Fitch: US Corporate Re-Domicile Changes Cash Access Implications

International mergers & acquisitions involving a change of domicile can remove a tax hurdle to accessing foreign earnings, according to Fitch Ratings. However, 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.

US corporations are giving more consideration to international mergers & 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 spate of US multinational corporations seeking favorable tax treatment of foreign earnings in jurisdictions that can significantly differ from US rules. Recent examples include US 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” because the federal US corporate tax rate is 35% while the tax rate in Ireland is 12.5% for most trading income.

US GAAP (Generally Accepted Accounting Principles) rules exempt corporates from recognizing deferred tax liabilities on foreign earnings that are reinvested abroad for an indefinite period. However, US companies cannot repatriate those earnings without paying corporation tax on the differential between the foreign tax and the likely higher US corporation tax. Unsurprisingly, US corporations have been disinclined to repatriate cash. Undistributed Foreign Earnings (UFE) consequently rise, (as do foreign cash piles), if not used for foreign capex or acquisitions.

To compensate, management may increase borrowings in its domestic US business if that 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 US-incurred debt.

When rating a US multinational corporate issuer or one that has redomiciled, Fitch 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.

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 US 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 US entities. 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.

Applicable Criteria and Related Research:

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