MasterCard and Visa Financial Results Released

MasterCard has reported financial results for the second quarter of 2008.



"MasterCard's worldwide purchase volume during the quarter rose 14.0% to $493 billion and its gross dollar volume increased 12.8% to $655 billion. Transactions processed grew 13.6% to 5.2 billion. MasterCard reported 951 million MasterCard cards issued, up 11%. Net revenue for the second quarter of 2008 was $1.2 billion, up 25.0%. Pricing changes contributed approximately 5 percentage points of the net revenue growth".



Click the links to view the webcast ...or to view the accompanying presentation.

Yesterday, Visa Inc. also released  it's third quarter financial results) stating that:  



"payments volume grew 19% to $652 billion and total volume, including cash, grew 22% to $1.0 trillion. Cards issued grew 14% worldwide to 1.6 billion and payments transaction volume grew 15% to 10.7 billion transactions. Total processed transactions were 9.5 billion, up 13%."



Click the links to view the webcast. or if you prefer, a presentation on the quarterly results can be viewed by clicking that link.

Priceless! $1.8 Billion Settlement May Be Tax Deductible!

I saw this article at CFO.com and while I normally find accounting articles boring and non-applicable to my interests, this one struck a chord. In fact, I found the article to be "almost" unbelievable - or at the very least "way eyebrow lifting".

So I thought I'd share it. The gist of the article is that MasterCard may be able to write off it's recent $1.8 Billion dollar settlement with American Express.

If MasterCard can, in fact, write off their recent $1.8 Billion dollar settlement with American Express, it certainly makes a mockery of the whole purpose of the DOJ antitrust laws.

When I first thought about it, I also ventured a guess that American Express wouldn't have had to pay taxes on their $1.8 Billion monetary gain. My reasoning was that the settlement was made in response to a lawsuit, and monies awarded as damages are not normally taxable. But monies weren't awarded, as it was a settlement and as this article points out, damages received in lieu of profits are treated as ordinary income.

Screw with Wal Mart: $1.0 Billion
Screw with American Express: $1.8 Billion
Screw with Discover: $3.0 Billion?
IPO to Cover Cost of Damages: Priceless!
Write the Whole Thing Off? Unbelievable!

Here's the article from CFO.com:

Priceless? Is MasterCards's Settlement Deductible?
The four-year court battle between MasterCard and Amex is over, but will the antitrust allegations nix MasterCard's tax break?

Robert Willens, CFO.com USJuly 15, 2008

After a four-year court battle, MasterCard Inc. announced on June 25, that it had reached an agreement to settle its outstanding litigation with American Express. The lawsuit, filed in federal court in 2004, alleged that MasterCard, Visa, and some of their member banks blocked Amex from the bank-issued card business in the United States.

The settlement calls for 12 quarterly payments by MasterCard, beginning in the third quarter of 2008, each of $150 million. The payments are contingent on the performance of Amex's U.S. Global Network Services business. According to the MasterCard press statement, "On a tax-affected net present value basis, the settlement payments are estimated to be, in the aggregate, approximately $1 billion. MasterCard will take a charge for the settlement in the current quarter. The maximum nominal amount of the settlement is $1.8 billion"

There is a question, however, as to whether MasterCard is entitled to a tax deductible for the payments it makes; and if so, when will the deduction arise? Although there is limited information with which to work, we believe we can come up with an accurate assessment of the issues.

Ordinary and Necessary Business Expenses

Regarding whether the settlement payouts are taxable, Section 162 of the Internal Revenue Code says that in carrying on any trade or business, a deduction is allowed for all of the ordinary and necessary expenses paid or incurred during the taxable year. There is no "moral" component to this rule. Indeed, a 1980 IRS ruling ( Revenue Rule 80-211, 1980-2 C.B. 57) provides an example of a corporation that deducts a payment identified as punitive damages as an ordinary and necessary business expense.

