Corporate Actions 2011: Top Five "Taxing" Foreign Events for U.S. Ops Execs
Corporate actions -- dividend, income and reorganizations generate plenty of work for Wall Street operations executives who have to understand what they are all about and communicate the information to investors. This year they will have even more work to do and could end up getting whammied by Uncle Sam if they aren't careful.
Under the U.S. Internal Revenue Service's new so-called cost-basis reporting rules which began last year, U.S.broker-dealers, banks, mutual funds and corporations must correctly calculate and report the cost of an investor's account so the investor can pay a fair share of taxes. To do so, financial firms must understand not only what the corporate action is all about, but its tax status. That means wheter it is taxable or not and if it is taxable what should the tax treatment be. Corporate action specialists working in operations units -- often called reorg departments at broker-dealers -- can easily input the wrong information in their portfolio accounting systems and incorrectly calculate the cost of the account. In a worse case scenario, investors who should be paying taxes on the corporate action event might end up being none at all.
Corporate action specialists aren't exactly tax experts, so often turn to the issuer for the information. The good news: the IRS is requiring corporations as of January 17 to submit the tax status of a corporate action, along with a detailed explanation of how financial firms should incorporate the tax status when calculating the cost basis of investors accounts. Alternatively, the corporations may post the same information on their websites as long as they use the same form provided by the IRS. As a rule of thumb, even non-U.S. firms must provide the information, if they have U.S. investors.
The bad news: so far a good chunk of foreign and even U.S corporations haven't done so, according to Wolters Kluwer Financial Services, a Minneapolis-based firm which offers software for financial firms to comply with new cost-basis reporting requirements. The firm also provides a separate datafeed discussing the tax consequences of thousands of corporate actions worldwide. The worst news: financial firms can't wail to the IRS about not being able to find the correct information as a way of explaining why they made mistakes when calculating the cost basis of investors' accounts. The IRS will still penalize financial firms for any errors and the fines can easily range into the multimillions of dollars.
Wolters Kluwer has come up with the following list of five foreign corporate action events in 2011 which U.S. corporate action professionals must pay the closest attention to and why. The list was compiled from over 6,000 corporate actions worldwide based on conversations with fund managers, banks and broker dealer clients and a survey of about fifty corporate action specialists across the globe. Only one out of the five companies on the list explained the tax consequences of the corporate action on its website using the IRS' required form. That form is designed to comply with the IRS' cost-basis reporting rules and includes specific questions corporations must answer.
1- Alcon's merger with Novartis. The Swiss drug maker Novartis purchased the remaining 23 percent of eye-care giant Alcon it didn't own. Novartis agreed to pay a witholding tax to Swiss tax authorities on behalf of all of Alcon's investors. Sounds great right, but there is a big problem. U.S. operations executives might not understand that Novartis paid the Swiss withholding tax so their firms might easily miscalculate the tax gain or loss of the transaction for U.S. investors, according to Wolters Kluwer.
2- Western Copper Corp.'s spin-offs, The Canadian metals explorer spun off two subsidiaries last year. The problem: U.S. operations executives might think the spinoffs aren't taxable because investors were offered shares in the new firms. However, under U.S. tax law they are. The reason: the IRS classifies them as "passive foreign investment companies."
3- Brookfield Office Properties rights offering: The subsidiary of Toronto-based Broofield Asset Management, which manages office properties in the U.S. and Canada, offered shareholders a chance to buy shares of affiliate Brookfield Residential Properties for $10 a share until June 10, 2011. U.S. operations executives might think the rights offering isn't taxable but the IRS has ruled it is; U.S. investors must pay the same tax they would for dividends.
4- New Flyer Industries' rights offering: The rights offering of this U.S bus manufacturer, headquartered in Winnepeg, Canada, could very well pose a pretty severe operational challenge. The rights offering was designed to separate subordinated notes that were attached to common shares in a financial instrument called an income deposit security or IDS. Each IDS of New Flyer consisted of a combination of a C$5.53 in a 14 percent subordinated note and one common share of New Flyer. To exercise their rights to buy more common shares of New Flyer, investors were required to tender their subordinated notes. They could ultimately exchange C$5.53 worth of the 14 percent subordinated notes for nine shares of New Flyer common stock giving them a total of ten shares. The glitch: some portfolio accounting systems might not be able to separate the subordinated notes from the income deposit securities and exchange or replace the notes with additional New Flyer stock. The result: U.S. financial firms cannot correctly calculate the appropriate tax gain or loss on the rights offering for investors.
5- Telecom Corporation of New Zealand's spin-off -- New Zealand's telecommunications giant did something right. It was the only one of the five cited by Wolters Kluwer to correctly identify to the IRS the tax consequences of its spin-off of a subsidiary called Chorus. The event is nontaxable and Telecom even explained to the IRS how the tax cost of the spinoff to U.S. investors needs to be divided for the parent company Telecom and the new company Chorus. So why did it make Wolters Kluwer's top five list. The firm says it is because corporate actions executives surveyed noted the firm's listing on the all-important New York Stock Exchange and were only too happy to get the precise "cost basis allocation" so quickly.
Written by Chris Kentouris, Editor-in-chief (Chris can be reached at Chris.Kentouris@hotmail.com)
