Freddie Mac 2004 Annual Report Download - page 218

Table 14.3 reconciles the statutory federal tax rate to the eÅective tax rate.
Table 14.3 Ì Reconciliation of Statutory to EÅective Tax Rate
Year Ended December 31,
2004 2003 2002
Statutory corporate rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35.0% 35.0% 35.0%
Tax-exempt interest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (4.7) (2.1) (1.2)
Tax credits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (7.3) (3.0) (1.1)
Provision (beneÑt) related to tax contingencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2.0) 0.4 (1.0)
OFHEO civil money penalty and loss contingency accrual ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 1.0 Ì
Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 0.2 0.1 0.1
EÅective rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21.2% 31.4% 31.8%
Impact of tax issues. The IRS has a policy to examine the income tax returns of large corporate
taxpayers, including Freddie Mac, generally every year. Management believes that an adequate provision in
accordance with SFAS 5 has been made for contingencies related to all income taxes and related interest.
However, the ultimate outcome of these tax contingencies could result in a tax beneÑt or tax provision that
could be material to Freddie Mac's quarterly or annual results of operations. Based on current knowledge and
after consultation with outside counsel, management does not believe that liabilities arising from these
matters, if any, will have a material adverse eÅect on Freddie Mac's consolidated Ñnancial condition.
Tax Years 1985 through 1990. In 1998, the IRS issued Freddie Mac a Statutory Notice which asserts
income tax deÑciencies for the company's Ñrst two tax years, 1985 and 1986. In the Ñrst quarter of 1999,
Freddie Mac Ñled a petition in the United States Tax Court (the ""Court'') to contest the deÑciencies. In the
third quarter of 1999, the IRS issued a Statutory Notice for Freddie Mac's tax years 1987 through 1990, and
Freddie Mac Ñled a petition in the Court. Subsequently, the Court combined the 1985 through 1990 tax years
into one case. The principal matters in controversy in the case involve questions of tax law as applied to
Freddie Mac's transition from non-taxable to taxable status in 1985 and primarily involve the amortization of
certain intangible assets, the two most signiÑcant of which are:
‚Favorable Financing. A number of Ñnancing arrangements where the contract rates of interest
were less than the market rates of interest as of January 1, 1985 due to an increase in interest rates
since the date on which Freddie Mac had entered into the respective arrangements; and
‚Customer Relationships. Freddie Mac's business relationships with a substantial number of
mortgage originating institutions that sold mortgages to Freddie Mac on a regular basis.
Tax Court Rulings. On September 4, 2003 and September 29, 2003, the Court decided favorably for
Freddie Mac on two preliminary motions involving questions of law in the case. On September 4, the Court
ruled favorably for Freddie Mac on the question whether Freddie Mac's intangibles are amortizable using, as
the adjusted basis, the higher of (a) the regular adjusted cost basis or (b) the fair market value on January 1,
1985. On September 29, the Court ruled favorably for Freddie Mac on the question whether, as a matter of
law, ""favorable Ñnancing'' (as deÑned above) was amortizable for tax purposes. As part of this case, Freddie
Mac claimed, and the court agreed, that the economic beneÑt of this below-market Ñnancing as of January 1,
1985 is an intangible asset subject to amortization. In October 2003, the Court ruled unfavorably on two other
less signiÑcant issues in the case.
While signiÑcant, the Court's rulings do not dispose of all of the matters in controversy in the case, which,
upon Ñnal resolution by the Court of all such matters, are subject to appeal by the parties. In addition, Freddie
Mac still must demonstrate that the intangible assets in question have an ascertainable value and have a
limited useful life, the duration of which can be ascertained with reasonable accuracy. A trial on the value and
useful life of Favorable Financing began in early June 2005.
In view of the favorable rulings described above and in accordance with GAAP, Freddie Mac recorded in
the fourth quarter of 2002 a reduction in its tax reserves in the amount of $155 million. If the IRS were to
Freddie Mac
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