Banks are making a billion dollars a year by helping wealthy investors duck taxes on stock dividends, the Wall Street Journal reported.
When hedge funds know that a company in which they invest is about to make a dividend payment, they ask banks they do business with to change the legal ownership of their stocks to some third party based in a country with lower tax rates on stock dividends. The third party complies with the tax laws in that lower-tax jurisdiction, and all three parties to the transaction split the tax savings and higher net revenue from the dividend payment.
The scheme shrinks taxes on dividends “from as much as 30 percent of the dividend payment to 10 percent or so — and sometimes to zero,” according to the Journal. The practice is called “dividend arbitrage,” and it is legal, though Senate scrutiny in recent years has made it more difficult than it used to be.
Bank of America alone has made over $1.2 billion on these deals since 2006, according to Journal sources.
Accounting maneuvers that shift legal ownership of assets across national borders to take advantage of a patchwork international tax system are plentiful. The details of a dividend arbitrage deal are different from the corporate profit-shielding structures that have drawn negative press to companies like Apple, Google, Microsoft, and Caterpillar in the past few years, which are themselves different from the tax inversion mergers that have put Burger King, Pfizer, and others in the news in 2014.
But the arrangements share key features — namely that they save wealthy companies so much money in taxes that they’re willing to spend eye-popping amounts on fees to the accountants and bankers that arrange them — and rely upon the same basic dynamic in international tax law. Many small countries have used low corporate tax rates or strict banking secrecy laws to attract sophisticated, tax-averse companies to their shores. These tax havens do not necessarily see broad or sustainable economic benefits from convincing multinational companies to set up their official mailing address within their borders, as Ireland learned in recent years. But they do perpetuate an international race to the bottom on corporate tax law — a dynamic that is difficult to reverse since it means the majority of these tax avoidance strategies are legal.
American companies are holding some $2 trillion offshore to avoid paying taxes on that sum to the U.S. Treasury. Tax evasion and tax avoidance by individuals and businesses costs the U.S. about $300 billion each year by one estimate.
Government officials are trying to crack down on some of that tax avoidance by prosecuting Swiss banks that facilitate individual tax cheats, by investigating the absurd-sounding legal and accounting gimmicks that allow companies to starve government treasuries, and by setting up new rules to make mergers for tax purposes less attractive. Those efforts to build a better mousetrap may or may not succeed, but the deeper kind of sea change in international tax policy that would remove the incentive for bankers to outsmart tax officials year in and year out still seems to be a long way off.