By Paritosh Bansal
NEW YORK (Reuters) - A recent change in U.S. tax rules that determine how a buyer treats a target bank's losses on loans and bad debts could spur more deals in the troubled sector.
An Internal Revenue Service notice last week effectively lifts a limit on the amount of the buyer's taxable income these losses at the target bank can offset, allowing the buyer of the bank to get immediate tax benefits instead of having to do so over several years, experts said.
The rule change could prompt more deals in the sector, helping weaker banks find buyers when the credit crisis has made it hard for these banks to find fresh capital, they said.
"That's what it is designed to do," said Robert Willens, president of tax consultant Robert Willens LLC. "It makes it much easier for the buyer to use the built-in losses of the acquired company to offset and reduce its taxable income."
The change may already be making a difference. Experts said the new rule likely played a role in Wells Fargo & Co's
Wells Fargo's offer for Wachovia came after Citigroup Inc
"Last weekend, Wells was unwilling to buy Wachovia. That was before the tax law change went into effect," said Guhan Subramanian, a professor at Harvard Law School. "Wells can justify a higher price now than they could a week ago because of the tax law change."
The rule change could mean that Wells Fargo would potentially be able to recognize tax benefits of $23 billion over three years, compared with $3 billion under the old rules, Deutsche Bank analyst Mike Mayo said in a research note.
"These write-downs in the past would only help reduce tax burdens modestly over many years," Mayo wrote. "Now the tax benefits can potentially be used to reduce much if not all taxes in the first couple of years after a merger."
Stifel Nicolaus analysts estimated that either deal for Wachovia -- with Citigroup or Wells Fargo -- would cost the government about $21 billion.
PROVIDING ENCOURAGEMENT
U.S. Treasury spokesman Andrew DeSouza said the change in tax rules had been in the works for a while and was not meant to address any one taxpayer.
"Treasury has worked very hard at expediting tax guidance to provide clarity regarding uncertain tax issues relating to the financial markets," DeSouza said. "The guidance we've issued over the last several weeks is part of that initiative."
Not many U.S. banks are strong enough to make acquisitions, and they will not benefit from the tax break if they do not have any income. But for those that can, the rule change could be a good break.
"It certainly provides encouragement," said Stephen Feldman, a tax partner at law firm Morrison & Foerster. "And it seems pretty generous."
(For more M&A news and our DealZone blog, go to http://www.reuters.com/deals)
