Shire stands to be paid a break-up fee of about $1.64 billion if AbbVie's shareholders follow the advice and reject the transaction.

The reversal -- which had been anticipated after Chicago-based AbbVie said it was reconsidering the deal -- hands a major scalp to the U.S. Treasury, which has been fighting to make tax-avoiding acquisitions more difficult.

It could also open up fresh deal-making permutations, since Shire itself has a strong track record of making acquisitions to fuel its fast-growing business and may now look around to buy other companies, with its firepower boosted by the break-up fee.

The U.S. government's tax proposals are designed to make it harder for American firms to shift their tax bases out of the country and into lower cost jurisdictions in Europe.

"The agreed-upon valuation is no longer supported as a result of the changes to the tax rules and we did not believe it was in the best interests of our stockholders to proceed," AbbVie's chief executive Richard Gonzalez said in a statement.

AbbVie's move for Shire, a leader in drugs to treat attention deficit disorder and rare diseases, was announced in July amid a spate of deals in the pharmaceutical sector.

Gonzalez said at the time that the acquisition, involving the creation of a new U.S.-listed holding company with a tax domicile in Britain, was not just about tax.

But the firm said on Thursday that the changes in the U.S. tax regime "eliminated certain of the financial benefits of the transaction, most notably the ability to access current and future global cash flows in a tax efficient manner as originally contemplated in the transaction. This fundamentally changed the implied value of Shire to AbbVie in a significant manner."

Shire said it was considering the current situation and would make a further announcement in due course.

News on Wednesday that AbbVie was cooling to the transaction hammered shares in Shire, sending them down 22 percent to where they were before the deal talks emerged in June, and the shares were down a further 7 percent at 3,732 pence by 0830 GMT.

AbbVie's charge of heart has been a bombshell for some of the world's top hedge funds, which have lost out heavily on the Shire stock they were holding.

SHAREHOLDER MEETING

AbbVie said the withdrawal of its recommendation alone would not cause a lapse in the offer for Shire and it must convene a shareholder meeting before Dec. 14 to vote on the deal.

A spate of so-called tax inversion merger deals, particularly in the healthcare sector, prompted the U.S. move to change its tax regulations, including placing a ban on loans that allow U.S. companies to access foreign cash without paying tax in the United States.

AbbVie said the breadth and scope of the changes "introduced an unacceptable level of uncertainty to the transaction".

The company also took a swipe at the "unilateral" nature of the U.S. government's move and complained about "the unexpected nature of the exercise of administrative authority to impact longstanding tax principles".

AbbVie's second thoughts on the deal have surprised Shire investors, coming just weeks after Gonzalez, in the wake of the Treasury proposals, told employees of both companies he was "more energised than ever" about the transaction.

Aside from the tax benefits, buying Shire offered AbbVie a way to diversify its business and reduce reliance on arthritis treatment Humira, the world's top selling medicine, whose $13 billion in annual sales accounts for more than 60 percent of company revenue.

The Shire episode has also fuelled doubts about whether Pfizer, which abandoned a $118 billion bid for AstraZeneca in May after its offer was rejected, will ever make another run at its British rival.

Tax experts say inversions are still possible but the U.S. action has reduced their appeal, suggesting they will only make sense when there is a compelling strategic fit between two companies.

Salix Pharmaceuticals also called off its $2.7 billion merger deal with Italy's Cosmo Pharmaceuticals this month because of the U.S. crackdown.

SHIRE'S OWN DEAL-MAKING

Analysts are now looking ahead to Shire's strategy as an independent company once again and its own potential for making acquisitions -- or else becoming a target for another company.

Before the AbbVie agreement, Shire Chief Executive Flemming Ornskov had made clear he was interested in buying assets and Jefferies analysts said a standalone Shire could now be poised to aggressively target acquisitions.

Shire itself might also be a target for other pharmaceutical companies less driven by tax considerations. Allergan, for example, which is fighting a bid from Valeant Pharmaceuticals International, has approached Shire in the past.

(Additional reporting by Abhiram Nandakumar and Aurindom Mukherjee in Bangalore; Editing by Greg Mahlich and Pravin Char)

By Ben Hirschler