(Bloomberg) Hal Hicks cleared his throat and addressed a roomful of peers in a midtown Manhattan auditorium. The topic: the tax-avoidance technique called inversion, in which a U.S. company claims a foreign legal address.
Waving his hands back and forth as if tracing a pendulum’s swing, Hicks explained how four government attacks over three decades had failed to stop the practice. “There’s been lots of law thrown at these transactions,” he said at the January session.
Hicks ought to know. He was the one doing the throwing, during four years as a top government tax lawyer. Then, he returned to private practice and helped set in motion a spree of inversions that a congressional panel estimates will cost at least $19.5 billion in lost tax revenue over the next decade.
Hicks epitomizes the world of high-level Washington lawyers who have played a behind-the-scenes role in helping these tax-driven address changes proliferate. Top federal tax officials, many of them career corporate lawyers, have sometimes closed loopholes only after companies slipped through them. And former officials like Hicks use skills and contacts honed in office to help companies legally outmaneuver the government.
Changing Address
Until this year, when address-shifting by more than a dozen companies worth $100 billion caught policy makers’ attention and President Barack Obama clamped down again, inversion rules had for a decade attracted little notice outside the small community of international tax lawyers in Washington.
At the Treasury Department and Internal Revenue Service, officials, many on hiatus from private practice, crafted the rules in dialogue with top corporate law and accounting firms.
While some European nations have historically relied on career civil servants, the top ranks of the U.S. tax administration have swapped staff with industry for decades.
It’s a low-cost way to provide government with the best legal talent, said Gregory Jenner, a former acting assistant Treasury secretary, who calls it an “incredibly beneficial tradition.”
“Putting rookies into these jobs—they would be overwhelmed,” Jenner said. “It’s too high-level, too sophisticated, too complicated.”
The risk, critics say, is that some government lawyers may continue to sympathize with corporate interests, or be swayed by former colleagues.
U.S. Loses’
“The government loses,” said Susan Borkowski, an accounting professor at La Salle University in Philadelphia who has studied IRS staffing. “It’s very hard to be sitting across from someone that you know—you may have dealt with that company in the past and you know you’re going to deal with it in the future—and be totally objective.”
Hicks declined to comment for this story. Since 2000, the five people including Hicks to leave the international tax counsel post at the Treasury joined private law or accounting firms. All but one registered as lobbyists. Only two had stints in government that lasted more than five years.
In a statement, the Treasury said that hiring from the private sector helps “keep us at the forefront of emerging issues.”
“We have benefited from numerous staff who bring their extensive expertise on a range of issues, including tax policy, financial markets and economics from their time in the private sector,” the department said.
Former Officials
Current and former officials mingle at dozens of tax conferences each year, where the business cards change yet not the faces. At a 2009 conference, Hicks took the opportunity to rib a fellow panelist—an IRS lawyer whom he’d worked with in government—about a rule that Hicks deemed unreasonable.
“Who the hell are you,” he exclaimed, “and what have you done with my friend Steve Musher?” The audience of tax lawyers erupted in laughter.
The revolving door was again on display at Hicks’s talk in January, at a legal education forum hosted by New York-based non-profit Practicing Law Institute. To his right and left at the panel discussion were three prominent corporate lawyers, all of whom had previously served at the IRS or Treasury.
One was Hicks’ former boss at the IRS, Nicholas DeNovio. Last year, DeNovio helped New Jersey’s Actavis Inc. become Irish in one of the largest corporate inversions. Through a spokesman, DeNovio declined to comment.
Treasury Rules
Some 45 companies have inverted over the past three decades. Most of these companies don’t move their executives or factories out of the U.S., just their legal domicile. Treasury Department rules issued last month to discourage inversions stopped three planned transactions. Six more are still in the pipeline.
The incentive for companies to invert is simple: foreign- owned companies operating in the U.S. typically pay less tax than multinational companies incorporated here. That’s because the U.S. has a corporate income tax of 35 percent, the highest in the developed world. And the tax applies to U.S. companies’ global income; foreign-owned firms don’t pay U.S. tax on their worldwide income.
What’s more, tax lawyers have developed sophisticated methods of shifting reported profits from the U.S. to lower-tax jurisdictions abroad, increasing the potential payoff for escaping the U.S.’s tax on foreign income.
Tax Maneuver
No U.S. law firm has helped more companies escape the tax system through inversions in the past decade than Skadden Arps Slate Meagher & Flom LLP. Hicks, 55, who runs its international tax group, has pulled off three inversions himself, including one involving an innovative maneuver nicknamed a “skinny down distribution.”
A jovial Virginian who rarely misses a chance to crack a joke, Hicks once co-wrote a paper that compared the IRS to Mr. Wilson, the grumpy neighbor in the Dennis the Menace comic strip.
In and out of government, Hicks has argued that federal officials should focus on policing the most clear-cut examples of abusive tax dodging, eschewing broad attacks that could hinder legitimate business.
“If there’s a pro-taxpayer position that we can take, especially if it’s going to reduce the compliance burden on IRS, we’ll take it,” he told the legal publication BNA in 2007. “If there’s a real problem, we’re going to shut it down.” BNA is now owned by Bloomberg News parent Bloomberg LP.
