US Senator Urges Closure of Loopholes to Prevent Banks Aiding Tax Dodgers

Matt Smith

12 September 2008

A senior US lawmaker has called on his colleagues to close loopholes exploited by investors with offshore bank accounts to dodge paying tax based on an investigation that implicated a handfull of Wall Street firms in a “billions of dollars of tax abuse”.

Michigan Senator Carl Levin pointed the finger of blame at US investors, particularly hedge funds, advised by the investment banking businesses of large firms, for avoiding an estimated $100 billion in taxes every year.

The tax in question is the US tax imposed on foreign investors receiving US stock dividends.

“Hedge funds run by Americans and invested in the US stock market often create a shell of a presence in tax havens, presumably in part to avoid paying US taxes. Then, when confronted by the one US tax imposed on foreign investors receiving US stock dividends, they turn to financial gymnastics to escape paying that tax as well,” Senator Levin said in his opening remarks at the committee hearing in Washington.

A report highlighted the role investment firms, in particular Morgan Stanley, Lehman Brothers, UBS, Maverick Capital (a hedge fund advisor) and Citi played in helping clients avoid US tax using swap transactions and stock loans.

Mr Levin called into question the legitimacy of the use of Cayman Island accounts by sophisticated US investors.

“When the Subcommittee began contacting them , all of their key personnel turned out to be here in the United States,” Mr Levin said.

“The Cayman Islands, in fact, have 10,000 hedge funds, more than any other country in the world,” he said. “But the Cayman hedge funds we examined did not operate in any meaningful sense from the Caymans. Instead, their physical presence often amounted to little more than a Cayman post office box or a plaque on the wall of the infamous Ugland House, that small white building where more than 18,000 companies maintain a Cayman address,” Mr Levin said.

“It adds insult to injury when hedge fund managers who live in the United States, enjoy all its benefits, protections and prosperity, and use US markets to make money, arrange tax dodges so their offshore hedge funds escape the minimal US tax obligations they are supposed to pay,” he added.

The investigation and subsequent report drew upon email messages between investment banking staff and clients. It said Morgan Stanley enabled its clients to dodge payment of $300 million in US dividend taxes from 2000 to 2007; Lehman Brothers estimated that in one year alone, 2004, it helped clients dodge perhaps $115 million in US dividend taxes; for UBS, the figure is $62 million in unpaid dividend taxes over a four-year period, 2004 to 2007.

According to the report, Maverick Capital calculated that from 2000 to 2007 its offshore funds used so-called “dividend enhancement” products from multiple firms to escape dividend taxes totalling nearly $95 million. In 2007 it said Citi surprised the Inland Revenue Service by paying $24 million in unpaid dividend taxes on a select group of swap transactions from 2003 to 2005, where no dividend taxes had been paid.

The firms either declined to comment when contacted by WealthBriefing or pointed to the fact they are operating within the boundaries of current tax law.

Commented a Morgan Stanley spokesperson: "We believe that Morgan Stanley's trading at issue fully complied and continues to comply with all relevant tax laws and regulations."

UBS in the US said: “"We decline comment on the specific contents of the report but have been cooperating with the PSI on this matter."

Commented a Deutsche spokesman: “Our total return swaps business operates within the letter and spirit of the law, and we have policies and procedures in place to ensure that is the case.”

As of November 2007, UBS terminated its Cayman Islands stock lending program. It told the committee it no longer conducted any stock lending transactions for policy reasons and because it was not making money.