Thursday, September 11, 2008

A Note On the Latest Tax Evasion Scheme

Full disclosure: I'm a tax lawyer. I have an LLM with a dual concentration in both domestic (US) and international taxation. Part of any LLM curriculum is anti-avoidance law. And anyone -- anyone -- with a modicum of anti-avoidance law under their belt will recognize the latest tax "planning" scheme as pure crap.

Let's start with the basic law. foreign corporations are taxed at a rate of 30% on income from dividends within the US. For those of you who are legally oriented, here's the relevant law:

(a) Imposition of tax
Except as provided in subsection (c), there is hereby imposed for
each taxable year a tax of 30 percent of the amount received from
sources within the United States by a foreign corporation as -
(1) interest (other than original issue discount as defined in
section 1273), dividends, rents, salaries, wages, premiums,
annuities, compensations, remunerations, emoluments, and other
fixed or determinable annual or periodical gains, profits, and

Pretty straightforward, right? Here's the latest scheme to avoid this rule:

In one kind of dividend-enhancement product, offshore hedge funds would sell stocks to Wall Street firms near the time for a dividend payment. At the same time, the securities firms entered into swap contracts in which, for a fee, they agreed to pay investors the equivalent of the dividend plus any stock gains.

The swaps changed the definition of the income under IRS rules, letting offshore funds claim they didn't earn dividends subject to the 30 percent withholding tax. The Wall Street firms, in turn, might owe taxes on the dividends -- at the lower, 15 percent rate for U.S. taxpayers -- while claiming even larger deductions for the swap payments to investors.

Here's the problem with this scheme: it violates one of the oldest anti-abuse rules in tax law which is substance over form. All that means is the IRS will look at what is actually happening rather than what the parties to the transaction say is happening. Here, the situation is pretty clear. The foreign owners of the stock are still receiving a dividend. They're just calling it something different. And any tax adviser worth his salt knows this is what is happening.

Here's what really ticks me off. In several news reports, advisers from several Wall Street firms said they believe the transactions to be legal. BULLSHIT. These guys are lying their asses off. At that level of the game, the people involved should be getting much better legal advice.

On top of that, there are plenty of legal ways to lower taxes. And these guys also know that. Instead, they are going for the bullshit scheme rather than really earning their money.