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Bank of New York Case Tests IRS Power to Halt Foreign Tax Abuses

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Posted on Apr 16, 2012
AP/Richard Drew

By Megan Murphy and Vanessa Houlder, Financial Times, and Jeff Gerth, ProPublica

This piece originally appeared at ProPublica.

In November 2001, Bank of New York, a mid-tier U.S. bank, transferred nearly $8 billion of its own assets to a trust in the small, business-friendly state of Delaware through several layers of newly created companies.

A mixture of home mortgages, shares and other securities, the transferred assets made up almost 10 percent of the bank’s total assets at the time. Yet, the transaction was not discussed with BNY’s regulators; nor was it noted in the bank’s financial statements or annual report. It had little practical effect on the lender’s day-to-day operations—the assets continued to be managed and serviced by the same employees in New York.

But it was a critical first step in setting up a complex structure known as STARS—structured trust advantaged repackaged securities—which U.S. tax authorities claim was used by several American banks as an abusive tax shelter that has cost the government more than $1 billion in tax revenue in the past decade.

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This week, BNY will square off against the Internal Revenue Service in U.S. Tax Court in New York over STARS and the tax benefits tit triggered for the U.S. bank and U.K.-based Barclays, its counterpart in the deal. At issue is whether STARS was set up primarily to generate artificial foreign-tax credits, as the IRS contends; or was a legal way for BNY to obtain financing at rock-bottom rates.

The arguments heard this week will pose a crucial test of the U.S. government’s resolve to rein in sophisticated corporate tax planning that has sapped vast amounts of potential revenue. Tax authorities worldwide, notably in the U.S. and U.K., are under mounting pressure to show that large companies are shouldering their share of the tax burden as part of a broader political debate about fairness and corporate social responsibility.

“We are upping our game in the large business area, particularly as it relates to international tax issues,” Douglas Shulman, the U.S. internal revenue commissioner, said in a speech this month in Washington, D.C.

For the IRS, losing the STARS disputes would be a serious blow to its strategy in high-value cases, tax lawyers said. For the banks, the risk is both financial—$900 million is at stake in the BNY case alone—and to their reputations.

An investigation last year by the Financial Times and ProPublica first detailed how STARS produced tax benefits for U.S. banks beginning in 1999. In all, six banks—BNY (now Bank of New York Mellon), BB&T, Sovereign (now a unit of Santander), Wachovia (now part of Wells Fargo), Washington Mutual and Wells Fargo—participated in STARS deals with Barclays between 1999 and 2006.

Five of those banks are challenging IRS rulings that disallowed foreign tax credits generated in those transactions. WaMu has settled a STARS dispute in bankruptcy court by agreeing to forgo $160 million in claimed tax credits. In total, the IRS says, the STARS deals created $3.4 billion in foreign tax credits.

Now, documents filed in BNY’s case in the past few weeks—the court proceedings begin Monday—provide unprecedented detail about how STARS was crafted at a time when banks and accounting firms were offering deals for multinational corporations to take advantage of loopholes in rules governing foreign tax credits.

At the simplest level, foreign tax credits are designed to prevent U.S. companies from being taxed twice on overseas income by allowing them to claim credit for taxes paid in foreign jurisdictions.

In the BNY case, the IRS claims STARS allowed both Barclays and BNY to claim credits for the same “illusory” foreign tax charges, ultimately reducing the U.S. government’s tax revenue by $18.15 for every $100 of income funneled through the Delaware trust. “The record will establish that STARS was a pricey financing that no prudent banker would undertake but for the tax benefits generated by the meaningless circulation of cash flows,” according to a court filing by the IRS on March 27.

BNY has argued that the deal was a complex but entirely legal, allowing the bank access to low-cost financing from Barclays for its everyday business activities.

Brainchild of Barclays

Like hundreds of other foreign-tax-driven transactions sold to companies in the boom years before the financial crisis of 2008, STARS was developed by Barclays’ famed structured finance group, known as Structured Capital Markets. Roger Jenkins, one of Britain’s best-known dealmakers, and Iain Abrahams, the expert behind most of the bank’s tax arbitrage transactions, led SCM. The idea was for STARS to manufacture tax credits for Barclays and a U.S. corporate taxpayer by circulating U.S. income through an entity taxed in the U.K., the IRS said in its filing.

Because of the differences between U.S. and U.K. accounting rules, STARS would allow Barclays to reimburse a U.S. company for half the tax paid in the U.K. while not reducing the amount of foreign tax credits that could be claimed by either party, the IRS said. Barclays is not a party to the IRS dispute with BNY and has not been accused of wrongdoing by U.S. authorities.

According to the IRS, blue-chip U.S. companies including Microsoft and insurers AIG and Prudential Life passed on early versions of STARS for unspecified reasons. But the IRS said BNY, which bought the deal in 2001, had grown “addicted” to tax-driven transactions, which provided it with an important source of revenue.


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By Laurie Bowen, April 24, 2012 at 1:07 pm Link to this comment
(Unregistered commenter)

Fullblad:

I so agree with you . . .

very well said . . . We used to tax the tar out of huge profits . . . & those that ended up with them as a matter of general practice . .

Not any more!

I think the general sentiment used to be . . . we don’t care where you got the profits or how you got these profits . . . We will tax it! And tax it hard . . .

