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LIFTING THE LID-Tax man aids some blue chips this quarter
Thu Oct 14, 2004 03:24 PM ET
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By Arindam Nag

NEW YORK, Oct 14 (Reuters) - As the third-quarter earnings season heats up, a number of blue-chip companies are getting a hand from the tax man to fuel their bottom lines, and investors should have a close look at this trend, experts say.

This week restaurant operator McDonald's Corp. (MCD.N: Quote, Profile, Research) and computer chip maker Intel Corp. (INTC.O: Quote, Profile, Research) , the largest players in their respective industries, both reported hefty earnings gains, with both partly helped by tax issues.

Brokerage firm Merrill Lynch & Co. (MER.N: Quote, Profile, Research) , which beat analysts' earnings estimates by a whisker, also benefited from a lower tax rate.

"Given all the emphasis is on hitting the consensus expectations, it is important for investors to be able to see through some of these transitory or strategic moves made by some of these firms to hit the target," said Campbell Harvey, finance professor at Duke University in North Carolina.

On Wednesday, McDonald's surprised investors with preliminary earnings that topped forecasts, powering a 5 percent rise in its stock.

The company said earnings would likely total 61 cents per share for the quarter, well above an average forecast of 49 cents. But 7 cents -- more than 11 percent of its total profit -- was derived from a lower tax rate triggered by an international transaction plus a change in some tax-loss carry-forward assumptions.

U.S. tax law allows companies to write off losses incurred at some businesses against future tax bills, thereby boosting profits in following years. The U.S. corporate tax rate is 35 percent, but friendly rules like this or plant depreciation and other deductions allow corporations to pay a much lower tax bill.

According to a study by Citizens for Tax Justice, a Washington-based nonprofit research organization, 28 corporations paid no taxes from 2001 and 2003 despite having profits of nearly $45 billion during that period.

Merrill Lynch also used past losses to help this quarter's bottom line.

The company's effective tax rate remains the lowest among its peers at 23.6 percent and the full year rate is expected to below 25 percent, Deutsche Bank wrote in a note to clients. The lower tax rate is attributable to carry-forward losses in Japan as well as a larger component of revenues in some international markets.

Intel, which had lowered its forecast last month, on Tuesday reported a 15 percent rise in earnings, cheering investors who pushed its shares higher the next day. But the company also got a benefit of 3 cents per share by lowering a previous tax estimate.    Continued ...

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