Death of a loophole

March 30th, 2010

We recently reported on the disclosure provision to combat tax evasion incorporated into the Hiring Incentives to Restore Employment (HIRE) Act, a new job creation bill signed by President Obama on 18th March. A contact in Miami now draws our attention to another provision in the same bill which closes off a sneaky little tax avoidance device which, according the US Government Accountability Office is losing American taxpayers billions of potential revenue through the use of so-called dividend equivalent strategies.

Under US tax laws, dividends paid by US companies to foreign shareholders should be taxed at 30 per cent. For decades, however, US banks have structured deals using derivatives that allow clients to turn their dividends into “dividend equivalents.” These have the appearance of a dividend, but by being embedded into a derivative they don’t generate a tax liability.

According to the New York Times, here’s how they work:

Say a hedge fund holds shares in General Electric. By entering into a swap agreement with a financial institution, the fund can simultaneously sell its G.E. shares a few days before the dividend is issued and receive a derivative tied to the value of the shares and the dividend payment.

After G.E. pays the dividend, the swap is canceled and the investor gets back the shares plus the dividend equivalent payment. The bank that did the trade typically charges a fee linked to the amount of tax savings the hedge fund reaps.

The new law eliminates the tax-free aspect to this transaction, because it treats the swap payments as dividends.

The NYT article reports that this particular wheeze was dug up by the ever-vigilant staff of anti-avoidance crusader Senator Carl Levin, the Michigan Democrat who heads the Senate Permanent Committee on Investigations. Yet again, we raise our hats in their direction.

Interestingly, the same article carries a comment by Lee Sheppard of Washington-based Tax Notes, saying that while the new provisions embedded in the HIRE act will go some way towards tackling the tax evasion culture in America, the radical route to closing down the tax evasion industry would be to make tax evasion a predicate act under anti-money laundering provisions:

“If you really wanted to stop this, you would define tax evasion as a predicate act to money laundering. Currently the money-laundering information the banks give the government is not given to the I.R.S. for civil tax enforcement.”

This is a proposal that TJN has been campaigning on for several years. For too long, a vast (and vastly overpaid) army of lawyers, bankers, accountants and other camp-followers, have been allowed to play the wilfully blind professional when it comes to advising their tax evading clients. Requiring them to raise a suspicious transaction report each and every time they have grounds to suspect that a client is evading tax, will make it far less easy for them to get away such monkey-business. We know that this matter is currently under review by the International Monetary Fund, and we say bring it on.

Written by Tax Justice Network

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