Tax Credits: Scam or Legitimate Business?

September 26th, 2011
in econ_news

money-under-the-table Econintersect: A study has found that international banks are conducting business in a way that avoids billions in taxes. Some banks are even suing the U.S. government to recover tax credits that the IRS has disallowed. The study was conducted by the non-profit organization ProPublica jointly with the Financial Times and a news report has been published September 25 in the FT. The technical term used in the news report is tax arbitrage and the investigation addressed the question of whether banks conspired to create artificial arrangements for to create extra tax credits.

Follow up:

The IRS has often challenged business arrangements and personal transactions that had no other purpose than to avoid taxes that would otherwise be paid. In the cases now studied, the question is whether banks created transactions no real business purpose other than to create extra tax credits.

Some details from the Financial Times:

Four US banks – BB&T, Bank of New York Mellon, Sovereign (now part of Santander of Spain), and Wells Fargo – are in turn suing the US government over more than $1bn in tax credits that the Internal Revenue Service has disallowed over the past decade. Washington Mutual has settled a similar dispute and Wachovia is pursuing an administrative complaint over a deal.

The UK’s Barclays emerges as a pivotal promoter of the complex cross-border deals, which the IRS claims were designed to generate artificial foreign tax credits.

The cases have become a crucial early battleground between the US and multinational banks and companies in the wider debate over so-called tax arbitrage, and whether companies exploit gaps between international tax systems to benefit their bottom lines.

Some specific convoluted bank deals carried out for no other apparent purpose than to reduce taxes are presented in the form of slide shows with audio at the Financial Times

The purpose of the tax credit provisions is to prevent double taxation of earnings in multiple countries for international operations. Apparently some banks have found that they can contrive situations that do more than prevent double taxation, but go further and create fractional taxation.

More details from ProPublica:

STARS – short for “structured trust advantaged repackaged securities” – were deals between U.S. banks and Barclays, one of the U.K.’s premier banks in London, that have come under particular scrutiny in bankruptcy, tax, district and claims courts.

At issue in the cases is whether the transactions had a legitimate business purpose or were designed specifically to generate improper U.S. tax credits.

Six U.S. banks — BB&T, Bank of New York Mellon, Sovereign (now a unit of Banco Santander), Washington Mutual, Wells Fargo and Wachovia (now a Wells Fargo subsidiary) — have been battling the government over tax credits they claimed through STARS. In one instance, government lawyers said STARS permitted BB&T to claim $1 in foreign tax credits for every 50 cents in tax, “grossly exploiting the tax laws [1].’’

BB&T, based in North Carolina, responded in court that it participated “to maximize profits’’ and not “to avoid or evade’’ taxes.

The U.S. banks all contend their deals had economic substance because Barclays provided them with billions in financing at below-market costs. But each arrangement involved a complex set of transactions, including creation of a trust and multiple subsidiaries, which also provided significant tax breaks.

The U.S. government, in recent court filings, contends that STARS was a highly complex tax-shelter transaction used by the U.S. banks to generate foreign tax credits. In court filings, government lawyers allege that the BB&T [2] and Wells Fargo [3] deals were a “sham.’’ In Wells Fargo’s case, they assert that STARS was designed so the U.S. bank’s “entire economic profit would be totally and exclusively sourced from U.S. foreign tax credits. [4]’’

Wells Fargo says in court papers [5] that its deal with Barclays was a lawful way to obtain reduced-cost financing for its ordinary business.

Sources: Financial Times and ProPublica

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