Corporate Inversions: Why Are Corporations …

1 Corporate Inversions: Why Are Corporations Leaving the and What It Means For Your Company January 28, 2016 Moderated by: Shawn Haque of Accenture Federal Services Presented by: Daniel Davidson, Christine Lane, and James Wickett of Hogan Lovells Today s Speakers Daniel Davidson Partner, Washington, Hogan Lovells Shawn Haque Corporate Counsel Accenture Federal Services 2 Christine Lane Partner, Washington, Hogan Lovells James Wickett Partner, Washington, Hogan Lovells Program Outline is an inversion and Why Do companies Invert? or Anti-Expatriation Rules of inversion Transactions Erosion, Tax Competitiveness, and BEPS International Tax Reform s Next? Biographies inversion Defined 4 Why Invert? Worldwide taxation of Corporations Relatively high Corporate tax rate 35% federal tax rate, plus State taxes (as high as 8% or 9%) Earnings from foreign subsidiaries of Corporations subject to tax on distributions to parent.

2 Far-reaching CFC rules ( Subpart F rules) may cause tax before actual distribution. Limitations on use of foreign tax credits 5 Examples of Countries With Lower Headline Corporate Tax Rates Than the United States Ireland ~ United Kingdom ~ 21% Canada ~ 15% federal; 10%-11% provincial Tax havens ~ zero 6 Why Invert? Many countries have much lower Corporate income tax rates, no or less comprehensive CFC rules and may not tax dividends received from subsidiaries ( , participation exemptions). 7 Overview of Inversions An inversion is the process whereby a foreign Corporate entity becomes the parent entity of an established company Goal of an inversion is to move the ultimate parent of a company out of the global taxation system A self inversion is accomplished via an entirely internal transaction no third party merger required but curtailed after 2004 An acquisitive inversion is typically accomplished through a reverse triangular merger with a merger subsidiary of an existing foreign Corporate entity Two key goals for many inversion transactions.

3 Ability to lower effective tax rates both through accessing lower global tax rates and reducing earnings Access offshore cash to boost shareholder value through acquisitions, stock buybacks, and dividends 8 Illustrative Example 9 Co Foreign Co Co $25B Foreign Co $3M Co Foreign Co Foreign Co Co + = + = VS Typical Merger inversion 10 Co Foreign Co Subsidiaries Co Subsidiaries Merger Sub (United States) Foreign Co Co Subsidiaries Shareholders Shareholders issues new shares Shareholders Original Structure inversion Transaction Final Structure Does inversion Eliminate Tax? The inversion does not entirely escape the US tax net: Co. still subject to tax. Foreign IP (and associated profit) held in pre-existing foreign IP holding company may still be subject to tax (foreign IP HoldCo would remain under US Co in structure, thus foreign profits must still be repatriated through US Co).* Foreign subsidiaries under US Co still considered CFCs and subject to tax on certain income.

4 * Depending on exit costs, CFCs and foreign IP remaining under US Co could be transferred to new foreign parent. 11 Foreign Co Co Subsidiaries, , pre-existing foreign IP HoldCo Shareholders Final Structure So Why Invert? Potential benefits: Going forward, possible lower tax rate for new: Foreign IP Foreign ventures Foreign subsidiaries Intercompany transactions or borrowings may further reduce tax as typically may be the case in large multinational groups. 12 Foreign Co Co Subsidiaries Shareholders Final Structure New Foreign Ventures New Foreign Subsidiaries New Foreign IP Hold Co How Many Corporations Have Implemented (or Plan to Implement) Inversions? 13 Source: Representative inversion Transactions Since 2012 14 Announcement Date Close Date Acquirer Target Transaction Value ($bn) New Jurisdiction 03/19/14 09/19/14 Horizon Pharma Vidara Therapeutics $ Ireland 06/15/14 01/26/15 Medtronic Covidien $ Ireland 07/14/14 03/25/15 Mylan Abbott $ Netherlands 08/26/14 12/15/14 Burger King Tim Hortons $ Canada 03/28/12 09/28/12 Pentair Tyco $ Switzerland 05/21/12 11/30/12 Eaton Cooper $ Ireland 02/05/13 06/07/13 Liberty Global Virgin Media $ United Kingdom 05/20/13 10/01/13 Actavis Warner Chilcott $ Ireland 07/29/13 12/18/13 Perrigo lan $ Ireland 11/05/13 02/28/14 Chiquita Fyffes $ Ireland 15.

5 [W]e have a huge inversion problem in this country. I mean, you look at some of the companies that are talking about leaving the United States and many of these companies are run by people from Britain, and from They have no loyalty to this country. Donald Trump* [Treasury and the IRS] do intend to issue additional guidance, and we are still very mindful of the type of planning that s out Daniel McCall, Special Counsel, IRS Office of Associate Chief Counsel (International)* "If something is legal, you should always do it. That's why I'm going to Japan on my next vacation to hunt dolphins. Stephen Colbert addressing Corporate inversions on The Colbert Report* How Santa Got To The North 16 ~ Sun Sentinel 17 Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury. There is not even a patriotic duty to increase one s taxes. ~ Judge Learned Hand; Helvering v. Gregory, (2d Cir.)

