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New Tax Inversion Rules to Hurt Investment Banking Income

New tax inversion rules not only led to the collapse of the Pfizer Inc. PFE-Allergan plc AGN merger, but are also likely to dampen global M&A volumes to some extent. So, the new rules are not-so-welcome news for investment bankers as these will hurt investment banking income.

According to Freeman Consulting, The Goldman Sachs Group, Inc. GS topped the global M&A table in 2015, receiving $2.8 billion as advisory fees. The company was followed by Morgan Stanley MS and JPMorgan Chase & Co. JPM, which earned $2 billion and $1.8 billion, respectively.

Notably, if the Pfizer-Allergan merger deal had gone through, Morgan Stanley and JPMorgan would have split $160–200 million in fees between them as advisors to Allergan, while Pfizer’s advisors – Goldman, Guggenheim Securities, Centerview Partners and Moelis & Co. MC – would have earned $120–150 million (in aggregate) as advisory fees.

But because of the new tax inversion rules, these investment banking firms lost out on their potential fees.

Are you wondering what these rules are and the reasons for their implementation? Actually, tax inversions are not new. These have been in place for quite some time. However, to prevent U.S. companies from avoiding paying corporate taxes, the U.S. Treasury Department has been fine tuning business tax reforms to plug loopholes.

According to the Treasury, in an inverse transaction, U.S. companies acquire foreign firms and then relocate their base offshore with an aim to lower their tax burden. Notably, the U.S. has a higher corporate tax rate of 35% as compared to several other countries.

However, the new rules proposed by the Treasury impose further restrictions on U.S. companies to curb inversions. The rules prevent U.S. companies from undertaking inversion transaction, if they have done so within the past three years.

Also, the Treasury proposed rules against the practice known as ‘earnings stripping’, which is often undertaken following an inversion. In this regard, the new rules would restrain related-party debt for U.S. subsidiaries in transactions that do not finance new investments in the U.S.

For investment bankers, advising on tax inversions is a profitable business. Per Dealogic, since 2011, U.S. investment banks have advised on over $700 billion of announced tax inversion transactions. According to a Credit Suisse analyst, tax inversion deals represent approximately 5–6% of total M&As globally.

The recent clamp down by the Treasury has however put several mergers in jeopardy. Some of the noteworthy inversion deals include the proposed merger of Johnson Controls Inc. JCI with Ireland’s Tyco International plc TYC and UK-based Markit Ltd. MRKT and IHS Inc. IHS. Notably, nearly $750 million advisory fees are at stake if all seven pending inversion deals are taken into account, according to Freeman.

Smaller advisor firms including Guggenheim, Lazard Ltd. LAZ, Centerview, Evercore Partners Inc. EVR, Greenhill & Co., Inc. GHL and Moelis are expected to be hurt the most as inversion-related fees form a large part of their overall revenues compared with big Wall Street banks.

Further, many big banks finance several large inversion deals. If such transactions dry up, bank loans and fees earned from underwriting bonds will also be hurt.

According to Dealogic data, which recently released its preliminary investment banking review for the first-quarter 2016, global investment banking revenues declined 36% year over year to $12.8 billion, marking “the lowest quarterly total since 1Q 2009” (read more: Investment Banking Revenues Lowest Since Crisis).

As it is, investment banks are reeling under manifold challenges. The introduction of new tax-inversion rules is likely to hamper their top-line growth even further.

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JPMORGAN CHASE (JPM): Free Stock Analysis Report
IHS INC-A (IHS): Free Stock Analysis Report
PFIZER INC (PFE): Free Stock Analysis Report
ALLERGAN PLC (AGN): Free Stock Analysis Report
JOHNSON CONTROL (JCI): Free Stock Analysis Report
TYCO INTL PLC (TYC): Free Stock Analysis Report
MORGAN STANLEY (MS): Free Stock Analysis Report
GOLDMAN SACHS (GS): Free Stock Analysis Report
GREENHILL & CO (GHL): Free Stock Analysis Report
EVERCORE PARTNR (EVR): Free Stock Analysis Report
LAZARD LTD (LAZ): Free Stock Analysis Report
MARKIT LTD (MRKT): Free Stock Analysis Report
MOELIS & CO (MC): Free Stock Analysis Report
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