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Pfizer pursues inversion, shows companies undeterred

Pfizer Inc. has approached Actavis Plc to express its interest in an acquisition that could allow the U.S. drugmaker to move overseas and reduce taxes, in a sign the Obama administration’s efforts to curtail such deals could fall short.

Pfizer made its approach before the U.S. Treasury Department announced new rules Monday to make such deals – called tax inversions – more difficult, people with knowledge of the matter said. Those changes won’t deter Pfizer, even if they are a complication, one of the people said, asking not to be identified discussing private information.

Another high profile inversion deal, Burger King Worldwide Inc.’s purchase of Tim Hortons Inc., will proceed, the Canadian company said after the rule changes were revealed. While Treasury Secretary Jacob J. Lew could take further steps, he steered clear of putting an end to a key benefit of inversions, which allow companies to lower their U.S. earnings by shifting profits overseas using a technique known as earnings stripping.

“The ability to shelter future foreign earnings from U.S. tax seems to be a principal objective and, as far as I can see, that benefit remains,” said Robert Willens, a corporate tax consultant in New York.

While Pfizer isn’t just looking to cut taxes – it’s also seeking to bolster its product pipeline – Chief Executive Officer Ian Read, has made no secret of his objections to U.S. tax policy.

“There’s no substantial advantage to being a U.S. company, to doing business in the U.S.,” he said on a July conference call. “We are at a tremendous competitive disadvantage.”

No offer

Reed also said he’s tired of criticism directed at companies and CEOs for doing what he says may be the best strategy to help shareholders.

Pfizer and Actavis aren’t currently in formal talks and Pfizer hasn’t made an offer, the people said. The approach comes after Pfizer in May abandoned a $114 billion bid for AstraZeneca Plc.

Actavis, which is run from Parsippany, New Jersey, obtained an Irish tax domicile by acquiring Warner Chilcott Plc last year. The company has a market value of almost $64 billion.

Although AstraZeneca rebuffed Pfizer’s approach, the U.S. drug giant is still considering pursuing that deal as well as other options, the people said. Representatives for Pfizer and Actavis declined to comment.

New hurdles

Presented under pressure from Democrats, and constrained by the strictures of the tax code, the Treasury Department’s plan sticks to areas where the administration has clear legal authority without needing approval from Congress, and mostly targets deals where the value of an inversion is derived from unlocking U.S. companies’ stockpiled foreign earnings.

That stockpile, now over $2 trillion, is a result of the fact that companies don’t have to pay taxes on profits as long as they’re kept outside of U.S. borders.

Pfizer has indicated it has as much as $30 billion in offshore cash and investments.

Still, the government didn’t address earnings stripping – a maneuver that companies use to load their U.S. operations with deductions for debt and other items, effectively pushing the profits to the foreign country with a lower rate.

“They’re ignoring the most important post-inversion planning and that’s earnings stripping,” said Bret Wells, a tax law professor at the University of Houston. Although the government may make more changes, “the tepid response that this represents could well embolden companies to believe that Treasury is not going to deal with earnings stripping through regulations, that they’re going to wait for broader reform to do that.”

Pfizer’s effort to acquire AstraZeneca was among a number of high-profile deals that have caught U.S. lawmakers’ attention this year, prompting Treasury’s response, including Burger King’s deal to buy Tim Hortons and move its address to Canada.

Scott Bonikowsky, a Tim Hortons spokesman, said the deal is “moving forward as planned” and is driven by long-term growth and not tax benefits.

The new rules won’t affect companies’ ability to put future foreign profits outside the U.S. tax system, said Joan Arnold, a partner at Pepper Hamilton LLP in Philadelphia.

“If I had one where I was planning a lot of new business outside the U.S., it wouldn’t stop me much at all,” she said.

Congressional action

The Treasury Department is limited by the tax code itself, which contains specific numerical pegs that can’t be circumvented. For example, because a 2004 law essentially defines inversions as transactions where U.S. shareholders own more than 80 percent of the new company, the Treasury Department can’t change it unilaterally.

In July, Actavis closed a $28 billion takeover of Forest Laboratories Inc., making it large enough for Pfizer to target in an inversion under U.S. law. Changing that law would require congressional action.

While many Democrats, including President Barack Obama, support the idea, it hasn’t advanced in Congress, even in the Democratic-controlled Senate. Republicans prefer a broader revamp of the tax code, which is at least a year away.

Pfizer may not make any moves until late November, after U.S. elections, one person said.

The Treasury Department left open the possibility that it will impose new limits on earnings stripping, with the notice from the government seeking comments on the issue. Still, the fact that government has been talking about tightening those rules for more than a decade may diminish the impact of the warning, Arnold said.

“Until they come out with an earnings stripping rule,” she said, “I don’t think people are going to be very worried about it.”