United we stand, dividended we fall

Here we go again.

Financial wunderkind, most Blue-blood Yanks, concoct a scheme to allow "foreign" investors to avoid paying their fair taxes to the US Treasury, and make a mint in the process.

And who are these wunderkind? Lehman for one bunch, the folks who are looking/hoping for some kind of salvation from the losses they've concocted by floating and flogging other Financial Frankensteins.

USA Today reports,

Top financial institutions helped non-U.S. investors avoid billions of dollars in federal taxes due on dividends from American companies by marketing allegedly abusive offshore transactions, according to a Senate report set for release at a hearing Thursday.

Lehman Bros., Morgan Stanley, Deutsche Bank, UBS, Merrill Lynch and Citigroup were among numerous financial firms that promoted the strategies.

Under the U.S. tax code, foreign investors are required to pay a 30% federal tax rate on dividends they receive from American companies. But the Senate report found that financial firms have devised strategies, often equity swaps or stock loans routed through offshore transactions, to duck the tax requirement.

In what the report called "one of the most blatant" strategies, an offshore hedge fund executes an agreement with a financial institution several days before a U.S. firm pays its stock dividend. Under the agreement, the hedge fund sells its holdings in that stock to the financial institution while replacing the shares with a swap agreement tied to the stock's market performance.

After the dividend is issued, the offshore hedge fund gets a "dividend equivalent" equal to the amount paid by the U.S. firm, minus a fee for the financial institution. The transaction enables the hedge fund to receive as much as 97% of the dividend, instead of the 70% it would have received had federal taxes been withheld.

Days after the dividend date, the hedge fund repurchases the stock and terminates the swap.

Levin stressed that many equity swaps and stock loans are legitimate and not linked to tax evasion.

Lehman Bros. calculated its Cayman Islands stock-lending operations produced $12 million in 2003 profit, and projected $25 million in 2004 gains. Morgan Stanley estimated $25 million in 2004 revenue from dividend transactions.

Reuters adds,

The report by the U.S. Senate Homeland Security subcommittee on permanent investigations said investment bankers use phrases like "dividend enhancement," "yield enhancement" and "dividend uplift" to market an array of transactions "whose major purpose is to enable non-U.S. persons to dodge payment of U.S. taxes on stock dividends."

The committee estimates that using offshore entities to avoid paying U.S. taxes costs the federal treasury about $100 billion annually. The report did not put a specific amount on tax losses due to stock swaps and loans transactions with offshore entities, but said the amount is "substantial."

"It adds insult to injury when so-called 'offshore' hedge funds turn out to have a shell operation offshore and their real headquarters are in the United States with U.S. personnel advising them on how to dodge U.S. taxes," said Levin.

There's more at Bloomberg and elsewhere.