Grassley Questions Tax Deductibility Of SEC Fines

by Leroy Baker, Tax-News.com, New York

19 August 2008

United States Senator Chuck Grassley (R - Iowa) has called on the Securities and Exchange Commission (SEC) to consider changes to enforcement rules which currently allow firms to effectively pass off the cost of fines for misleading investors onto the taxpayer by deducting the fine for tax purposes.

Grassley stated last Friday that “if these financial institutions are allowed to deduct these payments from their taxable income, that would amount to a tax windfall for these financial institutions that is paid for by US taxpayers.”

The issue of the tax deductibility of certain payments by financial institutions arose in 2003 in connection with a USD1.4bn global settlement between the SEC and 10 financial institutions over allegations that the institutions misled investors regarding certain corporations to attract business from corporations underwriting these corporations’ securities.

That year, Grassley and Senators Max Baucus (D - Mont.) and John McCain (R - Ariz.) introduced the Government Settlement Transparency Act, which would have made clear that payments made to acknowledge actual or potential violations of any law would not be tax-deductible. The legislation was never passed by Congress.

Grassley said that until such a "common sense proposal" becomes law, the SEC needs to do what it can to make sure that the after-tax amount of the payment reflects the amount that the SEC actually intends to be paid by the financial institution.

"I understand that the Securities and Exchange Commission (SEC) is investigating whether Citigroup and other financial institutions misled investors regarding the safety and liquidity of auction-rate securities," Grassley wrote in a letter to SEC Chairman Christopher Cox, dated 15th August.

"If the SEC determines that monies should be paid by Citigroup or other financial institutions as a result of these allegations, the SEC should consider the potential tax deductibility of these payments by Citigroup or other financial institutions when determining the appropriate amount of such payments," he added.

Grassley observed that if the SEC levies a USD600mn fine against Citigroup, the firm may be allowed to deduct this payment from its taxable income, resulting in a tax benefit to Citigroup of USD210mn, which is equal to the USD600mn payment multiplied by the corporate tax rate of 35%.

To prevent Citigroup from receiving this potential tax windfall at the expense of American taxpayers, Grassley recommends that the SEC should consider "grossing-up" the payment by Citigroup to an amount of USD923mn. This way, Citigroup may be able to deduct the USD923mn payment at the 35% corporate tax rate, which is worth USD323mn in tax benefits to Citigroup, but the company would still have effectively paid a fine of USD600mn.

"This common-sense revenue-raising legislation has not been enacted into law, due in part to opposition from financial institutions including Citigroup," Grassley noted in the letter.

"Until such a proposal becomes law, please consider grossing-up any payment amount by any financial institution in connection with auction-rate securities so that the after-tax amount of the payment reflects the amount that the SEC actually intends to be paid by the financial institution," he advised Cox.

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