lew yesterday unveiled reforms to make tax inversion more difficult and less attractive, potentially killing a plethora of pending mergers with foreign companies, including Medtronic's ($MDT) $43 billion tie-up with Ireland's Covidien ($COV).

Minneapolis-based Medtronic touted easier access to its foreign earnings and nearly $14 billion stockpile of overseas cash and cash equivalents as one of the acquisition's major benefits. To accomplish that, the company planned to lend money to its new Irish parent company, Medtronic PLC, upon closure of the transaction. But that attraction is diminished by the reform's ban on "hopscotch loans" by which companies could access their foreign subsidiary's earnings while deferring U.S. taxes.

"For some companies considering mergers, today's action will mean that inversions no longer make economic sense," Lew said in a statement. Is the Medtronic-Covidien deal among them? The Wall Street Journal previously reported that the two companies' agreement allows for Medtronic to cancel the deal without penalty in the case of changes to U.S. tax laws.

Medtronic told FierceMedicalDevices in an email that the company is studying the Treasury's actions and will release its "perspective on any potential impact on our pending acquisition of Covidien following our complete review."

The other reforms prevent companies from restructuring a foreign subsidiary to access its earnings tax-free, prevent the tax repatriation of cash or property to the U.S., and make it more difficult for a foreign company to surpass the 20% ownership threshold that triggers inversions. The reforms are not retroactive and only apply to deals that will close in the future.

The $43 billion proposed merger between Medtronic and Covidien would be the second largest inversion deal since the failed marriage between Pfizer ($PFE) and the U.K.'s AstraZeneca ($AZN) unleashed a wave of inversion deals in the healthcare arena (the largest deal, between Big Pharma companies AbbVie ($ABBV) and Ireland's Covidien, is also threatened).

Political pressure led drug store Walgreens to cancel the inversion element of its merger with the U.K.'s Alliance Boots, and now a tighter squeeze of the fist from government could undo the rest. For example, Bloomberg reports that the provisions in the section designed to make it harder to surpass the 20% ownership threshold threaten Abbott's sale of its developed markets generic drug business to Mylan ($MYL). This is a big part of the former's strategy to focus more tightly on medical devices, while the latter will be renamed Mylan NV and based in Netherlands, assuming now-uncertain closure.

Omar Ishrak

Companies tried to sell the inversion deals to a skeptical public and politicians. Medtronic CEO Omar Ishrak promised the new company would invest an additional $10 billion in the U.S. over the next decade. But 68% of Minnesota residents still say companies should not be allowed to move to obtain tax benefits, according to a recent Minneapolis StarTribune poll (including a majority of Republicans).

Ishrak's statement was overshadowed by his company's decision to a cover a special tax bill for 15 executives and 10 company directors at a cost of $63 million, including $24.8 million in special taxes for the CEO himself. The special tax was a result of a 2004 law that imposes a 15% tax on stock and option awards to top executives of companies seeking tax inversion deals--a reflection of the government's longtime dislike of inversion, and an example of companies' moves to navigate around disincentives to the practice.

Ordinary shareholders disliked picking up the tab for the tax bill. They also heckled Ishrak at Medtronic's annual shareholder meeting because (assuming the deal goes through) they will face hefty capital gains taxes upon the sale of their old stock in return for shares of the new Irish company Medtronic PLC. Still, the company's stock price was up slightly since the merger was announced, but has fallen a little more than 2% as of this morning, back to its pre-announcement level.

Congressional Democrats support the proposal, while House Ways and Means Committee Chairman Rep. David Camp (R-MI), said "a few campaign style speeches and stopgap measures from Treasury won't do it," but didn't recommend repealing the reforms, according to the Wall Street Journal. The Treasury Department's moves comes in the context of congressional inaction on the inversion issue and corporate tax reform more generally.

Whether the Medtronic-Covidien deal goes through or not, a big part of its draw is now diminished. The company's previous recruitment of lobbyists to combat anti-inversion legislation has been undone by executive branch action.

- here's the release from the Treasury Department
- more details about the reforms from the Treasury Department
- here's more from The Wall Street Journal (sub. req.)
- here's more from Bloomberg Businessweek