The New York Times Lynnley Browning reports that the feds are scrutinizing certain financial derivatives that they say Wall Street banks have been using to avoid collecting billions of dollars in withholding taxes on stock dividends (emphasis added):
The Internal Revenue Service is examining whether banks are using the swaps to mask who really owns the shares underlying the instruments, thereby avoiding collecting dividend withholding taxes.
In effect, the IRS suspects that the banks are disguising who owns the stock in order to help their offshore hedge fund clients avoid the withholding tax — a tax the banks are supposed to collect.
Mark H. Leeds, a tax lawyer at Greenberg Traurig, said on Wednesday that the scrutiny indicated the IRS increasingly viewed equity swaps as “evidence of tax avoidance.”
The IRS has told its field auditors how to identify and scrutinize “equity swap transactions” (emphasis added):
In a directive issued last Thursday, the IRS. instructed its field agents on how to audit American banks and United States branches of foreign banks with an eye to “uncovering and developing cases” related to certain swap transactions “that may have been executed in order to avoid tax with respect to U.S. source dividend income” paid to offshore hedge funds and foreign investors.
“The audit guidelines reflect suspicion that all cross-border equity swaps are tax-avoidance transactions, even though the IRS’s own regulations treated these transactions favorably,” Mr. Leeds said.
Tax lawyers regard the directive as significant because it concerns a vast, unregulated market and could lead to tax disputes between the IRS and Wall Street banks. The exact size of the equity swaps market is difficult to ascertain, but the Bank of International Settlements puts the notional value of all equity-linked swaps and forwards, which are similar derivatives, at nearly $1.7 trillion as of last June.
Browning says the targeting of equity swaps has been in the works for a long time:
The IRS made rooting out abuses with equity swaps a top priority in March. A bill in the Senate, which passed the House last December, would sharply curtail the tax benefits on equity swaps.
In September 2008, a Senate subcommittee issued a scathing report, “Dividend Tax Abuse,” that accused Wall Street banks of marketing and selling complex swaps intended to evade taxes on dividend payments.
The report said trades in equity swaps had flourished over the last 10 years and grown lucrative for Wall Street banks.
A typical equity swap involves a hedge fund agreeing to pay a Wall Street bank’s losses on a stock in exchange for the bank’s promise to pay stock gains and dividends to the fund. Because the swaps are derivatives, no shares actually change hands.
The IRS directive identified four types of swaps: cross in-cross out; cross in-interbroker dealer out; cross in-foreign affiliate out; and synthetic equity transactions.
The IRS calls these shenanigans “tax avoidance,” but they feel different than the run of the mill tax avoidance that average taxpayers employ to minimize their taxes. I am no expert in the taxation of derivatives, but it seems to me that the structuring of transactions in such a way so as to disguise true ownership and thereby make it technically unnecessary to comply with IRS tax withholding rules, is not tax avoidance, which is perfectly legal, but rather, a form of tax evasion.
Kudos to the feds for going after tax cheats, which in my mind is a form of eliminating waste.
I’ve said this before, but it’s worth repeating: The government should close the tax gap and eliminate waste before asking the taxpayers for a raise.
Related Posts:
- No Government Contracts for Deadbeats, Says President Obama
- Op-Ed on Tax Increases: The Government Doesn’t Deserve a Raise
0 responses so far ↓
There are no comments yet...Kick things off by filling out the form below.
Leave a Comment