Friday, November 30, 2007

Treasury Dept. Report: Foreign Companies Stripping U.S. Assets

By leveymg

* Bush IRS Helps Hedge Funds Strip U.S. Assets, Evade Taxes

* Wealthy Tax Exiles Hail IRS as It Generously Extends Deadline For Offshore Corporations to Report "Assets Stripping" Until After Bush-Cheney Leaves Office

Put this is the category of things only your tax attorney knows that might kill your job and cost middle-class Americans billions in additional taxes. In a little noticed IRS ruling on August 31st, the Bush Administration gave offshore companies doing business in the U.S. until December 14, 2008 to report assets moved overseas.

Read this another way: foreign-owned companies, and those that only pretend to be, now have a 13-month window of opportunity to move assets in the U.S. into offshore accounts and hedge funds, but they don’t have to tell anyone about it until after Bush-Cheney leaves Washington. That puts the burden of chasing down international tax cheats squarely on the incoming Democratic Administration and Congress, and shifts the tax burden away from global equity funds such as Carlyle Group and foreign-based companies, such as Dick Cheney’s Halliburton.

Thanks, Dubya, for making capital flight cheap and easy, and all you’re doing for America.


BIGGEST CORPORATE TAX DODGE OF ALL TIME: Bush Admin. Makes Tax Evasion Cheap and Easy for Offshore Corps.

Like most other disasters that have occurred since 2000, it’s not as if Bush Administration officials are unaware of the problem. See,

Some foreign-owned firms "strip" US profit-Treasury
Wed Nov 28, 2007 2:44pm EST

WASHINGTON, Nov 28 (Reuters) - Foreign-controlled U.S. companies that move their headquarters overseas are rampantly "stripping" earnings to avoid paying U.S. corporate income taxes, according to a new U.S. Treasury Department study released on Wednesday.
The practice of earnings stripping by foreign-controlled firms involves adding excessive debt or other costs to a U.S. subsidiary to reduce local profits and avoid tax liabilities.

The Treasury study noted the existence of "strong evidence" of earnings stripping by foreign-controlled corporations that have undergone so-called "inversion" transactions -- those in which a U.S.-based parent company is replaced with a foreign parent in a low-tax or no-tax country.

That raises the question, what are the current crop of Congressional leaders and Presidential Candidates going to do about it?


Inversion, also called "assets stripping", has allowed huge multinational corporations such as Wal-Mart and McDonald's to move money offshore while they evade paying U.S. taxes. What a deal.

Here’s how that particular offshore scam has worked.

Let’s say you’re a big retailer, Wal-Mart for instance, that’s publicly listed on a U.S. stock exchange, has three-quarters of a million American employees working at thousands of locations across the 50 states, with corporate headquarters in Arkansas, and is incorporated in Delaware. Pretty safe to say, that company has to pay U.S. federal and state taxes on earnings, right?

Guess what.

Wal-Mart, like many large American-based companies, such as McDonald’s Corp., with subsidiaries abroad has been claiming deductions for rent it pays an off-shore subsidiary, a Real Estate Investment Trust (REIT), which it claims owns its real estate in the U.S., and then deducts that money from its U.S. taxes. See, See,

How Wal-Mart and other corporations cheat states of taxes
Why Wal-Mart Set Up Shop in Italy
Retailer Has No Stores, As Tax Spat Lays Bare

By Jesse Drucker
Wall St. Journal, Nov 14, 2007

More than 4,500 miles separate a small Wal-Mart Stores Inc. office in Florence, Italy, from the company's dozens of Illinois retail outlets. But thanks to a convoluted tax arrangement, court records show, Wal-Mart's Italian Wal-Mart set its affairs so that its Italian outpost is the only operating unit of a real-estate subsidiary that controls billions of dollars of the retailer's property in Illinois and other states. Because technically its only employees are based in Italy, the real-estate unit claims its operations are foreign, exempt from Illinois corporate income taxes.

Earlier this year, the Illinois Department of Revenue objected to the Italian tax maneuver, demanding $26.4 million in back taxes, interest and penalties. Wal-Mart paid the amount in dispute and then sued the state for a refund, according to a complaint filed in May in Illinois Circuit Court in Springfield, Ill.

A Wal-Mart spokesman declined to comment beyond a prepared statement: "We have a disagreement with the state of Illinois over our tax liability last year, and we've asked a judge to resolve that for us." He declined to explain why Italy was chosen as the home of this particular foreign operation or whether Wal-Mart has other such arrangements.

The dispute with Wal-Mart is part of a wider effort by some states to crack down on what they believe is abusive use of so-called 80/20 companies. These companies are domestic subsidiaries that conduct at least 80% of their business overseas. States typically don't tax income from outside the U.S., and many companies have used 80/20 subsidiaries to legitimately shield foreign operations from state taxation.

But authorities in several states have challenged a number of companies over the 80/20 units, claiming the structure was improperly used to shift income away from the purview of state taxing authorities.

The misuse of 80/20 companies is "shocking to the conscience," said Brian Hamer, director of the Illinois Department of Revenue. "These kinds of manipulations clearly were never contemplated by the state legislatures," added Mr. Hamer, who wouldn't comment on any single company or legal case. "It ought to have been clear to businesses that this was highly questionable conduct."

