US Senate Questions Wall Street Firms In Offshore Tax Probe

by Glen Shapiro, LawAndTax-News.com, New York

17 January 2008

United States Senators are reportedly investigating whether a number of high-profile Wall Street investment firms have improperly structured certain transactions to help offshore investors avoid hundreds of millions of dollars in US dividend withholding taxes.

According to a recent report by the Wall Street Journal, the Senate Permanent Subcommittee on Investigations has subpoenaed at least four major banking groups, including Citigroup, Lehman Brothers Holdings, Morgan Stanley and UBS, on the use of derivative transactions by offshore investors, some of which may include large hedge funds.

Senate investigators are examining whether securities firms and banks acted improperly by failing to withhold US dividend taxes on the transactions, the Journal reported, citing individuals familiar with the matter. Specifically, they are focusing on 21-day swap trades. Using these trades, clients would sell the bank stock for a short term when a dividend payment was scheduled. The bank would then pay the client the returns from the trade, including dividends. However, because the fund didn't hold the stock at the time of the dividend payment, it could potentially avoid paying 30% in taxes on that payment.

It is understood that the potential loss to the US Treasury in dividend tax revenues could run to more than USD1 billion.

Reports suggest that the investigation has been launched in response to an earlier report by the Wall Street Journal, published last year, which shed light on a new strategy undertaken by a major bank, dubbed "the Cayman Islands trade", which claimed to extract higher yields on dividend-paying stocks.

Senator Carl Levin, the Michigan Democrat who chairs the Senate committee reportedly conducting the probe, has so far refused to comment on the report, as have the four banks named by the WSJ.

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