Objectionable Transaction’
Not everyone in the tax community favored that style of regulation. In a 2007 article in Tax Notes, columnist Lee Sheppard criticized Hicks for using an approach that “attacked an objectionable transaction in narrow and specific terms while letting near-misses have a pass.”
The son of a Virginia Beach lawyer, Hicks was rush chairman for his fraternity at the College of William & Mary, in Williamsburg, Virginia, before earning law degrees at the University of Virginia and New York University.
In a 2012 note to fellow Virginia law alumni, Hicks said he had been married for 27 years—“clearly the woman is a saint”—and one of his sons had become a teacher. “Much more noble than a tax lawyer,” he wrote.
Hicks started at Skadden in the 1980's, followed by roles at the accounting firm Ernst & Young LLP and two other law firms. In 2003, the top international job opened up at the Internal Revenue Service’s chief counsel’s office.
“He really thought he had missed something by not spending some time inside the IRS or the Treasury,” said David Benson, a former colleague at Ernst & Young in Washington. “He wanted to put that arrow in his quiver.”
Death Star’
During his time in government, Hicks and his colleagues published volumes of regulatory guidance, and he was quoted extensively in the tax trade press. He nicknamed one anti-abuse regulation he authored the “Death Star,” after the world- destroying weapon in the “Star Wars” movies.
Hicks’s tenure coincided with a temporary lull in inversions. Responding to a flurry of deals in the early 2000's, Congress had adopted an anti-inversion law in 2004, leaving it to Bush administration tax lawyers to implement details of the law.
In some cases, Hicks sought to temper the law’s effect. Echoing a suggestion from industry lawyers, he successfully pushed for a rule that any company with at least 10 percent of its business in a foreign country could establish tax residence there without running afoul of the law.
More Restrictive
Others, including the IRS’s Musher, argued unsuccessfully for a more restrictive threshold, according to a person with knowledge of the discussions. Musher declined to comment, as did the IRS.
At another point, Hicks told a tax conference that he was considering an idea, floated by the corporate tax bar, to eliminate the tax that shareholders of U.S. companies reincorporating overseas are required to pay. That idea didn’t go anywhere.
One of the few U.S. companies that shifted its address overseas during Hicks’ government tenure was Lazard Freres & Co., an investment bank founded in New Orleans in 1848 and now run from New York. Lazard shifted its tax address from Delaware to Bermuda when it sold shares to the public in May 2005—and then used a former government official to protect its tax advantage.
Tax Penalties
The 2004 anti-inversion law had targeted U.S. companies that set up a new parent corporation abroad, but it was silent on what would happen if they used a foreign partnership. That’s what Lazard did, creating an unusual Bermuda entity that issued publicly traded shares like a corporation but that qualified as a partnership under U.S. law.
Concerned that the “partnership” gap rendered the new law toothless, the Treasury Department published rules in December 2005 to close it. And it threatened to make the rules retroactive, erasing the tax advantage of Lazard’s new Bermuda domicile.
Lazard warned in a securities filing that it would face “substantially higher” taxes if the government applied the anti-inversion law to Lazard retroactively, adding that the company believed the law didn’t apply. Lazard hired four lobbyists to make its case to Congress and the Treasury.
One of Lazard’s advocates was Hicks’ predecessor in his Treasury job, Barbara Angus, who had returned to private practice after about four years of government service.
Make Retroactive
In June, the Treasury Department withdrew its threat to make the regulation retroactive. Although no more companies would be allowed to follow Lazard’s path to Bermuda, the bank kept its tax-haven domicile. Now at Ernst & Young, Angus declined to comment.
In a statement, Lazard said its 2005 reorganization shouldn’t be characterized as an inversion. “Lazard pays significantly more U.S. corporate tax as a Bermuda company than we did as a private global partnership,” the company said. “Lazard is rooted in three partnerships separately founded in 19th-century France, the United States and the United Kingdom, and now spans 27 countries.”
At the time the Treasury was weighing action on the type of transaction Lazard had used, Hicks was the department’s international tax counsel. It’s unclear what role, if any, he played in the decision to give Lazard a pass. The author of the published guidance was an IRS lawyer whom Hicks had hired,
Jefferson VanderWolk, who now also works at Ernst & Young. Through a spokeswoman, he declined to comment.
Radical Assertion’
After leaving the IRS, VanderWolk wrote a paper denouncing the 2004 anti-inversion law as a “radical assertion of tax jurisdiction.”
In early 2007, at a meeting of corporate tax lawyers, Hicks announced that he was returning to private practice after almost four years in government.
“I promised my wife I would be there for two,” he told the International Tax Review.
He was headed back to Skadden, which he told the Tax Review he’d chosen after considering a number of “wonderful firms.” In 2007, the average Skadden partner earned $2.3 million, according to American Lawyer magazine, more than 10 times what a top government lawyer can make.
