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What is The Impact on Medtronic As Treasury Tightens Screw On Inversions?

What is The Impact on Medtronic As Treasury Tightens Screw On Inversions?
The U.S. Treasury announced some changes to make corporate inversion deals more difficult. How does this affect the Medtronic acquisition of Ireland-based Covidien?

On Monday, the U.S. Treasury announced new rules that would make it harder for companies to do tax inversion deals and relocate abroad in order to avoid paying U.S. taxes.

The new rules which aim to "reduce the tax benefits of — and when possible, stop — corporate tax inversions" are effective immediately which means that any inversion deals closing on or after Sept. 22 will be subject to it.

This includes $42.9 billion deal by which Medtronic was hoping to buy Covidien to become the newly-inverted Medtronic plc with headquarters in Ireland, where Covidien is based.

A Medtronic spokesman declined to comment on the impact of the new rules merely providing the following statement:

"We are studying Treasury’s actions. We will release our perspective on any potential impact on our pending acquisition of Covidien following our complete review,” wrote Fernando Vivanco in an email. 

Meanwhile as both Medtronic's and Covidien's stock price declined on the news Tuesday morning, Wall Street analysts were trying to answer the question of how the new rules will impact this megadeal that Medtronic announced in June.

Below are some reactions of analysts from JPMorgan Chase and RBC Capital Markets regarding the potential impact of new rules for the Medtronic-Covidien deal

  •  According to the press release from Treasury, currently U.S. multinationals owe U.S. tax on the profits of their controlled foreign corporations (CFCs) that they pay only when those profits are brought back home. Tax inverted companies get around this problem by having their CFC's make a loan to the newly formed foreign parent instead of the U.S. parent. But new rules as of Monday remove this so-called "hopscotch loan" loophole making those loans "U.S. property" and thereby subject to U.S. taxes.

"This means that Medtronic can’t access its [outside the U.S.] cash for a U.S. transaction, and specifically Medtronic’s Swiss [subsidiary] can’t make a loan to the new (post-inversion) parent without it being considered a taxable event," wrote Michael Weinstein with JPMorgan Chase in a note to investors Tuesday.

  • Consequently, Medtronic will likely have to borrow abount $15 billion to finance the Covidien purchase, Weinstein surmises, noting that Medtronic's earnings-per-share is going to take a hit assuming that the Minnesota device maker borrows in the U.S. to fund the cash portion of the deal.
  • Like Weinstein, Glenn Novarro, analyst with RBC Capital markets feels that "there could potentially be negative tax consequences for Medtronic plc associated with the provision seeking to close the "hopscotch" loophole."
  • But unlike Weinstein, who wasn't sure whether the Treasury was taking aim at the practice of "earnings stripping" - where the inverted foreign entity loads up the U.S. subsidiary with excessive debt with the goal to reduce the latter's U.S. taxable income - Novarro wrote that the new rules do not in fact do so.
  • Weinstein believes that Treasury's actions do not change the rationale for the Medtronic-Covidien and Novarro wrote that he expects the Medtronic-Covidien deal to close despite the new rules.

"... [Medtronic's management has recently (in fact as recently as September 8th) said that they remain committed to the [Covidien] transaction under different scenarios (inversion, non-inversion, etc), but might have to  'adjust based on new [tax] rules,'" Novarro wrote in his note to investors.

[Photo Credit: iStockphoto.com user ca2hill]  

-- By Arundhati Parmar, Senior Editor, MD+DI
[email protected]

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