That was the intent of the income tax . . . in my opinion of history . . .

It surely tempered naked greed.

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By Fullblad, April 19, 2012 at 12:21 pm Link to this comment

I think we’re all beyond being shocked by this type of behavour. The capitalist and neo classical economic mantra has always been the maximizaton of profit, either legally or not. Getting caught crimminally is often written off as the cost of doing business. The only way to control this penchant for uncontrolled greed is through regulations; and as one economist said, ( I think it was John K Galbraith)
“they must feel it in their bones.” Regulate and massively fine the bastards until we are all safe from their predations.

Of course the time of an the ever expanding capitalist economic dictum, called growth, is rapidly coming to an end. The earth has finite resources and carrying capacity,which if pursued in a classical capitalistic style will be exploited until exhaustion of life’s biosphere and it’s death and all in the name of profits for a few. A radical shift in mindset and a new system for providing the necessities of life is now of upmost importance.

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By Laurie Bowen, April 19, 2012 at 10:32 am Link to this comment
(Unregistered commenter)

Great Article . . . Good Job . . .

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Lafayette's avatar

By Lafayette, April 18, 2012 at 12:51 am Link to this comment

FIX AN ARCHAIC TAX CODE

CC: I will be even more shocked if BNY ever gets to see the inside of a jail cell.

What makes anyone think that jailing the responsibles for fraud will change the situation? That’s just the cherry on top of reforming the Tax Code Cake.

The problem is systemic dysfunction of America’s Tax Code. Let’s fix an Archaic Tax Code; make it far more progressive with fewer deductions and no tax-eluding corporate manipulations and we’ll see far fewer shenanigans as recounted in this article.

Let’s also get a unified Corporate Tax Rule that requires companies to declare in the US all foreign profits and bank balances held offshore - under a threat of total confiscation of such funds if not accounted for fiscally to the IRS as taxable. In fact, some corporations declare domestic funds as “offshore provenance” in order to avoid taxation.

Some uncomfortable facts:
* The vast majority of the world’s estimated 9,000 hedge funds are formed in Cayman Islands, British Virgin Islands, Luxembourg or Bermuda.
* From Senator Levin (see here):

New data released today [PDF] by Sen. Carl Levin, D-Mich., chairman of the U.S. Senate Permanent Subcommittee on Investigations, show that large multinational U.S. corporations with substantial offshore funds have already placed nearly half of those funds in U.S. bank accounts and U.S. investments without paying any U.S. tax on those foreign earnings.

The 27 U.S. multinationals surveyed by the Subcommittee reported holding a total of $538 billion in tax-deferred foreign earnings at the end of FY2010.  By comparison, in mid-2011, all U.S. corporations held tax-deferred foreign earnings totaling an estimated $1.4 trillion.

Those tax-deferred foreign earnings are in addition to the overall domestic cash holdings of U.S. corporations, which the Federal Reserve has recently estimated at $2 trillion. “U.S. multinationals, as a whole, have record amounts of domestic and offshore cash,” said Levin.

(And so we want to reduce overall corporate taxation? Gimme a break!)
* B.t.w. - why does Mrs. Romney have $3M in a Swiss bank account? (Her share of hubby’s venture-capital loot safely socked away in a Geneva bank account?)

MY POINT?

Greed has overcome the One-Percenters. It is impossible to imagine that 22/25% taxation does not compel some individuals to fix markets, cheat on taxable revenue or offshore funds and employ the all-too-numerous tax deduction schedules in order to either avoid or reduce taxation?

And with smart Tax Lawyers, they do all the above quite legally. We need to reform the Tax Code. Only a progressive Congress will accomplish that long overdue miracle.

POST SCRIPTUM

What are 10,000 Tax Lawyers all tied together and anchored to the ocean’s floor? A good start ...

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Lafayette's avatar

By Lafayette, April 18, 2012 at 12:14 am Link to this comment

PUT RIGHT THE UNFAIRNESS

It is unimaginable that such fiscal shenanigans come up in front of a court.

The IRS should have sufficient legal backing to enforce its own rules. And if the American Tax Code were not a labyrinth of over 6000 pages and were it not employed to embellish Corporate Welfare, then maybe it would allow Americans a more egalitarian society.

Not one of One-Percenters and of Ninety-nine Percenters. One with Income Equity whereby individuals earn an income according to their talents and not their Congressional political-pull.

Let’s rewrite the Tax Code from page one, ridding it of the manipulation deductions that allow upper income tax (both marginal and capital gain) to be taxed effectively at between 22/25% according to the IRS.

This is a rip-off of the Ninety-nine Percenters by the One Percenters. It is unjust, immoral and unacceptable. And we, the sheeple, should vote progressives into power to put right the unfairness.

MY POINT?

Remember in November nothing will change if Romney becomes PotUS - and we must get off our duffs to bring more progressives into Congress. Without such a Seismic Political Shift we’ll be bitching-in-a-blog about the unfairness for some time to come.

Or we all immigrate to Canada ...

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By Cliff Carson, April 17, 2012 at 4:54 pm Link to this comment

I am shocked, shocked mind you, that a pristine white Bank would do something so unethical.

I will be even more shocked if BNY ever gets to see the inside of a jail cell.

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By rend, April 16, 2012 at 5:49 pm Link to this comment
(Unregistered commenter)

casino with fixed decks.

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