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Financial Reform Insights

Living wills, taxes, and the law of unintended consequences


Systemically important financial institutions (SIFIs) in the United States are in the throes of developing their “living wills” — detailed plans required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) to guide regulators through recovery or resolution in the event of material financial distress or failure.

SIFIs include all bank holding companies with more than $50 billion in assets, plus other banks and nonbanks whose distress or failure, regulators believe, could have an adverse effect on the U.S. financial system.

Living wills comprise two plans: a recovery plan (for going concerns) and a resolution plan (for “gone” concerns). Both plans need to consider the tax consequences of the proposed transactions they include, such as the sale of assets to shore up capital positions. Living wills that lack proper tax planning could fail to achieve their intended result for the financial institution.

Discussing the importance of tax planning in living wills in this issue of Financial Reform Insights are John Rieger, Neal Yaros, and Elana Mourtil.

Rieger is the national tax managing partner of Deloitte Tax LLP’s Financial Services Tax practice. He has more than 21 years experience serving global financial services companies, including foreign-based financial institutions with U.S. operations. His experience includes due diligence and structuring relating to merger and acquisitions; assistance with transfer pricing and cost-allocation studies; federal, state, and local tax planning; income tax accounting matters; and, assistance with federal, state and local tax audits and tax controversies.

Yaros is the national tax managing partner of Deloitte Tax LLP’s Banking and Securities Tax practice and has more than 30 years of experience serving global financial institutions. His experience includes federal, state and local planning, assistance in tax controversies, mergers and acquisitions, ASC 740 and financial products.

Mourtil is a director in Deloitte Tax LLP’s New York Financial Services Tax practice. She has more than 20 years experience working with foreign financial institutions, including banks, securities companies, trust banks, and various other bank special-purpose companies, including workout subsidiaries, commercial paper companies, and investment companies (real estate, private equity, and energy). Her experience includes federal, state, and local tax planning; assistance with federal, state and local tax audits and tax controversies, head-office allocations, and financial products.

Q. Why should the tax team have a seat at the table when banks develop their living wills?

Rieger: You cannot design a living will without your tax team involved. Living wills are designed, in part, to be a preliminary roadmap to an unwinding of the complexity of certain financial institutions, making them smaller and simpler. Such a plan will involve multiple transactions that will likely be fraught with significant tax issues, ranging from the limitation on the ability to use net operating losses, to tax leakage on the triggering of taxable gains, possibly resulting in an impact on what Tier 1 capital or liquidity might remain after the living will is executed.

Mourtil: In terms of the recovery plan, as John just said, it could be problematic to put together a plan that doesn’t take into consideration taxes. For example, if part of the plan is to dispose of a particular entity or repatriate earnings from a foreign subsidiary and management hasn’t taken into consideration the tax ramifications, the plan could result in tax cost that they hadn’t considered.
I think the regulators are going to expect that everything including taxes is going to be taken into consideration when banks come up with their recovery plans.

Q. It sounds a little bit like the recovery plan and the taxation associated with the recovery plan is similar to taxation associated with a bankruptcy. Is that correct?

Yaros: To a certain extent, except that there will likely not be a formal bankruptcy filing for all of the SIFIs entities so the body of case law applicable to bankruptcy proceedings may be less relevant. Nevertheless, SIFIs will need to consider in their recovery plans how best to retain the value of their deferred tax assets, including federal, state and foreign net operating losses, and the ability to monetize deferred tax assets through carryback claims or other alternatives. One additional complexity to consider is the tax sharing and other agreements that determine how proceeds from tax claims and other tax assets are shared among the consolidated group.

Mourtil: And, in both instances, the company is still liable for taxes and it would be important to take into consideration the tax cost of the recovery and resolution plans. As mentioned before, a resolution plan is a road map for the regulators to unwind the company and just because the government steps in to unwind a company, it does not mean that the tax liability goes away. There are still going to be tax issues, and it would be best if the resolution plan is developed in a tax efficient manner to favorably impact the financial institution.

Q. So, a living will that doesn’t account for tax consequences of proposed actions could impact depositors and shareholders?

Rieger: The whole purpose of the living will is to protect the market and depositors. If a living will is put forth as a viable plan and doesn’t address potential tax pitfalls, the tax leakage or other tax impacts associated with the transactions could cause the plan to fall short of its intended results. Specifically, lost tax attributes or cash tax burdens could adversely impact the financial institution — limiting the stability the living will was supposed to create.

Mourtil: For example, if a bank includes in its recovery plan, repatriation of earnings from a foreign subsidiary, which it believes will enable it to raise a billion dollars of cash but the company did not take into consideration the $400 million tax implications of such repatriation, the company may not be able to achieve its recovery plan objective. If taxes are addressed in the planning stage of the recovery and resolution plans, the company can identify and address the issues during the planning stage rather than try to deal with them when the company is in financial distress and does not have the flexibility to remedy the tax issues. As the living will is expected to be updated annually, it will be important for the company to revisit the tax implications to determine its objectives will continue to be met on an after tax basis.

Q. What can corporate tax directors do to help their companies develop living wills that are effective from a tax perspective?

Yaros: The first thing is to have a member of his or her team serve as an active participant on the committee developing the living will. Once plans are far along or fully developed modifying them becomes a challenge. My second suggestion is to draft a one or two page list for circulation to the committee members of tax considerations that should be addressed as part of the plan. Our list below is a good starting point. In most organizations, once the importance of addressing tax is recognized as a critical element in a distressed company’s plan to retain and enhance value, the tax director’s ability to help his company will be a lot easier.

Q. It sounds like a lot of the things that we are talking about here might be described as unintended consequences of Dodd-Frank?

Rieger: Definitely.

For further information about this subject, please contact

John Rieger
Deloitte Tax LLP
+1 212 436 6934

Neal Yaros
Deloitte Tax LLP
+1 212 436 4310

Elana Mourtil
Deloitte Tax LLP
+1 212 436 2260

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