The Senate subcommittee chaired by Carl Levin (D-MI) held a hearing on Thursday that coincided with the release of its report laying out the evidence that offshore entities are evading taxes on dividends, and that U.S. financial institutions are helping them.
The controversy examined by the Homeland Security and Governmental Affairs Subcommittee on Permanent Investigations surrounds stock dividends paid by American companies to "non-U.S. persons." Such dividends are subject to a withholding tax of 30 percent, unless the recipient is located in a country that has a tax treaty with the U.S. allowing that country to have the primary (or sole) taxing power. Offshore hedge funds and other entities that are based in tax haven countries having no such treaty with the U.S. have carried out various schemes to avoid this tax.
A simplified version of such a scheme would consist of an offshore hedge fund entering into a "swap" agreement with a U.S. entity, handing its stock over to the U.S. entity in return for payments that are technically not dividends (and therefore not subject to the withholding tax) but that are "dividend equivalents." After the dividend is paid, the stock can be returned to the offshore hedge fund so that all parties are in the same position they were in before the swap took place, except that the offshore hedge fund has paid the U.S. entity a fee that is a fraction of whatever it saved by avoiding the tax.
The subcommittee found evidence that many leading financial institutions in the U.S. have peddled such schemes to their clients and have probably cost American taxpayers billions of dollars over the last decade or so. Morgan Stanley alone seems to have helped clients escape paying $300 million from 2000 through 2007. The report says that the Treasury and IRS have failed for years to make needed regulatory changes or take enforcement measures that would block these schemes, and calls for Congress to enact legislation that stops these institutions from disguising dividend payments.
Observers of issues related to tax evasion are not surprised by these findings. In 2001, CTJ director Robert McIntyre wrote about what he called the "tax cheaters' lobby" that was forming under the umbrella of the so-called Center for Freedom and Prosperity, which opposes attempts to crack down on those who wish to move their income offshore to avoid U.S. taxes. He explained that the Bush administration actually withdrew support for an OECD effort to solve some of these problems, and quoted the Treasury Secretary at that time, Paul O'Neill, as saying that stopping tax evasion "is not in line with this administration's tax and economic priorities."