What is “Inversion” and how does it impact shareholders?

Written by: Martin X. Shields
A term you hear recently in the news is the “inversion” of U.S. companies as they merge with a foreign company in order to reduce their U.S. federal tax bill. There are a number of firms who have recently taken this action including AbbVie (ABBV) a U.S. pharmaceutical firm that plans to merge with Irish drug firm Shire this year. Once the deal is consummated, the combined company will be taxed as a U.K. corporation with an estimated tax rate of about 13% by 2016.

As a stock shareholder it is important to know that these mergers could have you incur a capital gains tax liability. Although the U.S. company will ultimately control the foreign company, the U.S. company is technically being acquired. The shareholders will receive new shares to replace their old ones and the exchange is considered taxable by the Internal Revenue Service.

To illustrate the situation, if an investor purchased shares in a company at $20, and the firm “sells” itself in an inversion merger at $50 a share, the investor will typically receive shares in the new firm and owe tax on the $30 per-share. This gain is the difference between the original cost and the price at the time of the merger.
Currently, the rate on long-term capital gains ranges from zero to nearly 24%, depending on an individual’s taxable income.
The irony about these deals is that they are structured to lower the tax rate of the company for the benefit of investors but as explained above, they frequently cause a tax liability for investors. Not surprisingly, executives of these companies have included language in many of these deals that the company will pay for any tax liability that is incurred by executives because of the inversion.