WASHINGTON -- President Obama and the Treasury Department have lately been taking aim at corporate inversions -- the practice of a multinational U.S. company merging with a foreign firm and reestablishing corporate headquarters outside U.S. borders for tax purposes.

Obama has blasted the tactic as unpatriotic, and, last week, Treasury announced a set of steps aimed at limiting the tax benefits for inverted companies when they access earnings through their foreign subsidiary.
But beyond the headlines and sound bites, how should advisors evaluate inversions when developing investment strategies for their clients?

Andy Friedman, a political analyst and publisher of the Washington Update, addressed the issue this week at FSI's financial advisor summit.


"The rules really nibble at the outskirts of inversions," Friedman says of the Treasury Department's recent action. "For now, these inversions are here to stay. That's all fine as a theoretical matter. What does it mean for your clients?"

The short answer, according to Friedman, is that it depends.

The most recent high-profile example of a U.S. multinational going the inversion route came in August, when Burger King announced that it was buying Tim Hortons and relocating its legal home to Canada, where the doughnut outfit is based.

That followed on a string of similar moves that have been cited in the long-simmering debate over U.S. corporate tax policy, one which Friedman anticipates could return in the next session of Congress, though the veteran Beltway observer stops short of predicting that any specific proposal will make its way to the president's desk.

"As we say here in Washington, tax simplification is complicated stuff," he says.


In the meantime, as an investment opportunity, corporate inversions are a mixed bag. Friedman cites a Reuters analysis of 52 such transactions over the last 30 years. Of those, 19 inverted companies outperformed the S&P 500 and 19 underperformed. The remainder went on to be acquired by other firms or went out of business, and one reincorporated into the United States.

Given that 50% success rate, corporate inversions, when undertaken for tax purposes, cannot be considered as a solid investment strategy, Friedman argues.

"Looking at that more carefully, it seemed to me that many companies undertook these mergers solely for tax reasons," he says. "So in deciding whether your client should invest in an inverted company, the first question I would ask is: Is this is a good merger?"

Friedman does not dismiss the tax issues out of hand, noting that companies facing lower rates will of course post higher post-tax earnings, and that money can be used for dividend payments or stock buybacks.

At the same time, he also warns that long-time shareholders can be caught off guard when a company inverts, pointing out that those transactions will trigger a "forced recognition event." That means that clients with positions in the company will be forced to recognize gains on any appreciation in their holdings when the company inverts.

"Worse, there's no cash coming to that shareholder with which to pay tax," Friedman says.

"If you have clients who are long-time shareholders in companies that are planning to invert, you better get a hold of them," he adds. "Talk to them, because they may find they are about to have a gain recognition event when the company inverts."


Tax implications aside, Friedman urges a back-to-basics approach when weighing investment in an inverted company that focuses on traditional merger considerations, such as whether the transaction will yield efficiencies and reduce operating costs.

"If the answer's yes, then the taxes are an icing on the cake -- that's a good investment," he says. "If the answer's no, this is a bad merger, the taxes aren't going to save a company that isn't making any money."
Kenneth Corbin is a Financial Planning contributing writer in Washington.

Read more:

Register or login for access to this item and much more

All Financial Planning content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access