Facebook’s IPO Grabbed The Headlines But Eaton Pulled a Coup

May 25, 2012
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Facebook captured the headlines, but Eaton Corporation’s (“Eaton”) acquisition of Cooper Industries PLC “(Cooper”) may prove to be a more significant long-term story.  Eaton not only acquired a valuable asset in Cooper, but also moved its headquarters to a country with a 12.5% tax rate, a patent box regime and a valuable treaty network.  Given the upcoming changes in US tax law to take effect on January 1, 2013, the opportunity to close the deal will end this year absent progress in Washington on tax law changes. Why is this noteworthy?  The Wall Street Journal reported on the expected synergies and savings in several areas.  The Journal also cited tax reasons.  Eaton will avoid imposing the complex US tax rules on Cooper’s business.  Eaton will also not have to worry about repatriating Cooper’s earnings back to the US.  Instead, Eaton will have more flexibility as it seeks to expand around the world. It may also be noteworthy that Eaton chose a taxable form of transaction whereby the shareholders of Eaton will be taxed at the time of the exchange, but not the corporation.  2012 is the last year for lower individual tax rates, unless Congress acts,  so it is easy to understand the timing. There were alternative forms to the one chosen by Eaton.  The §367(a) anti-expatriation rules are designed to prevent corporate flight.  Even if the rules of §367(a) are satisfied, §7874 may apply.   §7874 was enacted to stop corporate inversions and thwart expatriation.   Corporate “inversions” are a type of expatriation where a foreign corporation becomes the direct or indirect owner of the domestic parent’s stock or assets. In an inversion, the foreign corporation is a subsidiary of the former domestic parent. The corporate structure is “inverted,” with the former foreign subsidiary becomes the new parent.  Consider the corporations that have inverted: Seagate Technologies, Stanley Works, Weatherford International Inc., Cooper Industries [yes, the same one], Fruit of the Loom, PricewaterhouseCoopers Consulting (Accenture), Ingersoll-Rand, Nabors Industries, Foster Wheeler, and Tyco International. Over time, more of Eaton’s treasury operations, intellectual property royalties and sales in foreign countries will be placed beyond the taxing jurisdiction of the US. The plan calls for an Irish company (“New Eaton”) to acquire all of the outstanding shares of: (a) Cooper from Cooper shareholders for cash and newly issued ordinary shares of New Eaton, and (b) Eaton, with shareholders to receive one share of New Eaton stock for each share owned.  Eaton will merge with an Ohio corporation that is a wholly owned subsidiary of New Eaton, with Eaton surviving the merger. As a result, Eaton and Cooper will become wholly owned subsidiaries of New Eaton but New Eaton will not be subject to US taxation, except for business conducted in the US. This is the tax law of unintended indirect consequences at work. Laws imposing higher taxes are designed to close budget deficits; however, these laws eventually cause larger deficits by encouraging behavior (expatriation) that the anti-inversion rules were designed to prevent.  Steely Dan, I believe, already has the copyright on Pretzel Logic, but certainly not the monopoly.