Shearman & Sterling LLP | M&A and Corporate Governance Litigation Blog | Texas Federal District Court Invalidates IRS Regulations Limiting Inversion Transactions  <br >  
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  • Texas Federal District Court Invalidates IRS Regulations Limiting Inversion Transactions  
     

    10/24/2017
    On September 29, 2017, the United States District Court for the Western District of Texas granted summary judgment in favor of the U.S. Chamber of Commerce and Texas Association of Business, holding that the Internal Revenue Service (“IRS”) and U.S. Treasury Department violated the Administrative Procedures Act (“APA”) when they promulgated an anti-inversion rule that ultimately inhibited the merger of Allergan PLC and Pfizer Inc.  Chamber of Com. of the U.S., et al. v. Internal Revenue Service, et al., No. 1:16-CV-944-LY (W.D. Tex. Oct. 6, 2017) (Amended Order).  Specifically, the Court found that the government agency defendants were required—but failed—to provide the public and affected parties adequate notice and an opportunity to comment on the proposed anti-inversion rule before enacting it.  The ruling, which also held that plaintiffs had standing to challenge the rule (and that the government agencies had authority to implement it), creates an opening for other companies considering a possible inversion transaction.
     
    In 2015, Pfizer, a U.S.-based corporation, sought to acquire Allergan, a company domiciled in Ireland, and structure the transaction as a so-called “inversion.”  Under this structure, the combined entity was to have been treated as an Irish-domiciled company for tax purposes.  Following the announcement of the transaction (after having recently observed several other transactions very similar to it), the IRS and Treasury Department issued a rule providing for the treatment of foreign companies that acquire U.S.-based companies as U.S. corporations for tax purposes.   Under the new rule, the merger was no longer financially advantageous because the combined entity would no longer realize savings based on Ireland’s considerably lower corporate tax rate, and the parties terminated the transaction.  Plaintiffs subsequently filed suit to invalidate the rule on the grounds that the agencies exceeded their statutory jurisdiction, had acted arbitrarily and capriciously, and had failed to provide adequate notice and the opportunity to comment before issuing the rule. 
     
    The Court first overruled various challenges by the IRS and Treasury Department under the Anti-Injunction Act and to plaintiffs’ standing to challenge the rule.  The Court then rejected plaintiffs’ arguments that the agencies lacked the statutory jurisdiction to issue the rule and that the rule was “arbitrary and capricious.” 
     
    However, the Court found that the agency defendants failed to provide sufficient notice and opportunity to comment on the rule.  The Court further concluded that because the rule resulted in “substantive modifications to the application” of the IRS Code by changing the computation for determining tax treatment of a foreign company, an opportunity for notice and review was required.
     
    Although the ruling invalidated the anti-inversion rule on a procedural, rather than substantive, basis, the Court’s decision creates the opportunity for tax-driven mergers that may have been tabled in the wake of the rule’s promulgation to move forward, at least temporarily.  On the other hand, the decision could be construed to suggest that a comparable anti-inversion rule, reenacted with the requisite opportunity for notice and review, could withstand a legal challenge.
    CATEGORIES: Deal DisputesStanding

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