Senate Accuses Major Banks Of Helping Foreign Clients To Dodge US Taxes

by Leroy Baker, Tax-News.com, New York

12 September 2008

At a hearing today (Thursday), US Senators will examine allegations that some financial institutions have designed, marketed, and implemented transactions to enable foreign taxpayers, including offshore hedge funds, to dodge millions of dollars of taxes on US stock dividends each year.

The hearing, to be held by the Senate Permanent Subcommittee on Investigations, follows a year-long bipartisan investigation into the practices of some well-known Wall Street banks, and is part of a series of Subcommittee hearings on offshore tax abuse.

The Subcommittee is chaired by Carl Levin, the Michigan Democrat with a mission to stamp out all forms of offshore tax evasion which, he claims, costs the United States an estimated USD100 billion in tax revenues every year.

“Financial gimmicks are being used to help foreign investors dodge US taxes on US dividend taxes, and it is an open secret among insiders that they can get away with it,” Levin commented.

Under current law, taxes on US dividends can be as high as 30% if the foreign investor is resident in a country with which the US does not have a bilateral tax treaty, although this can be reduced to 15% through the legitimate application of a tax treaty. However, according to Levin, major financial institutions have devised complex financial structures to enable their offshore clients to evade US dividend taxes.

"Over the last ten years, dividend tax abuse has cost the US treasury and honest taxpayers billions of dollars in lost revenue. We need legislation to take these abusive tax avoidance gimmicks off the market, and we need to end the silence and inaction of the Treasury and IRS in the face of rampant dividend tax dodging," he stated.

The Subcommittee began its investigation into offshore dividend tax abuse in September 2007 and has developed six 'case histories' involving Lehman Brothers, Morgan Stanley, Deutsche Bank, UBS, Merrill Lynch, and Citigroup. The investigation alleges that these firms developed and marketed products that allowed investors to circumvent withholding tax rules, involving primarily stock swaps or loans, which were described as offering “dividend enhancement,” “yield enhancement,” or “dividend uplift.”

The Subcommittee also interviewed managers of offshore hedge funds that used these products, including Angelo Gordon, Goldman Sachs Asset Management, Highbridge, Maverick, Moore Capital, and funds managed by Wall Street banks. The investigation found that many of these offshore hedge funds functioned as shell entities controlled by US professionals who facilitated their participation in "dividend-dodging transactions."

The investigation disclosed that Morgan Stanley helped clients, from 2000 to 2007, avoid payment of US dividend taxes of over USD300 million. Lehman Brothers estimated that in 2004, it helped clients avoid US dividend taxes amounting to perhaps USD115 million. UBS enabled clients, from 2004 to 2007, to avoid USD62 million in dividend taxes, but last year stopped offering the Cayman stock loans that produced that figure.

The probe also accused Maverick Capital, which runs several offshore hedge funds, of using dividend enhancement products at multiple firms to escape dividend taxes from 2000 to 2007, totaling nearly USD95 million. Citigroup meanwhile, told the IRS that it had failed to withhold dividend taxes on a limited set of swap transactions from 2003 to 2005, and voluntarily paid those taxes which totaled USD24 million, according to the investigation.

However, the report also points an accusing finger at the US government, and it has rebuked the Treasury Department and the Internal Revenue Service for allowing such dividend tax abuse to proliferate by effectively turning a blind eye to it. It also calls for tougher legislation and enforcement to prevent investors from utilising swaps and stock loans to avoid dividend taxes.

Levin and Ranking Minority Member Norm Coleman (R-Minn.) are due to release the 77-page joint staff report detailing the findings of the investigation in conjunction with the hearing.

“The Subcommittee’s bipartisan investigation leaves no doubt that some institutions have taken advantage of ambiguities in US tax law and pushed the tax-avoidance envelope too aggressively,” Coleman observed.

“The findings are compelling and we must reevaluate the wisdom and effectiveness of the tax regime governing these complex structures, some of which are designed solely to avoid taxes. A swaps transaction with no business purpose other than the avoidance of taxes is just a bridge too far. It’s especially troubling that the IRS has failed to address many of these problems for so long; in short, it appears that the IRS dropped the ball on preventing many of these egregious schemes."

The Subcommittee has announced that hearing witnesses will include representatives of financial institutions, hedge funds, a tax expert, and the Commissioner of the IRS, Doug Shulman.

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