New Tax Inversion Rules Put Merger Arbitrage ETFs In Focus

new etfsTax inversion has become so common a U.S. business practice that the U.S. Treasury Department needs to chalk out a set of rules to discourage domestic companies from shifting their headquarters. The companies often resort to this practice to evade higher tax payments, seeking to make their bases in nations with lower tax burdens.

The U.S. corporate tax rate is as high as 39.1% (per OECD), the highest among the OECD nations. Also, the U.S. is among the few OECD nations without a territorial tax scheme which provides overseas earnings of domestic companies a relief from domestic taxation, as indicated by Forbes.

Thanks to this stringent policy, a scurry of merger-acquisition deals was noticed in the recent past. Through such deals, the U.S. domiciled companies joined foreign companies and shifted their headquarters to foreign lands where tax rates are lower in order to see a cut in tax bills.

Prompted by this trend, we have seen some high profile merge deals taking place between Medtronic, Inc. (MDT) and Irish medical supplies firm Covidien plc (COV), between AbbVie Inc. (ABBV) and another Irish firm Shire plc (SHPG) and between the famous fast food chain Burger King Worldwide, Inc. (BKW) and Canada-based Tim Hortons Inc. (THI).

To stop the flow of these deals, and the resultant loss in tax revenues, the U.S. Treasury altered some sections of the tax code that make it harder for companies to enter into tax inversion deals. One change includes the end of ‘hopsctoch’.  This requires U.S. companies to pay U.S. tax on when their overseas profits are returned to the nation.

The other change is that a U.S. company can reach an inversion deal subject to less than 80% of ownership of the new company is owned by the U.S. partner. Thanks to this rule, U.S. companies cannot regulate their sizes now onward through corporate practices. Further, new rules lay down that U.S. companies can no longer shift ‘passive assets’ to a foreign subsidiary.

How to Play? 

Thanks to this recent surge in merge acquisition activities, IQ Merger Arbitrage ETF (MNA) and ProShares Merger ETF (MRGR) have gained investor attention. In any case, easy borrowings and a huge cash balance with corporate have been the basic tailwinds for the space. The flair for tax inversion was an added advantage.

Now, the recent inversion clampdown and potential rise in interest rates next year might take a bite out of these ETFs. However, several market participants still believe that these new regulations will not completely end the overseas deal making spree; and that these will just slow down the trend. We still believe merger and acquisition ETFs could be in focus in the coming days given the rising talks about tax inversion.

In fact, Tim Horton confirmed its progress with the Burger King deal despite inversion restrictions. Some experts expect the Medtronic and Abbvie deal to be sealed too. In such a backdrop, it might be worth it to take a closer look at the M&A ETFs. Below we have highlighted the ETFs and the strategy followed by these in detail.

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