Who says the IRS isn’t, umm, understanding?
The US tax authority exempted the Citigroup, and some other bailed-out companies, from rules which would otherwise have led to the troubled bank losing $38bn worth of tax credits.
Citi had planned to repay the US government’s Tarp stake, and under IRS regulation, companies that encounter a change in ownership lose these tax credits. The rule is designed, according to the IRS, to prevent profitable companies from buying loss-making ones to evade taxes.
The rule-change has nevertheless raised eyebrows. From the Washington Post on Wednesday:
The federal government quietly agreed to forgo billions of dollars in potential tax payments from Citigroup as part of the deal announced this week to wean the company from the massive taxpayer bailout that helped it survive the financial crisis.
The Internal Revenue Service on Friday issued an exception to long-standing tax rules for the benefit of Citigroup and a few other companies partially owned by the government. As a result, Citigroup will be allowed to retain billions of dollars worth of tax breaks that otherwise would decline in value when the government sells its stake to private investors.
The “quietly agreed to forgo billions of dollars in potential tax payments” is a bit of a red herring, bit it has sparked quite a bit of outrage from the Washington Post’s taxpaying readers (all available for perusal on the paper’s dot.comments blog).
The issue here is that these tax credits — Deferred Tax Assets (DTAs) — make up a significant proportion of Citi’s capital. Yanking them because of a change in ownership, one caused by the bank repaying the Tarp no less, would have defeated the purpose of them paying back the Tarp in the first place, and probably ended up costing the US taxpayer more US taxpayer in terms of lost Tarp monies and potential support costs.
Reuters columnist Rolfe Winkler, who’s been following the Citi capital debate for some time now, posted a good illustration of the problem:
To be sure, there’s a degree of moral hazard involved here. The US government has just changed the rules to reflect very specific circumstances, with the effect of, as one Republican staffer put it “[inflating] the returns that they’re showing from the Tarp.”
The market’s not stupid, however. It knows Citi still has problems — notably it could still lose some of its DTAs if there’s a regulatory crackdown, or if the bank’s future profitability is less than expected. That’s one of the reasons DTAs make such shoddy capital — they’re only really useful when a bank is making (enough) money.
In any case, Citi’s Tarp repayment fittingly fell through on Wednesday after investors demanded a lower price ($3.15) for the stock than the government paid ($3.25) when it acquired its stake.
Related links:
Citigroup’s share sale under fire – FT
What’s up with Citigroup? – The Baseline Scenario
The rise of deferred tax assets in Japan – University of Chicago paper (via SSRN)
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