The U.S. government's new regulations on companies seeking reduced U.S. tax bills by way of foreign acquisitions are unlikely to slow the $12-billion merger of Burger King Worldwide Inc. and Tim Hortons Inc., even as the move by the U.S. Treasury casts a shadow over future deals.
Treasury Secretary Jacob Lew unveiled proposals late Monday that aim to close a hole in the U.S. tax system called "corporate tax inversions," where U.S. companies merge with foreign firms and move their headquarters to a country with a lower corporate tax rate.
Proposed restrictions include a ban on "hopscotch" loans, which shield U.S. companies from being taxed on earnings repatriated from foreign subsidiaries. The other major change was tightening foreign-ownership rules that require a U.S. company control less than 80 per cent of the new joined company after a merger. In his remarks, Mr. Lew said Treasury is taking an initial step forward with the limited power it has, and criticized the "lame-duck" Congress for not bringing an end to inversion deals through legislation.
The new rules will be effective immediately, including pending deals as well as all of those proposed in the future. The changes will not be retroactive, meaning deals that have closed won't be held to the new standards.
The Tim Hortons and Burger King combination is the biggest deal in the crossfire for Canada, and is reportedly one of the tie-ups that sparked the regulatory change, but observers argue that the deal is unlikely to buckle under the new pressures.
"We believe that the transaction still qualifies for inversion notwithstanding the new regulations, which are targeted toward more abusive transactions," said Peter Sklar, analyst with BMO Nesbitt Burns, in a note to clients. In this deal, Tim Hortons is the bigger business by earnings, he said.
The two companies previously stated in their jointly filed takeover circular that changes in U.S. law or regulations would not provide a legal reason for either to walk away from the deal without paying hundreds of millions in termination fees.
"We are moving forward as planned," said Scott Bonikowsky, senior vice president of corporate, public and government affairs at Tim Hortons, on Tuesday. "This deal has always been driven by long-term growth, not by tax benefits."
Ratings agency Fitch agreed that while the tie-up of the two quick-service restaurant chains has "strategic merit" independent of its tax advantages, "future potential tax benefits provided by the proposed structure should not be overlooked, even if the firm's effective tax rate remains unchanged."
One advantage for Burger King becoming a Canadian entity with Tim Hortons is that the combined company could potentially avoid paying U.S. tax rates on earnings repatriated from future expansions in foreign countries, which is a big part of both brands' future growth strategy. As Fitch noted, "Canada's territorial tax system is to likely provide a more tax-efficient way to access this growing base of earnings."
The transaction "would likely be safe from the U.S. Treasury's latest effort to curb these deals," said Kenric Tyghe, analyst with Raymond James. He notes that the latest proposals doesn't change the "substantial business activities" exception in existing regulations, which "lets companies with at least 25 per cent of their business abroad qualify as non-U.S. companies for tax purposes," he said, adding that in the case of Tims-Burger King, about 68 per cent of combined revenues, and a large percentage of employees, will be based in Canada.
Either way, Tim Hortons is a "better operator with best practices that can be more easily levered" and a head office in the biggest revenue market for the combined group, Mr. Tyghe said.
Shares of Burger King fell 2.5 per cent on Tuesday, and Tim Hortons shares were almost unchanged.
International groups including the Organization for Economic Co-operation and Development (OECD) are also investigating inversions, and Mr. Lew and U.S. President Barack Obama have both condemned the exploitation of such loopholes as "wrong," even if they are legal.
Another deal in the spotlight as a result of the rule changes is the proposed buyout of Canadian eye drug company QLT Inc. by Auxilium Pharmaceuticals Inc., which, unlike Burger-Tims, was expressly billed as a deal directed at accessing the country's lower tax rates.
The QLT-Auxilium deal follows a number of transactions led by U.S. pharmaceutical companies, which have changed their ownership structures in order to lower their respective tax burdens.
With files from Boyd Erman