In Citi's tax plan, analyst sees much needed protection

Citigroup (C) raised some eyebrows last week when it unveiled a "tax benefit preservation plan" designed to make it very difficult for anyone to amass a big stake in the beleaguered bank. Was this, as Citi claimed, a necessary step to safeguard some $44 billion in tax deductions? Or was it a "poison pill" designed to block takeovers, as some analysts fretted?

According to Robert Willens, a corporate tax expert and former analyst at Lehman Brothers, Citi really does need the plan to protect its massive stockpile of deductions and credits. "The greater good is probably served by them preserving their tax situation," he says.
Citi's tax plan was crafted to discourage any shareholder from buying up more than five percent of the company's stock. This is important because too many big moves by investors with stakes above that threshold would mean Citi couldn't use its $44 billion in tax breaks.

Specifically, if shareholders with stakes in excess of five percent boost their total positions by more than half over any three year period, the "tax assets," as they're known, could disappear.

That could be devastating. Those deductions and credits make up a healthy chunk of the capital regulators require the company to hold as a cushion against the possibility of future losses.

At first glance, it might seem like there's not much to worry about on that front. After all, the $58 billion preferred stock exchange Citi announced last week will dilute investors in its common shares by as much as 80 percent. In truth, however, it's the exchange that makes the tax plan necessary, Willens says.

That's because of the way tax law looks at the investors who could take advantage of the exchange. It treats them as one group that is about to get a five percent stake in Citi's common shares. The exchange will represent a 44 percent increase in their stakes, putting the company perilously close to losing the tax deductions, according to Willens.

In that light, the plan is a no-brainer, Willens says. "I don't want to overstate it, but it might be almost negligent for them not to do something to ensure these tax benefits will be available," he says.
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