Fitch Ratings has weighed in on the controversy stemming from corporate inversions, noting that it could have an impact on a company's cash access and credit.
While a change of domicile can remove a tax hurdle to accessing foreign earnings, Fitch noted, the “credit impact of such transactions would depend on the nature of the acquisition, the tax structure of the group, and the use to which any released cash or tax savings are put.”
Fitch acknowledged that U.S. corporations are giving more consideration to international mergers and acquisitions involving a change of domicile as a means to tap cash held overseas in a more tax efficient manner, as well as to better compete in the global marketplace.
There has been a series of deals in recent months in which U.S. multinational corporations have been seeking favorable tax treatment of their foreign earnings in jurisdictions that can significantly differ from the tax rules in the U.S.
Recent examples include AbbVie acquiring Ireland-based Shire for $55 billion; Medtronic Inc. purchasing Covidien Plc; Actavis Plc's purchase of Forest Labs; Mylan acquiring Abbot Laboratories’ generics business. Just this week Hospira Inc. is reportedly in talks to purchase Danone's medical nutrition unit. Ireland is particularly attractive for so-called “inversion deals,” Fitch pointed out, because the U.S. corporate tax rate is 35 percent while the tax rate in Ireland is 12.5 percent for most trading income.
Fitch pointed out that U.S. GAAP rules exempt corporates from recognizing deferred tax liabilities on foreign earnings that are reinvested abroad for an indefinite period. However, U.S. companies cannot repatriate those earnings without paying corporate taxes on the differential between the foreign tax and the likely higher U.S. corporation tax.
“Unsurprisingly, U.S. corporations have been disinclined to repatriate cash,” said Fitch. “Undistributed Foreign Earnings (UFE) consequently rise, (as do foreign cash piles), if not used for foreign capex or acquisitions.”
To compensate, Fitch noted that a corporation’s management could increase borrowings in its domestic U.S. business if the business does not have sufficient stand-alone cash flow or earnings to support shareholder returns that are based on the group's consolidated numbers, domestic capex and the servicing of largely U.S.-incurred debt.
When rating a U.S. multinational corporate issuer or one that has redomiciled, Fitch said it evaluates the potential credit profile imbalances between the entity's domestic and foreign activities.
“A highly leveraged domestic business, despite healthy consolidated metrics, could lead Fitch to take a rating action,” the credit-rating agency warned. “We would likely be neutral as to the potential benefit of re-domiciling and would assess each M&A transaction on a case-by-case basis. For example, issuers might choose to return the released’ cash to shareholders instead of creditors. Moreover, loans, other cash remittances and guarantees from foreign entities may still be necessary to support debt remaining in the U.S. business, which may lead to tax or other support complexities lying within the consolidated accounts.”
In some cases, however, such a restructuring may, for example, offer greater potential for tax deductible intercompany interest payments in U.S. entities, Fitch pointed out. “This type of restructuring might result in the group becoming more tax efficient overall, which could then permit taking the consolidated profile more at face value, if the potential for unprovided deferred tax has been reduced and cash is free-flowing within the group,” said Fitch.
For more information on the topic, Fitch has released a report, "Phantom Earnings: Offshore Accounts of US Multinationals May Come Back to Haunt Investors," which is available at www.fitchratings.com.