The ruling explains that the corporation's obligation to make the payment arose out of a civil lawsuit. In the suit, the company, called Chi Corp for this purpose, was sued by Upsilon Inc. for both breach of contract and fraud in connection with the "ordinary conduct" of its business activities. Judgment was rendered against Chi by the court in which the lawsuit had been filed.

The ruling concludes that payment of the judgment by Chi — including those amounts identified as punitive damages — is an ordinary and necessary "cost of doing business", and is therefore, deductible for federal income tax purposes. The ruling notes that both the courts and the IRS recognize that payments made in settlement of lawsuits are deductible if the acts which gave rise to the litigation were performed in the ordinary conduct of the taxpayer's business.

However, there is a caveat. When Section 162 was amended by the Tax Reform Act of 1969, Congress included a list of expenditures for which a deduction would be disallowed. That list was intended to be "all-inclusive," and not merely illustrative. Therefore, if the settlement payout relates to an activity not specifically enumerated in Section 162(c) — and the limitations set forth in other parts of Section 162 are not implicated — the outlays ought to be tax-deductible regardless of the fact that they stem from an activity which offends the sensibilities of most observers.

In the current case, we know that the settlement announced by MasterCards pertains to litigation which alleged violations of certain anti-trust provisions. Accordingly, it is possible that Section 162(g) might limit MasterCard's deduction for the settlement amounts. That section applies in cases in which: there is a criminal proceeding; the taxpayer is convicted of a violation of the antitrust laws; or the plea of guilty or nolo contendre to an indictment or information charging such a violation is entered or accepted in the proceeding.

In fact, under Section 4 of the Clayton Act such violations disallow deductions for two-thirds of amounts paid or incurred on any judgment for damages entered against the taxpayer. Deductions are also disallowed for settlement of any action brought under the Clayton Act on account of such violation.

But that doesn't appear to be the case with MasterCard. The tax status of the payments has not been judged to be adversely affected by the provisions of Section 162(g). The fact that the discounted and "tax affected" settlement amount ($1 billion) represents only 55 percent of the gross settlement amount ($1.8 billion) suggests that MasterCard will be taking a tax deduction — under the authority of Revenue Ruling 80-211— for the full amount, not merely one-third thereof, of the payment.

Timing of Deductions

Under the accrual method of accounting, a liability is incurred, and generally taken into account for federal income tax purposes, in the taxable year when: (1) all events have occurred that establish the fact of the liability; (2) the amount of the liability can be determined with "reasonable accuracy"; and (3) so-called "economic performance" has occurred. This rule is known as the "all events" test. (See Regulation Section 1.461-1(a)(2).)

In the MasterCard case, the first two conditions of the all events test are each satisfied in 2008. And pending the evaluation of the economic performance condition, the amount to be paid out by MasterCard over the period of the agreement would be deductible in 2008. However, in our view, the economic performance prong of the test will defer MasterCard's deduction.

To be sure, the economic performance of some liabilities occurs only when payment is made to the person to whom the liability is owed. For example, the rule applies to any workers' compensation act, or arises out of any tort, breach of contract, or violation of law. That includes a liability arising out of the settlement of a dispute in which such a tort, breach of contract, or violation, respectively, is merely alleged. (See Reg. Sec. 1.461-4(g)(2).)

It appears that the liability incurred by MasterCard in connection with the Amex settlement fits this description. That means it is likely that MasterCard's tax deductions related to the Amex payments will only arise in the years in which the payments are actually made. The fact that the charge will, for financial accounting purposes, be taken in 2008 has no bearing on the tax consequences of the settlement. For that purpose, under the all events test, the tax deductions should be available only as and when the payments are actually remitted to A.*

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.

*There is little doubt that the payments will be accounted for as ordinary income by American Express. Under the "origin of the claim" rule, it is well-settled that damages received in lieu of "lost profits" are taxed. In the MasterCard case, the amounts to be derived from the settlement might have to be taken into account in the year 2008, in which the settlement terms are hammered out. Under the accrual method, income can be included in gross income when (1) all the events have occurred which fix the right to receive such income, and (2) the amount can be determined with reasonable accuracy. (See Regulation Section 1.451-1(a).)