6 1934) Pfizer-Allergan 18 One of the most recent and largest ($160 billion) Corporate inversions. Good example of the impact of recent rhetoric the deal s break-up fee because of a change of law is only $400 million. Anti- inversion or Anti-Expatriation Rules - IRC 367 19 inversion transactions are not new. Early well-known examples include McDermott Inc. (1982) and Helen of Troy (1993). Congress has tightened certain provisions of the Internal Revenue Code (IRC) periodically to address inversion transactions. Example, IRC 367(a) imposes a shareholder-level gain on transfers of appreciated property by a person to a foreign corporation in what would otherwise qualify for tax-free treatment under tax rules. Reg. (a)-3(c): shareholders who exchange domestic stock for foreign stock generally have to recognize gain unless certain conditions satisfied. Intended to allow non-recognition treatment when a larger foreign company acquires a smaller one for business reasons, but not when the company is larger and trying to invert.

7 Anti- inversion or Anti-Expatriation Rules - IRC 367 20 Reg. (a)-3(c) Requirements: No more than 50% of vote and value of transferee foreign corporation is received in the transaction by transferors; No more than 50% of vote and value of transferee foreign corporation is owned immediately after the transfer by persons who are directors, officers, or 5% shareholders of the target corporation ; The transferee foreign corporation has been engaged in business outside the for at least 36 months prior to the transaction, and the FMV of the transferee foreign corporation is at least equal to the FMV of the target company; and 5% shareholders of transferee foreign corporation enter into a 5-year GRA. Anti- inversion or Anti-Expatriation Rules - IRC 367 21 Market reaction to IRC 367 In a number of cases, companies tried to bring themselves within IRC 367(a) rules and in other cases, the fact that the shareholders might recognize gain did not serve as a deterrent, for example: Where shareholders are tax-exempt or have a loss rather than gain on their shares.

8 Public companies where taxation of the shareholders on the transaction may not be a deterrent if the tax or other benefits of the transaction are sufficiently great and may result in a higher value for the stock ultimately. Anti- inversion or Anti-Expatriation Rules - IRC 7874 22 IRC 7874 (introduced in 2004) is now the primary Corporate -level anti- inversion statute (IRC 367 may still apply at the shareholder level). For IRC 7874 to apply, two tests must be met: The shareholders of the target must end up with at least a certain specified percentage of the foreign acquiring corporation s shares (the Stock Ownership Test ); and The resulting Corporate group must fail to have substantial business activities in the country of the foreign acquiring corporation (the Substantial Business Activities Test ). Congress intended these criteria to distinguish legitimate business transactions from ones engineered primarily to reduce tax. Anti- inversion or Anti-Expatriation Rules IRC 7874 Stock Ownership Test Sets out two different levels of stock ownership and establishes separate and distinct consequences at each level.

9 60% stock ownership: Do the former shareholders of the target own at least 60% of the shares (by vote or value) of the foreign acquiring corporation ? If so and if the Substantial Business Activities Test is NOT satisfied the consequence is: Certain gain recognized by the target ( inversion gain ) in connection with the acquisition or for 10 years thereafter cannot be sheltered from tax ( , by NOLs or foreign tax credits). 23 Anti- inversion or Anti-Expatriation Rules IRC 7874 Stock Ownership Test 80% stock ownership: Do the former shareholders of the target own at least 80% of the shares (by vote or value) of the foreign acquiring corporation ? If so, the foreign acquiring corporation is treated as a domestic corporation . This creates a severe risk of double taxation. For purposes of the 60 and 80 percent ownership tests, it does not matter how many shareholders of the target corporation were themselves persons in contrast with IRC 367. 24 Anti- inversion or Anti-Expatriation Rules Substantial Business Activities Test IRC 7874 only applies if, after the acquisition, the expanded affiliated group ( EAG ) does NOT have substantial business activities in the foreign country in which, or under the laws of which, the entity is created or organized, when compared to the total business activities of the EAG.

10 25 Anti- inversion or Anti-Expatriation Rules Substantial Business Activities Test 26 Facts and Circumstances Safe Harbor/SBAT met if > 10% of each of the following are located in foreign country: (i) employees (measured by headcount and compensation), (ii) value of assets, and (iii) sales. 2004-June 2009 June 2009-June 2012 Facts and Circumstances Safe Harbor/SBAT met if > 10% of each of the following are located in foreign country: (i) employees (measured by head count and compensation), (ii) value of assets, and (iii) sales. Post June 2012 Facts and Circumstances Old Safe Harbor, but (1) raised 10% to 25%, and (2) made it substantive test (no longer safe harbor) Notices 2014-52 and 2015-79 inversion Transactions v. Legislation 27 McDermott ( 1248(i)) Helen of Troy 7874 Anti- inversion or Anti-Expatriation Rules Substantial Business Activities Test Now, to meet the Substantial Business Activities Test all of the following must be satisfied with respect to the relevant foreign country 25% of employees, both by headcount and compensation; 25% of the total value of all group assets; and 25% of all group income.