Former top government officials often end up at Skadden. Hicks’s new partners there included a former IRS commissioner and two former assistant Treasury secretaries, not to mention B. John Williams, who had been the top IRS lawyer when Hicks joined the agency, and who later represented an inverted company, Ingersoll-Rand Plc, in a $774 million tax dispute with the IRS. Through a spokeswoman, Skadden declined to comment.
That year, the Tax Review called Skadden “the law firm of choice for departing government officials,” citing Hicks’s hiring.
U.K. Address
Not long after, Hicks found a role on the biggest inversion since the 2004 crackdown. He advised the independent directors of a Dallas oil-rig operator, Ensco International Inc., on its attempt to claim a U.K. tax address.
After Hicks left the government, Treasury had declared that the standard he had backed, which let any company with at least 10 percent of its business in a foreign country establish tax residence there, was too lax. Each inversion would instead be judged case by case. Ensco, which would have easily passed the 10 percent test, now faced the possibility of an IRS challenge.
In November 2009, a few days after Ensco announced its plans to invert, Hicks attended the panel discussion with the IRS’s Musher. Unlike Hicks and others of his predecessors in his IRS post, Musher has spent the bulk of his career at the agency.
Tougher Stance
Musher defended the IRS’s tougher stance, according to BNA, prompting Hicks to reply with his wisecrack about “What have you done with my friend?”
A few weeks later, Ensco completed the reorganization, and soon three other U.S. companies carried out the same type of inversion. Eventually, the government imposed an even higher threshold, but didn’t take action against Ensco or the others that had already completed deals. Ensco declined to comment.
In 2010, Hicks helped put together a deal that would do even more to trigger the next wave of inversions. Michael Pearson, the chief executive officer of Valeant Pharmaceuticals International Inc. in Aliso Viejo, California, shifted his company’s address to Canada by buying a smaller drugmaker there.
Normally, such a deal would entail an exit tax—the one Hicks had considered eliminating—for the U.S. company’s shareholders. Pearson himself would face a tax bill in the millions of dollars.
Foreign Partner
The exit tax applies only to companies that took the legal address of a smaller foreign partner. If the Canadian company, Biovail Corp., were bigger, there would be no tax. The rule included an anti-abuse provision that prevented artificially inflating the size of the foreign company to be bigger than the U.S. one.
As Hicks explained to his audience at the seminar in January, there was no analogous barrier to making the U.S. company temporarily smaller. The rules “focus on stuffing, not stripping,” he said. He paused with a smirk. “It sounds like it’s racier than it is.”
So like a boxer before a weigh-in, Pearson put his company on a crash diet. He paid his shareholders $1.3 billion of cash just before completing the acquisition, shrinking the U.S. company’s value to about 49.5 percent of the merged enterprise. This was what Hicks called the “skinny down distribution.”
Skinny Down’
Would the “skinny down” pass muster with the IRS? Hicks later wrote in a trade journal article that the IRS won’t give companies a formal answer on its views, but that “informal” talks with the agency “confirmed” that it wouldn’t challenge his interpretation.
As a Canadian company, Valeant was able to record profits in tax havens such as Barbados and then return them to shareholders without paying extra corporate taxes. Its effective tax rate dropped from 36 percent to 3, Pearson told analysts on a conference call in May.
On another call that month, Pearson ticked off a list of tax maneuvers Valeant uses, starting with its Canadian domicile. “We ask our tax teams to continue to try to do things that are completely legal,” he said. “We just work harder at it.”
This gave Valeant a leg up in competing for takeovers against U.S. rivals. Pearson embarked on an acquisition spree to build one of the largest drug makers in the world. Not to be left behind, rival pharmaceutical companies carried out their own inversions.
Pearson’s stake in Valeant is worth more than $1 billion. Despite the paper headquarters in Canada, he runs the company from near his home in New Jersey. Through a spokeswoman, Valeant and Pearson declined to comment.
Inversion Pace
As the pace of inversions picked up, Skadden and Hicks gained one client after another. Hicks helped food company Sara Lee Corp. shift its European coffee business out of the U.S. tax system; other partners helped a Pearson protege take another U.S. drug company offshore, and advised Pfizer Inc. on its failed attempt to get a British address through a takeover of AstraZeneca Plc.
This year, Hicks helped AbbVie Inc., the Illinois drugmaker, strike a deal to become British. With a market value of more than $90 billion, AbbVie’s would have been the largest inversion on record.
Unpatriotic’ Move
But the Treasury Department, reacting to the increase in pace and size of the deals, had them in its sights. In September, after Obama called inversions an “unpatriotic tax loophole,” Treasury unveiled more rules meant to make them less attractive.
Two recent recruits from private practice, including one from Skadden, authored the regulations. AbbVie was among three companies forced to cancel inversion plans.
Treasury also clamped down on “skinny down” deals. It stopped short of demanding back taxes on completed inversions like Valeant’s.
Undeterred, CEO Pearson is pursuing a $50 billion hostile takeover of California-based Botox maker Allergan Inc. If he prevails, he intends to use the Canadian domicile to shrink Allergan’s tax bill down to the level of Valeant’s. One of the law firms helping Pearson with his tax plans: Skadden Arps.
—With assistance from Max Abelson in New York and Richard Rubin in Washington.