There is not, as there is on the deduction side, an economic performance prong that must be satisfied for the accrual of income to take place. Accordingly, even though MasterCard's deductions will likely be spread out over the period in which it makes the payments to Amex, the latter may well be required to account for the gross settlement amount in the taxable year in which the settlement agreement is entered into.

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Discover Seeks $6 Billion in Damages from V/MC

June 9 (Bloomberg) -- Discover Financial Services is seeking $6 billion in damages from Visa Inc. and MasterCard Inc. in an antitrust lawsuit accusing the bigger credit-card rivals of squashing competition.

The damages, which may be tripled, were included in confidential filings unsealed today in federal court in the Southern District of New York. Visa said today the amount was ``dramatically overstated'' and MasterCard called the suit ``baseless.'' Both companies fell in New York trading.

"The numbers on potential damages Discover is seeking are large,'' Sanjay Sakhrani, an analyst at KBW Inc. in New York, said in an interview. ``However we think a settlement for a meaningfully smaller amount still remains a likely scenario.''

Discover, the fourth-largest credit-card network, filed a lawsuit in October 2004 against Visa and MasterCard, claiming the two largest networks broke the law by barring member banks from offering rival cards. Visa agreed last year to pay $2.25 billion to American Express Co. in a settlement of a parallel suit, an amount Discover Chief Executive Officer David Nelms called ``cheap.'' MasterCard dropped $1.42 to $294.31 at 4 p.m. in New York Stock Exchange trading and Visa fell $1.51, or 1.8 percent, to $82.14. Discover fell 37 cents to $15.33. No Improvement Visa and MasterCard issued separate statements saying Discover's credit and debit businesses haven't benefited much since the ban was lifted, letting banks issue Discover cards along with Visa or MasterCard cards.

"Discover has not seen any increase in its overall percentage of the credit-card volume share'' after the policies were changed, Sharon Gamsin, spokeswoman for Purchase, New York- based MasterCard, said in the statement.

Visa, based in San Francisco, set aside $650 million for a possible Discover settlement from the $3 billion fund established after its record March initial public offering. The funds come from IPO proceeds of banks that owned the network, and the companies are obliged to pay for a larger Discover settlement if needed.

MasterCard didn't set up a similar system when it went public, which means shareholders may be affected by future settlements, Sakhrani said. He rates Visa and MasterCard ``outperform'' and Discover ``market perform.''

`Appropriate Settlement'

The documents had been filed under protective order since the case began. The lawsuits by Discover and American Express follow a U.S. Supreme Court ruling that Visa and MasterCard violated antitrust laws in competing against smaller companies.

I was a little surprised that AmEx settled as early or as cheap as they did,'' Nelms said in a Jan. 29 conference call with analysts. ``If we had an appropriate settlement at an appropriate time, we would consider that.''

Like New York-based American Express, Discover extends credit and runs a network that processes transactions for other lenders. Visa and MasterCard only operate networks and don't make loans to consumers.

Discover shares have declined 47 percent since the company was spun off a year ago by Morgan Stanley as the U.S. housing slump hurts consumers' ability to repay debt of all kinds. The company's market valuation is about $7.6 billion, according to Bloomberg data.

MasterCard shares have almost doubled in the past year and Visa shares have surged 84 percent since its IPO. The companies, which sidestep the rising customer defaults of lenders, capitalize on consumers' increasing preference for using credit and debit cards over cash and checks.

Visa's IPO raised $17.9 billion on March 18, the most for a U.S. company, and the tally passed $19 billion after more shares were sold to satisfy demand. It was the world's second-largest public offering after Industrial & Commercial Bank of China Ltd.'s $22 billion debut in 2006.

The case is Discover Financial Services, Inc. v. Visa U.S.A., Inc. et al, 04-CV-7844, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporter on this story: Hugh Son in New York at hson1@bloomberg.net

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