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In its recently announced stock swap deal with the government, Citi is looking to keep a poison pill handy to prevent a technical change of ownership.
Robert Willens, CFO.com | US
June 29, 2009
Citigroup announced the finalization of a definitive agreement with the U.S. government on June 10, and accordingly, will now launch its long-awaited exchange offers for its publicly held convertible and non-convertible preferred and "trust" preferred securities. In addition, the government will exchange a portion of its preferred securities - with an aggregate liquidation value of up to $25 billion - for "interim" securities and warrants, and will exchange its remaining preferred securities for trust preferred securities.
Citi also announced that its board of directors has adopted a "tax benefits preservation plan" to protect the company's ability to use certain tax assets.
What's more, Citi is quite clearly a "loss corporation." That is, Citi is a company entitled to use net operating loss (NOL) carryovers. It also has other favorable "tax attributes," including foreign tax credit carryovers. These carryovers, along with other so-called "deductible temporary differences," have conspired to produce a net deferred tax asset in the amount of some $44 billion. Citi has not, somewhat controversially, chosen to establish a valuation allowance against those deferred tax assets.
When a loss corporation experiences an ownership change, within the meaning of Section 382(g), certain penalties are exacted. In such cases, limitations are placed on the amount of taxable income that the "pre-change" losses can offset. The income affected is for any taxable year ending after the date of the ownership change.
This limitation is known as the "Section 382 limitation" and it is calculated by multiplying the value of the loss corporation's stock (including any straight preferred stock and the value of warrants) immediately before the ownership change by the "long-term tax-exempt rate" - which is currently around 4.5 percent.
Therefore, in cases in which an ownership change has occurred, only a limited amount of taxable income can be "sheltered" by the corporation's pre-change losses, with the result that such losses are robbed of a good deal of their value.
An ownership change occurs if, at the close of any "testing date," one or more of the corporation's "five percent shareholders" have increased their percentage ownership (by value) of the loss corporation's stock by more than 50 percentage points. The increase is relative to the shareholders' lowest percentage ownership of stock at any time during the "testing period" (a rolling three year period) that ends on the testing date.1
Every corporation, no matter how widely-held its stock, has at least one five percent shareholder - the so-called "public group." Moreover, when as in the Citi case, a corporation embarks on an issuance of its stock the so-called "segregation rules" apply.2 The segregation rules create an additional five percent shareholder, which is the public group that acquires stock in such an issuance, and whose increase in ownership will be taken into account when determining whether an ownership change has occurred.
Accordingly, the direct public group that acquires Citi stock in the exchange offer will increase its percentage ownership of Citi's stock by an amount perilously close to the more than 50 percentage points threshold. As a result, Citi feels the need to insure that acquisitions of its stock, during the ensuing three years, do not give rise to an ownership change. Indeed, that could happen when the acquisition of stock is added to the increase in ownership experienced by the direct public group acquiring stock in the exchange offer.
Hence, Citi, like other similarly situated corporations, intends to adopt a "poison pill" plan which it hopes will deter would-be acquirers from accumulating as much as five percent of its stock. Whether the Citi shareholders will look kindly on this "anti-takeover" measure is, perhaps, another story.
Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com
1 For this purpose, the government's increase in ownership is not counted towards the determination of whether an ownership change has occurred. See Notice 2009-38.
2 These segregation rules provide that where, as here, a loss corporation transfers its stock in a transaction to which Section 1032 applies, each direct public group that exists immediately after such transaction shall be segregated so that each direct public group that existed immediately before the transaction is treated separately from the direct public group that acquires stock in the transaction.