Illinois tax authorities are in a dispute with McDonald's Corp. over nearly $11 million stemming from its use of an 80/20 subsidiary. Details are sketchy, but McDonald's, based in Oak Brook, Ill., says in court papers that a Delaware financing unit that owns restaurants in St. Thomas, Virgin Islands, conducts 80% or more of its business activity outside the U.S., exempting its operations from being included in Illinois tax calculations.

Minnesota, BNSF Wrangle

Meanwhile, Minnesota tax authorities are taking issue with interest payments made by Burlington Northern Santa Fe Corp. to a pair of Delaware subsidiaries doing business in Canada. The railway company deducted the interest associated with the payments but didn't pay taxes on most of the income received by the subsidiaries. The state's revenue department says in an audit report that this was "done purely for tax avoidance purposes." The Fort Worth, Texas, company paid a disputed $4 million in back taxes and interest and sued the state in May for a refund.

(Wal-Mart’s REIT in Italy) employs 22 people at its office in central Florence, according to a company official who answered the door there on a recent weekday morning. The office is responsible for procuring merchandise from around Europe, he said. Wal-Mart has no stores in Italy.


The foreign real-estate holding company tax dodge is just one facet of a slew of slimy tax shelters that large U.S. companies have started using to evade paying their fair share of taxes to Uncle Sam and to State Governments. These creative accounting practices can be expected to continue during the remainder of the Bush Administration, because the IRS has announced it doesn’t want to know the details of assets transferred from U.S. holdings of companies that claim to be foreign-based.

The Adminstration has made it frighteningly easy for big multinationals to strip their assets and send them to offshore tax havens. They can forget about even filing the necessary paperwork with IRS until next summer. There won’t be any real penalties assessed, no matter how many billions of dollars of U.S. assets are converted and then counted as part of off-shored entities, most of which are located in foreign tax havens, such as the Bahamas, Cayman Islands, the Isle of Man, Singapore, etc., where real tax rates approach zero and the government, such as it is, would like you to offer you another rum punch with an umbrella in the mug.

If you’re Wal-Mart, or McDonald’s, or Halliburton, and you claim to be a Foreign-owned Domestic Company, the IRS just doesn’t want to know the details.

The rush is on to offshore hedge funds. A new IRS rule creates a window of opportunity until 12/14/08 for companies to avoid notifying IRS of U.S. assets sent offshore.

The penalties for foreign companies that fail to comply with IRS reporting requirements are ridiculously light. In it's final rule published in August, the Bush Administration gave foreign owned companies until next June to file without penalty. Even after that date, IRS imposes a $50,000 maximum fine for willful failure to file the required information about offshored assets. Of course, the only limit on the amount of U.S. assets companies can strip and divert abroad is the total value of their U.S. assets. There is no other incentive for foreign companies to report assets stripping. See,

August 27, 2007
T.D. 9338
Information Returns Required With Respect to Certain Foreign Corporations and Certain Foreign-Owned Domestic Corporations

(k) Failure to furnish information—(1) Dollar amount penalty(i) In general. If any person required to file Form 5471 under section 6038 and this section fails to furnish any information described in paragraphs (f) and (g) of this section within the time prescribed by paragraph (i) of this section, such person shall pay a penalty of $10,000 for each annual accounting period of each foreign corporation with respect to which such failure occurs.
(ii) Increase in penalty for continued failure after notification. If a failure described in paragraph (k)(1)(i) of this section continues for more than 90 days after the date on which the Director of Field Operations, Area Director, or Director of Compliance Campus Operations mails notice of such failure to the person required to file Form 5471, such person shall pay a penalty of $10,000, in addition to the penalty imposed by section 6038(b)(1) and paragraph (k)(1)(i) of this section, for each 30-day period (or a fraction of) during which such failure continues after such 90-day period has expired. The additional penalty imposed by section 6038(b)(2) and this paragraph (k)(1)(ii) shall be limited to a maximum of $50,000 for each failure.

How many billions can be sent to Bermuda accounts for a mere $50,000? Until the penalty is made large enough to be meaningful, the value of U.S. inversions into underlying hedge funds will remain unreported. If you don't know the scale of the problem, you can't possibly do anything about it.


Paul Krugman is widely credited as the economist who first accurately described the mechanism underlying the "balance-of-payments crisis". His work on currency crises is considered a pillar of neo-Keynesian literature, beginning with his seminal article, A Model of Balance-of-Payments Crises, Paul Krugman, Journal of Money, Credit and Banking, Vol. 11, No. 3 (Aug., 1979), pp. 311-325.

