Corporate Inversions Could Get Hit With Retroactive Legislation

Corporate Inversions Could Get Hit With Retroactive Legislation

As corporate inversions have ramped up from just one in 2010 to sixteen signed so far this year (though not all of them finalized), one of the common tropes about the ensuing political backlash is that it will only drive corporations finish their inversion deals before new legislation takes effect. But rushing into a merger purely for tax reasons could easily backfire as Congress has a record of making retroactive changes to the tax code, which the courts have allowed as long as the change doesn’t go back for more than about a year.


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Corporate inversions: Supreme Court allows retroactive changes to the tax code, up to a point

One of the stronger pieces of legislation working its way through Congress is the Stop Corporate Inversions Tax Act of 2014 submitted by Senator Carl Levin with essentially the same thing being supported by his brother Representative Sandy Levin in the House. This would give Treasury the power to limit tax inversion when the change in control amounts to 50% or less of the domestic company’s stock, as well as companies where control or management remains in the US along with at least 25% of employees, sales, or assets.

But this bill is only intended as a stop-gap measure, covering the period from May 8, 2014 to May 2016, so that Congress can take its time crafting a permanent solution. It extends back to last May specifically so companies can’t benefit from jamming a deal during the legislative process.

“The question of whether anti-inversion legislation can legally be applied retroactively, while obviously not settled, ultimately turns on whether it would pass constitutional muster,” writes Jason M. Halper in a post to the Harvard Law School Forum on Corporate Governance and Financial Regulation.

Looking for some precedent, Halper first looks at a 1927 case where the Supreme Court invalidated a change to the nation’s estate tax going back 12 years as a violation of the Fifth Amendment’s Takings Clause. But in 1994 the Supreme Court upheld retroactive taxes in United States v. Carlton as long as they only go back for about a year (fourteen months in that case).

A period of retroactivity longer than the year preceding the legislative session in which the law was enacted would raise, in my view, serious constitutional questions,” Justice O’Connor wrote in that opinion.

Backing out of a corporate inversion won’t be easy

Of course corporate lawyers are aware of this, and some of this year’s corporate inversions have provisions that would allow the companies to back out if there is a significant change to the tax code, but acting on those provisions only creates new risks.

“Obtaining the tax benefits associated with an inversion requires that the merging companies have a non-tax purpose for the deal. Terminating based solely on or following a change in law could lead to regulatory inquiries and shareholder litigation based on the accuracy of any disclosure previously made regarding the purpose of the deal,” writes Halper.

Leaving aside all the organizational turmoil that would result, companies that make a strategically doubtful merger solely for tax purposes risk being saddled with a partner they no longer want but can’t shake loose for fear of bringing on the regulators.

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