We have received a number of inquiries as to the tax consequences of the proposed amalgamation of the Bank of Bermuda and HSBC. This column will address the United States income tax consequences to a US citizen or resident alien who owns stock in the Bank of Bermuda.

Deemed Sale or Tax Free Exchange?

Some individuals who own stock in the Bank of Bermuda are confused as to whether they have a choice of either selling their stock, or receiving HSBC stock in exchange.

The confusion was sparked by two events. One, it is common in the United States for an acquiring company to request a ruling from the Internal Revenue Service that an exchange of stock by the acquiring company is a tax-free exchange.

Second, a communication from the Bank of Bermuda to its shareholders indicates that HSBC stock can be acquired without a commission being incurred.

As presently structured, if this transaction is approved, there will be a deemed sale of the Bank of Bermuda stock, and there will not be a tax-free exchange of Bank of Bermuda stock for HSBC stock.

How Is the Transaction Structured?

If the shareholders approve the amalgamation of the Bank of Bermuda and HSBC, all shareholders will:

1. Be deemed to have sold their Bank of Bermuda stock for $40 a share.

2. Receive a special dividend from the Bank of Bermuda of $5 a share

3. Be entitled to purchase HSBC stock without paying the normal brokerage commission.

What Happens If I Do Not Want To Sell My Shares?

IF the amalgamation is approved, you do not have a choice between keeping your shares and selling them. Your shares will be deemed to have been sold for $40 a share, and depending on your basis in the stock and your holding period, you will either have a short or long term capital gain or loss.

How Will the Bank of Bermuda Dividend Be Taxed?

the special dividend of $5 a share will be subject to US income tax as foreign source dividend income. Since the Bank of Bermuda has a listing on a United States stock exchange, it is likely that the dividend will qualify to be taxed at the new 15% tax rate for qualified dividends.

How Much Will I Save By Purchasing HSBC Stock Through the Bank of Bermuda?

There are two factors that you need to be aware of. One, the HSBC stock is not being offered at a discounted rate. You will buy the stock for whatever the fair market value of the stock is on the date of purchase.

The savings factor is that you will not have to pay a brokers fee or commission for the purchase. IF you normally use a broker to buy and sell stock, the cost savings could range from $50 to $250. If you normally buy and sell stock on the internet, your savings will probably range from $9 to $39.

Should I Purchase the HSBC Stock Through the Bank of Bermuda?

That is a personal investment decision that you need to make in conjunction with your financial advisor. In making your decision, there is one other factor to take into account, and that is the exchange rate differential. If the stock is purchased through the Bank of Bermuda, the HSBC stock will be purchased on the London Stock Exchange and will be denominated in United Kingdom Pound Sterling. When you invest in a security denominated in a foreign currency, you become subject to both the fluctuation in the price of the stock, as well as the fluctuation in the US dollar/UK pound sterling (GBP) exchange rate.

For example, suppose the cost of stock was GBP 1.00 and the exchange rate to the US dollar is $1.75 at the time of purchase. If the value of the stock increased to GBP 1.14, and the value of the US dollar to the GBP was $1.50 to 1.00, and you then sold the stock, you would realise an actual loss of $.04, even though the market value of the stock increased by 14%.

Why? Your cost basis is $1.75, while the amount you received from the sale is $1.71 (GBP 1.14 x $1.50 = $1.71).

Can I Purchase the HSBC Stock On Another Stock Exchange?

Yes and No. The HSBC stock is sold on the London Stock Exchange and the Hong Kong Stock Exchange. However, a stock equivalent, known as an American Depository Receipt (ADR), is sold on the New York Stock Exchange. The tax benefit of purchasing the stock (ADR) on a New York stock exchange is that you forgo the foreign exchange risk to a degree, and the dividend most likely will be taxed at the new 15% tax rate for qualified dividends.

How Will the HSBC Dividend Be Taxed?

If the dividend is received from the United Kingdom, it will be considered a foreign source dividend, with the US income tax being eligible to be offset by any foreign tax credits an individual may have.

Is There A Problem With Receiving A Dividend From the United Kingdom?

There is no problem, per se, but the individual should keep in mind that the dividend will be denominated in pound sterling, and that the exchange rate one receives on converting the dividend to US dollars is usually 5% to 10% less than one reads about in the newspaper. Also, it is not unusual for a bank to impose a flat collection fee of $25 for cashing a check denominated in foreign currency. If you do not own a large number of shares, the dividend check might be worthless.

Can the HSBC Dividend Be Deposited Directly to My Account In the HSBC Office in Bermuda?

In a telephone discussion with the Bank of Bermuda investor relations department, we were advised that the Bank is looking into the possibility of doing a "bulk" exchange rate conversion of HSBC dividends that would be paid in pound sterling, to either Bermuda or United States Dollar account holders. This would ensure that all investors with an account in Bermuda would receive a more favourable exchange rate.

Can I Receive Dividends In A Currency Other Than Pound Sterling?

A visit to the HSBC website indicated that shareholders on the UK register will receive their dividends in pound sterling, unless they elect otherwise. Hence, it would appear as though you can receive your dividends in other than pound sterling, and anyone interested in doing so should contact the HSBC shareholder relation department.

Should I Sell My Shares Now, or Wait Until the Amalgamation Is Approved?

The current price of the Bank of Bermuda stock on the New York exchange was $44.90 when we wrote this article. Prior to the announcement of the proposed amalgamation, the stock was selling for about $40 a share.

Local financial advisors appear to have differing opinions as to what to do. We have heard of one advisor recommending that the stock be sole immediately, on the premise that if the amalgamation is not approved, the value of the stock will immediately decline in value.

Another advisor is of the opinion that a better price can be received, perhaps from another buyer, and that clients should not sell now.

You and your financial advisor should decide what you do.

How Do I Determine My Basis In Bank of Bermuda Shares?

We have heard from a number of people who have been buying the Bank of Bermuda stock for a number of years. Over the years they have not kept track of the number of shares they received as stock dividends, and from stock splits.

To assist our clients in determining their basis, we called the Bank of Bermuda investor relations department.

We were told that the Bank of Bermuda did not yet have this information, indicating that historic pricing information is being calculated by the Bermuda Stock Exchange on a quarterly basis, going back to 1971, and that this pricing information will be made available to shareholders and the public through the Bank of Bermuda investor relations department.

The tax advice given by this column is, by necessity, general in nature.

You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the President of ETS Ltd., P.O. Box HM 1574, Hamilton HM GX , Bermuda. Questions should be sent to: jsabo@expatriatetaxservice.com