Handful of firms peddled equity swaps, stock loans to clients; 'IRS pussyfooted on this.'
Morgan Stanley, Lehman Brothers. and other Wall Street giants helped foreign investors dodge billions of dollars in U.S. taxes on stock dividends while the IRS looked the other way, a Senate investigation found.
The firms worked with the money of U.S.-run hedge funds that used offshore mailing addresses in the Cayman Islands and elsewhere.
The Wall Street banks arranged complex equity swaps and stock loans aimed at helping overseas investors circumvent U.S. tax laws, a staff report by the Senate Permanent Subcommittee on Investigations said.
For 10 years, the IRS has neither enforced existing rules prohibiting the transactions nor tried to draft new standards, the 77-page report said.
“These are gimmicks peddled by American financial institutions to deny Uncle Sam taxes owed under our law,” Senator Carl Levin, who heads the panel, told reporters.
“The IRS has pussyfooted on this.”
Morgan Stanley enabled foreign clients to avoid payment of more than $300 million in U.S. dividend taxes from 2000 to 2007, the report said.
Lehman estimated its customers eluded payment of as much $115 million in 2004. UBS helped clients escape payment of $62 million from 2004 to 2007.
Among some of the offshore hedge funds, Maverick Capital Management’s arrangements with Wall Street firms enabled it to avoid $95 million in taxes from 2000 to 2007, the report said. Many of the hedge funds had no offices or personnel in their offshore locations, but operated under the control of a U.S.-based manager.
“It’s easy for Congress to say these things, but the rules aren’t clear and they haven’t caught up with where Wall Street is,” said George Clarke, a Miller & Chevalier lawyer who represents large Wall Street investment banks on overseas tax issues.
“It’s not clear that the IRS has jurisdiction because some of these people are outside the U.S. It’s also not clear that the synthetic instruments being created are dividends.”
A Morgan Stanley spokeswoman echoed those sentiments: "We believe that Morgan Stanley's trading at issue fully complied and continues to comply with all relevant tax laws and regulations."
In addition to Morgan, UBS and Lehman, the report identified tax-avoidance schemes designed by DeutscheBank, Citigroup, and Merrill Lynch.
In one instance, a Lehman employee hailed the 2004 announcement of a special dividend to be paid on Microsoft stock and said,
“The cash register is opening!!!!” according to an email cited in the report. His boss responded: “Outstanding…Let’s drain every last penny out of this [market] opportunity.”
Several Merrill clients were so anxious about the legality of the transactions that they tried to put brakes on the firm or at least get a tax indemnity agreement from it, according to the report.
Olayan Group, an investment firm in Saudi Arabia, told Merrill that its U.S. lawyers cautioned them that too much use of a stock loan might draw IRS attention.
“It is the repeated ‘overuse,’ e.g. pigs trying to be hogs, that proves problematic,” the Saudi firm said. Merrill protested, but the loan wasn’t undertaken, the report said.
U.S. law requires foreign investors to pay a tax on the dividend paid by a U.S. company. Dividends sent abroad are supposed to be taxed at a rate of 30% in most countries, and 15% in countries having a tax treaty with the United States.
Morgan Stanley reported $25 million in 2004 revenue from dividend-related transactions. Lehman had $12 million in 2003, UBS had $5 million in 2005 and DeutscheBank had $4 million in 2007, the report said.
Merrill suspended one type of dividend-tax transaction when presented with questions by the subcommittee, the report said.
One firm, JPMorgan Chase & Co., was mentioned in the report only because it acted honorably: the bank raised red flags when asked by Merrill to participate in a questionable transaction.
The deal eventually was scuttled, the report said.
Mr. Levin, a Michigan Democrat, said he plans to ask the Senate Finance Committee to introduce legislation this year prohibiting the kinds of tax avoidance cited in the report.
