Johnson Controls-Tyco deal could be impacted by new federal regulations

Treasury rules aim to reduce tax inversion benefits

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Glendale-based global multi-industrial firm Johnson Controls Inc. is evaluating new federal tax rules proposed yesterday that could impact its planned merger with Irish fire protection and security solutions company Tyco International plc.

Johnson Controls Inc. headquarters
The Johnson Controls Inc. headquarters in Glendale.

The temporary and proposed federal regulations were introduced yesterday by the U.S. Department of the Treasury and the Internal Revenue Service. They aim to make corporate tax inversions less attractive to companies like Johnson Controls and Tyco, which are planning to locate their new company’s headquarters in Ireland in a move they say would save $150 million a year in taxes.

This shift in legal domicile to a country with lower taxes can have large tax benefits for the U.S. company. The strategy has recently been criticized by U.S. politicians for taking away tax revenue from the U.S. government.

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One of the moves the Treasury made yesterday would eliminate the tax deductible status of interest payments on intercompany loans, which could be used to reduce the taxes paid in the U.S. by a foreign company in a practice known as earnings stripping.

“They can borrow money from the company headquarters, so they get an intercompany loan, and then they will pay the interest back on that loan to the headquarters and the interest is tax deductible,” said Matteo Arena, associate professor of finance at Marquette University. “They would pay fewer taxes to the U.S.”

Another rule less likely to impact Johnson Controls and Tyco would aim to limit the benefits of “serial inverting,” or buying up several U.S. companies and using the subsequent growth in size to avoid the existing inversion thresholds for a subsequent acquisition in the U.S.

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In a filing with the SEC Tuesday, Tyco and Johnson Controls made the following statement about the impact of the new rules on their pending transaction:

“On April 4, 2016, the U.S. Department of the Treasury and the Internal Revenue Service issued temporary and proposed regulations regarding certain transactions involving a U.S. company and a foreign company. Johnson Controls and Tyco are conducting a review of these announced actions and are not making any statements regarding the possible impact of these announced actions prior to their completion of this review.”

But the corporate earnings repatriation tax advantage is still available to foreign domiciled corporations, which is likely where the majority of Tyco and Johnson Controls’ tax savings will come from in the transaction, Arena said.

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“It’s unlikely that (the merger is) not going to go through, but the possibility that they’re not going to merge is there,” he said.

“Treasury has taken action twice to make it harder for companies to invert,” said Treasury Secretary Jacob Lew Monday. “These actions took away some of the economic benefits of inverting and helped slow the pace of these transactions, but we know companies will continue to seek new and creative ways to relocate their tax residence to avoid paying taxes here at home. Today, we are announcing additional actions to further rein in inversions and reduce the ability of companies to avoid taxes through earnings stripping.”

Lew also encouraged Congress to pass legislation addressing the increasingly common practice of corporate tax inversion by adjusting the business tax code.

In his remarks about the economy today, President Barack Obama also addressed the regulatory change and his efforts to curb inversions.

“As a practical matter, (corporations that complete tax inversions) keep most of their actual business here in the United States because they benefit from American infrastructure and technology and rule of law. They benefit from our research and our development and our patents. They benefit from American workers, who are the best in the world. But they effectively renounce their citizenship. They declare that they’re based somewhere else, thereby getting all the rewards of being an American company without fulfilling the responsibilities to pay their taxes the way everybody else is supposed to pay them.

“When companies exploit loopholes like this, it makes it harder to invest in the things that are going to keep America’s economy going strong for future generations. It sticks the rest of us with the tab. And it makes hardworking Americans feel like the deck is stacked against them.”

The Johnson Controls-Tyco merger was announced in January and is expected to close in September. Its value is estimated at about $16.5 billion. The combined company’s headquarters will be in Cork, Ireland, while the primary North American operational headquarters will be in the Milwaukee area. Johnson Controls is also in the process of spinning off its automotive seating and interiors segment into a new company, called Adient, which is expected to close October 3.

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