US Senator Challenges Tax Rule Encouraging Bank Mergers

by Glen Shapiro, LawAndTax-News.com, New York

31 October 2008

Senator Charles Schumer has sought an explanation from the US Treasury over its decision to relax rules on tax losses, which have given banks the potential to save billions in taxes by taking over their ailing rivals.

In a letter to US Treasury Secretary Hank Paulson and the Internal Revenue Service (IRS) Commissioner Doug Shulman, Schumer, a New York Democrat, asked why Congress was not consulted on a measure which could have such wide ramifications for US banking industry at a time when its foundations have already been shaken to the core. He also expressed concern at the extent to which the new rules will impact on tax revenues.

"I am concerned that the notice, which was never debated by Congress, could end up costing taxpayers tens of billions of more dollars on top of the hundreds of billions of dollars already approved by Congress in the financial rescue plan," Schumer, a member of the Senate Banking Committee, stated in the letter.

"I also fear that the notice could have the unintended consequence of motivating more financial firms wanting future tax deductions to shelter their earnings to buy competitors, leading to more consolidation in the financial industry than would be necessary to restore stability in the financial sector," the letter added.

Senator Chuck Grassley, the Iowa Republican and ranking member of the Senate Finance Committee, has also condemned the new rules, warning that they could add billions to the deficit. Grassley lambasted the Treasury earlier this month for not informing Congress about the rule change, and is investigating the issue.

On October 1, the IRS issued a little-noticed but highly significant rule change, Notice 2008-83, allowing banks to take advantage of losses deriving from bad debts or loan write-downs in a change of ownership situation on a much more generous basis than previously. Before the change, treatment of pre-takeover losses followed IRS Notice 2003-65, under which fairly stringent limits applied to the availability of pre-takeover operating losses. The rule change helped to enable Wells Fargo's takeover of Wachovia Corporation in October.

Wells Fargo is thought likely to be able to utilize USD23bn of Wachovia's losses over the next three years under the new approach as against a mere USD3bn under the old rules. The tax benefits beyond this also look extremely attractive for Wells Fargo. Wachovia has projected USD26.1bn of future losses and Wells Fargo expects USD74bn of losses on Wachovia's USD482.4bn loan portfolio.

PNC Financial Services Group is also thought to gain several billion dollars in tax benefits as a result of its USD5.2bn take-over of National City Corporation, which will create America's fifth-largest bank and was helped through with a USD7bn capital injection from the Treasury. Similarly, Spain's Banco Santander is expected to gain tax benefits with its acquisition of Sovereign Bancorp.

According to Schumer, the new tax rules could ultimately cost the US taxpayer some USD140bn.

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