Medtronic is pushing ahead with a controversial “tax inversion” deal that could save billions in taxes, despite recent legal changes that aimed to make such maneuvers less attractive.

The Fridley-based medical device giant said Friday that it is changing the financing on its $42.9 billion acquisition of surgical supplier Covidien, a deal that would move the combined company’s headquarters to lower-tax Ireland.

But while the change eliminates one of the key tax benefits of the deal, Medtronic said it still believes the transaction will lead to a stronger company.

“This proposed acquisition was conceived and undertaken for strategic reasons and is intended to create a company that can treat more patients, in more ways and in more places around the world,” Medtronic CEO Omar Ishrak said in a statement.

Medtronic said it will now finance the Covidien deal through traditional borrowing rather than using $13.5 billion of profits it holds in overseas cash. Before the recent legal change, Medtronic could have structured the deal in such a way as to use the $13.5 billion without exposing it to U.S. taxes.

But last month Treasury Secretary Jacob Lew announced that U.S. companies would start to be taxed on so-called “hopscotch” loans, which are designed to avoid U.S. taxes by loaning cash held offshore among corporate subsidiaries without bringing it back into the United States.

Medtronic has strategically stockpiled $13.5 billion in cash earnings overseas, and had intended to use it as the cash portion of the Covidien deal. Instead, it will use a total of $16 billion in traditional borrowing to finance the deal.

All other terms of the deal remain unchanged, the company said.

“Treasury succeeded in ensuring that the [Medtronic] cash could not be accessed tax-free,” said tax consultant Robert Willens, former managing director of equity research for Lehman Brothers.

Willens predicted that other companies considering tax avoidance strategies similar to Medtronic’s would turn to external financing rather than trying to avoid U.S. taxes on existing assets.

Pros, cons of inversions

Medtronic’s deal is the second-largest of at least eight pending corporate inversions, behind Chicago-based AbbVie’s $54 billion deal to buy Dublin-based health care firm Shire. Inversions like these have stirred up opposition because they put the combined company under new parent corporations based in countries with lower tax rates. Critics say such plans are un-American and drive up the taxes for other taxpayers.

Defenders say companies are only reacting to incentives built into a broken U.S. tax code. The United States has one of the highest corporate tax rates in the world, and is the sole industrialized nation that continues to tax foreign-earned income of domestic companies.

In Medtronic’s case, company officials have argued that the deal is driven by business considerations like an expanded product line and far greater reach in sales and innovation, rather than tax benefits. Company officials said Medtronic’s global tax rate will only drop from about 18 percent today to 16 percent after the deal.

Operations based here

The combined company will maintain its principal executive offices in Ireland and operational headquarters in Minnesota. The company said the new structure would enable it to deploy its cash with greater strategic flexibility, particularly in the United States.

The deal is expected to close sometime after Nov. 15. Covidien shareholders will still receive $35.19 in cash plus 0.956 shares of the new Medtronic for each Covidien share, and Medtronic shareholders will still have to pay capital-gains taxes on their old shares when the deal is completed and they get shares of a new entity, Medtronic PLC.

Medtronic shares rose nearly 4 percent Friday, and Covidien shares jumped nearly 6 percent. Both companies were trading above their all-time high stock prices.

Like all multinationals, Medtronic is taxed in each local jurisdiction where it earns income, and then it pays the balance between the local tax rate and the U.S. rate if it brings that profit home. But the U.S. tax liabilities can be manipulated by keeping foreign-earned cash from being recognized on paper in the United States. In total, U.S.-based multinationals are believed to hold more than a trillion dollars overseas.

No ‘holidays’ on horizon

Before last month’s crackdown on hopscotch loans, inversions like Medtronic’s were one key strategy to avoid repatriation taxes by using overseas cash to buy foreign companies without bringing the money into the U.S.

For many businesses considering inversions, the new Treasury rules made the cost of external financing much cheaper than intracompany loans, Willens explained.

“The after-tax interest cost of an external loan is just a fraction of the tax cost of a hopscotch loan,” he said.

Another corporate strategy to avoid U.S. taxes has been to wait for a second corporate-tax holiday like the one that occurred in 2004, during which companies could bring back earnings at a fraction of the normal tax. Such a holiday has not happened, and virtually no one believes Congress will pass a bill to allow it in the near term. Some experts believe congressional gridlock on tax reform is driving the ongoing interest in inversions.

“I don’t think anyone is waiting for another tax holiday, or having any realistic expectations of that,” said Marty Sullivan, chief economist at the Washington-based nonprofit Tax Analysts. “That may be one reason why we sort of shifted gears and there is now more interest in doing inversions.”

 

Staff writer Jim Spencer contributed to this report.

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