Merrill Books Losses Through U.K., Can Offset Taxes

By Zachary R. Mider and Cathy Chan

Aug. 15 (Bloomberg) -- Merrill Lynch & Co. booked $29 billion of losses from U.S. subprime mortgages and collateralized debt obligations through its U.K. unit, reducing the likelihood the firm will pay British taxes for years to come.

Most of the losses were recorded this year, including $5 billion from the sale of $30.6 billion in collateralized debt obligations, the New York-based firm said in an Aug. 5 filing with the U.S. Securities and Exchange Commission.

Merrill's U.K. tax losses may cut its future tax bills by as much as $8 billion, based on a corporate tax rate of 28 percent, said the Financial Times newspaper, which first reported the firm's tax disclosure on its Web site. Merrill's U.K. subsidiary may not have to pay taxes for as long as 60 years, the paper said.

``It obviously makes commercial sense, though it would be subject to certain legal and tax law restrictions,'' said John Gu, a Hong Kong-based tax partner at KPMG International. ``No company wants the mismatch by losing money on one unit while paying tax on another profitable operation.''

Financial companies worldwide have reported writedowns and credit losses of more than $500 billion since the start of 2007. Some Wall Street firms may pay little or no New York City or state taxes for years, Mayor Michael Bloomberg said this week.

Some companies are seeking refunds from the city on taxes they paid ahead of time, saying losses have cut their tax liability to zero. The banks pay tax on 110 percent of earnings in advance as a ``safe harbor,'' protecting against penalties for underpayment.

Wall Street Taxes

``It will be a number of years before Wall Street starts paying taxes again,'' the mayor said at a press conference Aug. 11 in Manhattan. ``They will carry forward all of those losses.'' The mayor is founder and majority owner of Bloomberg LP, the parent company of Bloomberg News.

Tim Cobb, a London-based spokesman for Merrill, declined to comment. Officials at HM Revenue & Customs, the U.K. government department that collects and administers tax, didn't immediately return calls before office hours.

Merrill's losses led to the replacement of Chief Executive Officer Stan O'Neal with John Thain. Last month, Thain raised $9.8 billion in a share sale and sold the CDOs for 22 cents on the dollar to Lone Star Funds, a Dallas-based investment manager.

``The loss has an unlimited carryforward period and a tax benefit has been recognized for the deferred tax asset,'' Merrill said in the regulatory filing.

Spreading Taxes

Merrill has taken $51.8 billion in losses and cut 5,220 jobs while Citigroup Inc., the largest U.S. bank by assets, lost about $55 billion and slashed more than 14,000 jobs, according to data compiled by Bloomberg News.

Merrill, which lost money for four straight quarters, recorded a $4.2 billion global income tax benefit in 2007 and $4.8 billion in the first six months of 2008, according to company reports.

``It's one of the tax-planning ideas caused by uneven distribution of profit and loss at a multinational,'' said Jane Hui, a Hong Kong-based tax partner at Ernst & Young LLP. ``When a company expects that its losses cannot be recovered in the foreseeable future, it'll think of a way to utilize the tax law in a more efficient way.''

One of the ways to spread the tax burden is to reallocate employee costs to different regions to match revenue and profit, Hui said.

Companies such as Merrill are allowed to use those benefits to get refunds on taxes paid in the prior two years and to offset tax payments going forward for as long as two decades, said Robert Willens, president and chief executive officer of Robert Willens LLC, a tax consulting company in New York, on Aug. 13.

UBS said on Aug. 12 tax credits of 3.8 billion Swiss francs ($3.5 billion) helped offset losses at the investment banking unit, narrowing the second-quarter net loss to 358 million francs. The Zurich-based bank hasn't paid taxes for the past four quarter, during which it amassed 25.7 billion francs of net losses.

While analysts expect firms including Merrill and Lehman Brothers Holdings Inc. to report losses for 2008, some other Wall Street firms will probably remain profitable and keep paying taxes. Goldman Sachs Group Inc. and Morgan Stanley, the two largest U.S. securities firms, are expected by analysts to record profits this year.

Goldman had a net tax expense of $6.01 billion in 2007, including $488 million in current and deferred state and local taxes, according to the company's annual report.

Merrill imposed a freeze earlier this week on new hires through the end of this year. The freeze extends to previously budgeted posts as well as replacement hires, according to an internal memo. The firm eliminated more than 4,200 jobs in the first half, leading to more than $445 million in severance and other restructuring costs. Merrill says the cuts will save about $730 million this year.

To contact the reporter on this story: Zachary R. Mider in New York at zmider1@bloomberg.net; Cathy Chan in Hong Kong at kchan14@bloomberg.net