Wall Street and European investment banks are marketing and selling complex schemes meant to allow foreign investors, including offshore hedge funds, to avoid paying billions of dollars in dividend taxes illegally, US lawmakers said in a report, according to media reports.

The 77-page report, by the Senate Permanent Subcommittee on Investigations, is based on scores of internal data and documents and singles outMorgan Stanley,Lehman Brothers,Deutsche Bank,Merrill Lynch,UBS andCiti.  The committee holds a hearing on its finding today.

The report also names several hedge funds, includingMoore Capital,Highbridge andMaverick Capital, as using the dividend-dodging products. Maverick improperly used the banks’ schemes, mostly ones sold by UBS, to illegally avoid tapping its own investors for $95 million in dividend taxes from 2000 through 2007, the report said.

UBS and Lehman Brothers declined to comment on the report. Maverick Capital did not immediately return calls seeking comment.

If a foreign investor, including an offshore hedge fund, holds stock in a US company that pays a dividend, then the investor typically owes a 30 per cent tax on the dividends. Offshore hedge funds, many of them owned by large US and foreign banks, typically hold large amounts of dividend-paying stock.

The report said that over the last 10 years, the banks have marketed, sold and carried out the transactions underlying complex financial products that are meant to disguise dividend payments as non-taxable ones. The business has been highly lucrative for the banks.

Through programmes with names like “dividend enhancement” and “dividend uplift,” the banks are using complex equity swaps, fake loans and sham stock sales, sometimes through entities in the Cayman Islands, to disguise dividend payments to clients, the report said.

Stock-swap agreements have favourable tax rates for investors outside the US, making the dividend “equivalents” they generate tax free.

For example, the report discloses that from 2000 through 2007, Morgan Stanley used sham stock loans and other schemes, some involving Microsoft shares, to disguise dividend payments, thus helping its clients to dodge more than $300 million in US dividend taxes.

The report also says sham stock loans were handled through a Morgan Stanley subsidiary, Cayco, in the Cayman Islands, which paid out to investors dividends totalling $1.1 billion over 2000 through 2007 that were disguised as non-taxable.

The report cited a 2005 internal Morgan Stanley presentation showing that more than one-third of the revenue from its “ US equity swaps flow business” came from so-called dividend enhancement swaps. The enhancement swaps business brought in $25 million to Morgan Stanley in 2004 and was expected to bring in $40 million in 2005, the report cited the presentation as saying.

A Morgan Stanley spokeswoman said that “we believe that Morgan Stanley’s trading at issue fully complied and continues to comply with all relevant tax laws and regulations".