If the Treasury Department was trying to scare investors away from corporate inversions by saying the government would examine ways to stop the deals, it worked.
Stock markets last week punished companies pursuing inversions and investors have genuine reason for concern about the prospects for cross-border mergers that limit U.S. corporate tax liability.
The policy landscape on inversions has shifted significantly since late July when lawmakers -- deadlocked on tax policy -- left Washington for a five-week break. The lack of congressional action and the Obama administration's reluctance to move on its own had given companies and investors confidence that pending deals wouldn't be affected by government action.
However, President Barack Obama said Wednesday that he wants the United States to act "as quickly as possible" to discourage inversions using whatever authority the government already has.
"We don't want to see this trend grow," Obama said. "We don't want companies who have up until now been playing by the rules suddenly looking over their shoulder and saying, you know what, some of our competitors are gaming the system and we need to do it, too."
As Congress bickered, Obama began speaking about inversions in late July, turning a corporate tax proposal buried in his budget into the centerpiece of a speech on the economy.
A former Treasury official outlined steps the government could take without Congress. And Democrats this month began pressing Obama and Treasury Secretary Jacob J. Lew for action.
With one statement last week, the Treasury changed the market assumption that the government wouldn't act without Congress to stem inversion transactions.
On Tuesday, the Treasury said that it was examining regulatory changes that would amount to a "partial fix" while the administration keeps pushing Congress to curb inversions. Obama said that the administration was reviewing how it interprets existing laws and that he wouldn't announce details "in dribs and drabs."
On Wednesday, Walgreen Co. shares plunged after the drugstore chain said that it would buy the portion of Alliance Boots GmbH that it doesn't already own without changing its address for tax purposes. The company cited opposition in Washington and potential IRS enforcement among its reasons.
The decision drew enthusiastic approval from Democratic senators and the Change to Win coalition of unions. Investors sent Walgreen shares down $9.91, or 14 percent, Wednesday in New York, the biggest one-day decline since 2007, reducing the company's market value by more than $9 billion.
Walgreen, based in Deerfield, Ill., said a decision to shift its legal address out of the United States might have backfired because it could have been challenged under IRS tax-abuse rules. The largest U.S. drugstore chain warned of "almost certain, intense, protracted IRS scrutiny" that might have taken a decade to resolve.
The Treasury statement was a reversal for Lew, who had said July 16 that the government had scoured "obscure" tax code provisions and would be doing more if it could.
But tax lawyers say the Treasury has constrained powers to make inversions less attractive. Its tools include limiting companies' access to foreign cash to finance the deals and making it harder for them to engage in earnings-stripping transactions that reduce their U.S. taxable income after the inversion is completed.
"If people don't think they have authority, they're wrong," said John Buckley, former chief tax counsel for Democrats on the House Ways and Means Committee. "Whether they'll exercise it or not, that's a different question."
Any rules from the Treasury could affect at least eight pending inversions along with other companies considering similar deals. Depending on how the rules about earnings stripping are written, they could also affect companies such as Ingersoll-Rand PLC that inverted before the current wave.
Politically, the administration's statements maintain pressure on companies to consider the consequences of inversions even as it somewhat relieves Congress from taking quick action. For investors, the Treasury statement caused them to question whether the pending deals would face unforeseen hurdles.
The stock of other companies involved in planned inversions -- including AbbVie Inc., Medtronic Inc., Mylan Inc. and Shire PLC -- also fell last week as broader U.S. markets were little changed. The market reaction to the Treasury's announcement came even though the Treasury hasn't committed to doing anything and though the U.S. government has said its tools are limited without legislation.
"The prospect of action by the executive branch got everyone's attention," said Peter Sorrentino, a Cincinnati-based money manager who helps oversee $1.8 billion at Huntington Asset Advisors Inc. "Given the prospect that the White House is talking about implementing a change retroactive to May, I would be surprised if these inversions continue."
The Obama administration and Democrats propose to make it effectively impossible for companies to invert by buying a smaller foreign business. They want to make the change retroactive to May, which would affect the Medtronic and AbbVie deals, among others.
Such legislation hasn't advanced, in part because Republicans want to address the issue through a broader revamp of the tax code and because they are concerned about retroactive changes.
In its statement last week, the Treasury Department said it was looking at a "broad range of authorities" that would limit inversions or "meaningfully reduce the tax benefits after inversions take place."
Henrietta Treyz, an analyst at Height Securities LLC, wrote in a note to clients, "This is a sharp change in tone from the Treasury, which has to date been quite clear that it believed the power of its agency as well as the IRS to stem inversions has been exhausted."
Stephen Shay, the former top international tax lawyer at the Treasury, suggested two possibilities for addressing inversions, both of which he said could be accomplished by regulation.
One would characterize some debt of inverted companies as equity. That would prevent companies from engaging in earnings stripping because they wouldn't be able to get the same deductions for interest expenses in the United States. Stripping involves companies with legal addresses outside the United States loading up their U.S. subsidiaries with debt and other deductions
The other approach Shay recommended in a Tax Notes article last month would stop companies from financing inversions with offshore earnings that haven't been taxed by the U.S. Currently, the Treasury allows companies to lend their offshore stockpiles to their new foreign parents.
Buckley, the former House Democratic staff member, said that if the Treasury Department wants to stop the transactions, it would issue a statement saying it will issue regulations later that would be retroactive to the date of the initial statement. Such a statement could come quickly, even if the actual rules take time to write.
Buckley said Treasury officials could use section 482 of the tax code. That gives the government wide authority to reallocate deductions and income among a company's subsidiaries to prevent tax evasion or to more clearly reflect where income is earned.
Without legislation, the Treasury can really just operate "at the margins," said John Harrington, a former international tax counsel at the Treasury who is now a lawyer at Dentons in Washington.
Harrington said the regulatory process can take time as officials try to make sure they aren't creating gaps that companies can exploit.
"The likelihood that something will influence behavior will depend on how specific the proposal is," he said.
Information for this story was contributed by Tara Lachapelle, Zachary R. Mider, Alex Wayne, Margaret Talev and Lisa Lerer of Bloomberg News.
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