Treasury close to decision on action that might scuttle Medtronic-Covidien deal

WASHINGTON – The U.S. Treasury Department will decide "in the very near future" if it has the power to take away some tax incentives to American corporations relocating to foreign countries, Treasury Secretary Jacob Lew said Monday.

Lew believes action is required now to control the rising number of U.S. corporations shifting their legal residences abroad to avoid taxes while keeping operational headquarters here. If that action is retroactive, as the Obama administration says it should be, it could make Medtronic Inc.'s pending $43 billion acquisition of Covidien untenable in its current form.

"The Treasury Department is completing an evaluation of what we can do to make these deals less economically appealing, and we plan to make a decision in the very near future," Lew said in a speech at a business tax reform seminar at the Urban Institute. "Any action we take will have a strong legal and policy basis, but will not be a substitute for meaningful legislation — it can only address part of the economics."

Lew did not name individual companies, but he described tactics being employed by Medtronic and others seeking to shift their legal residences overseas.

Fridley-based Medtronic wants to buy Dublin-based Covidien and move its legal residence to Ireland while keeping the bulk of its operations in Minnesota. The company says the purchase will help deliver more and better medical devices to customers. But it also will allow Medtronic to avoid $3.5 billion to $4.2 billion in U.S. taxes on foreign profits it now holds while letting the company reorganize to avoid many billions more in U.S. taxes on future profits.

Lew took direct aim at the practice in general.

"This may be legal," he noted, "but it is wrong, and our laws should change."

Medtronic officials declined to say whether they disagreed with Lew's disparaging description of what the company hopes to do in the Covidien acquisition or the impact of potential regulatory proposals to take away some of the tax incentives.

"We can't speculate on what might happen but continue to follow the discussions in Washington, D.C., closely and are actively engaging with policymakers on the issues related to our proposed acquisition," Medtronic spokesman Fernando Vivanco said in an e-mail to the Star Tribune. "Our focus remains on doing the things we need to do to secure the necessary regulatory approvals around the world and plan for the integration of Covidien into Medtronic."

The Medtronic-Covidien deal is expected to close either late this year or in early 2015.

Whether the Treasury Department has the regulatory power to take away tax incentives that companies such as Medtronic are using, and whether they can do so retroactively, was a matter of debate for a panel of experts who discussed the issue following Lew's speech.

Harvard University law professor Stephen Shay believes the government has the power through its rule-making process to change the way corporations use interest on loans among subsidiaries to write off most or all foreign profits so the U.S. cannot tax them.

"When the patient is bleeding, you put on a tourniquet," he said, calling for Treasury to take action.

John Samuels, General Electric Co.'s top tax lawyer, countered that changes like those the Obama administration seeks can only be made by Congress and attempts by Treasury to implement them will ultimately fail and make tax reform harder.

All of this bears strongly on the Medtronic-Covidien deal, which has already attracted complaints and a lawsuit from shareholders who potentially face large individual tax bills on capital gains as the corporation avoids taxes.

Medtronic officials recently told the Star Tribune that the company will use a series of loans to gain access to $14 billion in foreign cash currently held outside the reach of U.S. tax collectors. That money will be funneled to a new Ireland-based holding company, which will use the funds to help buy Covidien. The maneuver allows Medtronic to spend the money without paying $3.5 billion to $4.2 billion in U.S. taxes it would owe if it used the cash for the Covidien purchase directly. While avoiding those current taxes, Medtronic also gets to use the cash to create a new company that will avoid billions more in future U.S. taxes.

Medtronic officials told the Star Tribune they do not consider this strategy tax avoidance.

Len Burman, director of the Urban-Brookings Tax Policy Center, called Medtronic's plan "tax avoidance 101."

Steven Rosenthal, a senior fellow at the center, said that using interest on internal loans to offset profits is like a person shifting money from hand to hand.

In an interview, Martin Sullivan, chief economist at the Washington nonprofit tax-research firm Tax Analysts, said well-respected attorneys disagree on how much authority Treasury has to reinterpret tax rules on corporate relocations.

But Sullivan noted that legal challenges to any future regulatory changes proposed by Treasury could also allow the Obama administration to realize its goal of slowing down corporate relocations, at least in the short term.

Courts are likely to take years to sort out the legality, he explained.