Krugman surveyed the causes that led to the 1997 Asia Crisis, a panic sell-off of overleveraged markets and currencies that spread to a dozen countries from Thailand to Brazil. That crisis resulted in a collapse of the Russian economy, and an end to much of the short-lived experiment in radical market-based restructuring of the former Soviet Union. See,

Most notably, Krugman’s study of the Asia Crisis describes the role of global hedge funds and speculator pools that preyed on vulnerable currencies and overvalued equities markets in overly-indebted countries. Following a decade-long binge of heavy borrowing, by the mid-1990s, a number of Asian economies suffered serious imbalances in the ratio of borrowing to national product and exports. Many of these countries displayed spectacular bubbles in real estate and seriously overvalued prices for stocks and bonds traded on national exchanges. This was blood in the water to global speculators, who moved in to short weakened national currencies, equities markets, and bonds, collapsing one overheated national economy after another. The hedge fund operators and foreign bargain-hunters that followed in their wake – buying up remaining assets at fire sale prices and exporting profits -- made huge fortunes, while local banks and investors were ruined, thousands of companies folded, and millions of people in the developing world were plunged into economic depravation that erased decades of gains in living standards.

This is a pattern of debt speculation, assets bubbles, stock shorting, and assets stripping that the United States has developed as a result of Bush-Cheney policies.

The looming balance of payments crisis and downward spiral in the U.S. Dollar has been long foreseen by financial industry analysts. Richard W. Arms advised readers on the financial services newsletter, on November 15, 2004:

"We believe that the US is moving toward a balance of payments/debt crisis. It is likely that the crisis period may now be starting, and that we have entered a new leg in the dollar decline. This leg of the dollar collapse will not be over until we have seen global central banks abandon their misguided attempt to stop the dollar decline. The big collapse in the dollar is likely close, and speculators are starting to see the blood in the water.

The attempt by central banks (largely Asian central banks) to stop the dollar from going where it needs to has only worsened the global imbalances. The US economy is spending 5% of GDP more than it is earning. Less than 1% of GDP worth of this financing gap is being financed by free-market private sector transactions. The rest (over 4% of US GDP) is financed by foreign central banks. Since these central banks are just trying to stop the dollar from falling, not pushing their currencies up, they are setting up a one sided bet that speculators across the globe are starting to see.

If central banks continue to intervene the dollar will stay flat, if they give up the dollar will collapse. The only way the dollar rises significantly is if, on net, the private sector suddenly wants to fill the 4% of GDP gap that central banks are currently filling. This is extremely unlikely. The markets rarely grant these kinds of great opportunities, and it is thanks only to the non-profit seeking activities of global central banks that this opportunity has materialized.

In addition to to hedge fund operators and central banking officials, investors and corporate officers also have a major role in setting off currency crises by offshoring funds in anticipation of market crisis. The Bush Administration is only making this easier, and the eventual spiral in the Dollar more severe by making assets inversion (capital flight) cheap and painless. As the economist Steven Suranovic explains:

The intuition for capital flight is simple. If an investor expects the domestic currency (and assets denominated in that currency) will soon fall in value, it is better to sell now before the value actually does fall. Also, as the domestic currency falls in value, the British pound is expected to rise in value. Thus, it is wise to buy British pounds and assets while their prices are lower and profit on the increase in the pound value when the dollar devaluation occurs.

The broader effect of capital flight, which occurs in anticipation of a balance of payments crisis, is that it can actually force a crisis to occur much sooner. Suppose the US was indeed running low on foreign reserves after running successive balance of payments deficits. Once investors surmise that a crisis may be possible in the near future and react with a change in their expected exchange rate, there will be a resulting increase in demand for pounds on the FOREX. This will force the central bank to intervene even further in the FOREX by selling foreign pound reserves to satisfy investor demand and to keep the exchange rate fixed. However, additional interventions implies an even faster depletion of foreign reserve holdings bringing the date of crisis closer in time.

It is even possible for investor behavior to create a balance of payments crisis when one might not have occurred otherwise. Suppose the US central bank depletes reserves by running balance of payments deficits. However, suppose the FED believes the reserve holdings remain adequate to defend the currency value, whereas investors believe the reserve holdings are inadequate. In this case capital flight will likely occur which would deplete reserves much faster than before. If the capital flight is large enough, even if it is completely unwarranted based on market conditions, it could nonetheless deplete the remaining reserves and force the central bank to devalue the currency.


The answer to that is, of course, if there's the political will to do so. Congress could easily impel the IRS to immediately implement the Inversion reporting rule by signalling that it will be considering doing this by law. Congress can also raise fines to a level that would truly serve as an incentive to companies to report what they're doing with their assets. Congress could also block the loopholes that allow multinationals to set up offshore shell companies to shelter their real estate holdings from taxes.

Democrats should demand that their representatives an presidential candidates address these issues in a meaningful and pro-active way.

There are also long-term solutions to consider. Just as HC emissions have spurred creative mechanisms for global controls and market-based approaches to pollution, the same "Cap & Trade" approach might be taken to solve the problems of capital flight and employment offshoring. Companies that want to move capital across borders to take advantage of taxation arbitrage might be required to offset those transfers (and loss of public revenue) with a collateral creation of jobs in the same country. Similarly, a company that increases employment would earn credits that could be traded for the ability to move capital across borders without penalty.

We aren't helpless to do something about this crisis. Do it today, or we and our children will pay, and pay, for it for decades.
2007. Mark G. Levey

Posted in full with author's permission.

Priginally posted at

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