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Unit 14: Advance Tax Planning and Tax Relief

Notes

Caselet Citi’s Deferred Tax – An Asset of Dubious Worth
itigroup is at the centre of a dispute among analysts and accounting experts over
whether it should set aside funds to cover $50bn of deferred taxes, a move that
Cwould reduce its capital buffer and weaken its balance sheet. As it says: The assets,
a product of the accounting principles applied by US tax authorities to companies, are
crucial to Citi’s financial health. At the end of the second quarter, deferred tax assets made
up more than a third of Citi’s tangible equity – a measure of balance sheet strength.
The US bank has rebuffed calls to reserve for its DTAs – the biggest held by a US company –
arguing that it will earn enough money in the future to justify keeping the assets on its
books. Under accounting rules, Citi has to be confident it will earn $99bn in taxable
income during the next two decades to avoid making provisions for DTAs. In the
2002–2006 periods Citi had annual pre-tax profits of at least $20bn.
However, some argue Citi is being too optimistic given its recent record – its pre-tax
losses in 2008 and 2009 topped $60bn – and continued global economic uncertainty. Deferred
tax calculation is at best a black art. In this case Citi says that because it has either losses it
can carry forward or the benefit of allowances it has not yet claimed their cash value for
tax purposes.
The most significant source of these timing differences is the loan loss reserve build,
which accounts for approximately $15 billion of the net DTA. In general, Citi would need
to generate approximately $86 billion of taxable income during the respective carry forward
periods to fully realize its U.S. federal, state and local DTAs. Two generic things to note
there first of all. Note that its clear future tax revenues from banks are going to be severely
limited by the carry forward of tax losses. Second, note the injustice in this: those losses
were already state funded.

Citigroup’s ability to utilize its deferred tax assets (DTAs) to offset future taxable income
may be significantly limited if it experiences an “ownership change” under the Internal
Revenue Code.

As of December 31, 2009, Citigroup had recognized net DTAs of approximately $46.1
billion, which are included in its tangible common equity. Citigroup’s ability to utilize its
DTAs to offset future taxable income may be significantly limited if Citigroup experiences
an “ownership change” as defined in Section 382 of the Internal Revenue Code of 1986, as
amended (the Code). In general, an ownership change will occur if there is a cumulative
change in Citigroup’s ownership by “5-percent shareholders” (as defined in the Code)
that exceeds 50 percentage points over a rolling three-year period.
The common stock issued pursuant to the exchange offers in July 2009, and the common
stock and tangible equity units issued in December 2009 as part of Citigroup’s TARP
repayment, did not result in an ownership change under the Code. However, these common
stock issuances have materially increased the risk that Citigroup will experience an
ownership change in the future. On June 9, 2009, the Board of Directors of Citigroup
adopted a Tax Benefits Preservation Plan. This Plan is subject to shareholders’ approval at
the 2010 Annual Meeting. The purpose of the Plan is to minimize the likelihood of an
ownership change occurring for Section 382 purposes. Despite adoption of the Plan, future
transactions in Citigroup stock that may not be in its control may cause Citigroup to
experience an ownership change and thus limit its ability to utilize its DTAs, as well as
cause a reduction in Citigroup’s tangible common equity and stockholders’ equity.
Source: Adapted from http://www.taxresearch.org.uk/Blog/2010/09/07/citis-deferred-tax-an-asset-
of-dubious-worth/

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