S&P: Inversions carry credit rating risks

Setting up shop overseas via a corporate “inversion” may be a good tax deal, but could hurt a company’s credit rating, according to a new report.

A draft report from the rating agency Standard & Poor’s claimed that the hot new trend of tax inversions is probably more risk than reward when it comes to credit ratings, and could damage most companies’ credit reputations. A copy of the report was obtained by The Hill.

{mosads}In it, S&P argued that if a U.S. company acquires a foreign competitor for purposes of setting up a new foreign headquarters and lowering their tax bill, they could also be heading towards a credit rating downgrade. Companies that undergo an inversion could end up having easier access to funds that were previously “trapped” abroad, which could in turn lead to more aggressive financial moves that could enrich shareholders but hurt company stability.

“A significant portion of pending large inversion transactions will likely hurt credit ratings if completed,” the report stated.

The findings cast a new cloud over the contentious tax practice, which has garnered heavy scrutiny from Washington. Treasury Secretary Jack Lew has said his team is close to taking steps to discourage the practice, but not legislative action is expected on the matter this Congress.

Under current law, a company is only permitted to invert and establish a new legal home abroad if it acquires a company that is at least 25 percent its size, with at least 20 percent of its shareholders coming from outside the purchasing company. In other words, a company seeking an inversion-driven tax break needs to spend substantial cash to line up an appropriate foreign business to complete the move.

S&P warned in its report that lining up such a deal could “constrain a company’s financial capacity” for future deals, placing it at further business risk moving forward.

In addition, companies could become so focused on shrinking their tax bill by lining up an inversion that they lose sight of the broader picture. S&P cautioned that companies could see their ratings trimmed if an inversion deal leads to immediate tax savings at the cost of longer-term strategic moves. In short, S&P said companies should not invert if the only reason to make the move was for tax purposes.

“An effective inversion strategy should make sense for business fundamentals and not just for tax reasons,” the rater said.

The rater also warned that future government action cracking down on inversions could expose inverted companies to higher tax bills than currently anticipated. Lawmakers in both parties, as well as the Treasury Department, have expressed an interest in cracking down on the contentious tax practice.

However, S&P did note that in circumstances where an inversion makes business sense as well as tax sense, it could be a boon for companies. Setting up headquarters abroad and enjoying a lower tax bill could free up cash and improve liquidity for the company.