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Tax inversion transactions, part 1: background for the new rules

In a junior-high civics class, the roles seem so settled. The legislative branch makes laws, the executive branch enforces them and the judicial branch interprets them.
n practice of course, the interactions of the branches of government are often not so clear.

Consider, for example, the current controversy about new IRS rules on tax inversions. In this two-part post, we will discuss those rules and the situation they are responding to.

Tax inversion transactions have received considerable scrutiny in the last couple of years. Broadly speaking, these transactions involve a U.S. company making an acquisition abroad and reincorporating in a different country to avoid U.S. tax obligations.

Two years ago, a leading case of this was the acquisition by Medtronic, a Minnesota-based medical device maker, of an Irish company called Covidien. We wrote about that transaction in a post on the capital gains considerations involved in inversion deals.

Since Medtronic's move, several more companies have its lead in moving corporate headquarters to another country as a shelter against U.S. taxes.

In April of this year, the U.S. Treasury Department issued rules intended to take away the tax benefits for companies that acquire U.S. partners. Though Congress had not specifically passed legislation on this, Treasury took the position that it had the authority to act under other tax laws.

The rules quickly had a significant effect on further deal-making. The rule change appears to have played a key role in scuttling a proposed merger between Pfizer, the giant American drug company, and a company based in Ireland called Allergan Plc.

Now the new rules are facing a legal challenge, brought by the Texas Association of Business along with the U.S. Chamber of Commerce. In part two of this post, we will update you on this suit.

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