Tax Haven Abuse: (Wyly Case)(Summary)
The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs) described Wyly Case History (see excerpted pages 7,8) :
Wylys: 58 Offshore Trusts and Corporations
The sixth, and final, case history comprises the most elaborate offshore operations reviewed by the Subcommittee. Over a thirteen-year period from 1992 to 2005, two U.S. citizens, Sam and Charles Wyly, assisted by an army of attorneys, brokers, and other professionals, transferred over 17 million stock options and warrants representing approximately $190 million in compensation to a complex array of 58 trusts and shell corporations. The offshore trusts had either been established by the Wylys or named them as beneficiaries; the trusts owned the shell corporations that took possession of the stock options and warrants. In return, the Wylys obtained private annuity agreements from the offshore corporations. The Wylys took the position, on the advice of counsel, that because they had exchanged their stock options for annuities of equivalent value, no tax was due on their stock option compensation, until they received actual annuity payments years later. The first annuity payment was made ten years later in 2003. To date, about $124 million in stock option compensation remains offshore and untaxed.
From 1992 through 2004, the Wylys and their representatives directed the offshore entities on exercising the stock options and warrants, and engaging in a wide range of securities trades and other transactions. The Wylys and their representatives conveyed their decisions to two individuals the Wylys had selected, called “trust protectors,” who communicated the decisions, worded as “recommendations,” to the offshore trustees, who implemented them. In addition to cashing in many of the options, the offshore entities used the cash and shares to generate substantial investment gains. The Wylys did not pay taxes on these gains, on advice from counsel, even though the U.S. tax code generally requires that income earned by a trust controlled by a U.S. person who funded or is a beneficiary of the trust be attributed to that U.S. person for tax purposes. The Wyly legal position was that the offshore trusts were independent entities. Over the thirteen years examined in this Report, the offshore entities used more than $600 million from untaxed stock sales and other investment gains to issue substantial loans to Wyly interests, finance Wyly-related business ventures, and acquire U.S. real estate, furnishings, art, and jewelry for the personal use of Wyly family members. The offshore entities placed nearly $300 million of these offshore dollars in two hedge funds and an investment fund established by the Wylys.
The stock options exercised by the offshore entities came from three publicly traded corporations with which the Wylys were associated, Michaels Stores Inc., Sterling Software Inc., and Sterling Commerce Inc. In addition to the tax issues, a key concern is whether, by sending millions of company stock options and warrants to offshore entities whose investments they directed, the Wylys were using offshore secrecy laws to circumvent basic U.S. principles intended to ensure fair and transparent capital markets, including disclosure requirements for major shareholders, trading restrictions on privately acquired shares, and prohibitions against trading on nonpublic information. For most of the thirteen years examined in this Report, U.S. securities regulators and the investing public were not informed of the extent of the Wyly-related offshore stock holdings and trading activity.
The Wyly transactions also raise issues related to compliance with anti-money laundering laws. Over the years, the 58 offshore trusts and corporations opened securities accounts at three prominent U.S. financial institutions, Credit Suisse First Boston (“CSFB”), Lehman Brothers, and Bank of America. All three financial institutions knew that the offshore entities were associated with the Wyly family, but never required the offshore entities to identify their beneficial owners. By 2003, when Bank of America had the accounts, the law was clear that the Bank had to identify the beneficial owners. Despite being pressed for nearly a year by its clearing broker to do so, Bank of America allowed the accounts to operate without obtaining the information required by law. In addition, when for tax purposes, the Wyly-related offshore entities submitted forms representing they were independent foreign entities not subject to IRS 1099 reporting requirements for U.S. taxpayers, Bank of America accepted the forms, despite knowing the Wylys were directing the offshore entities’ investments and benefitting from their account income. Had the offshore entities acknowledged that the Wylys were the beneficial owners of the offshore trusts and corporations for purposes of complying with the anti-money laundering laws, and allowed their connection to the Wylys be documented at Bank of America, it would have been harder for the Wylys to deny a connection to these entities for tax and securities purposes.
Many of the offshore mechanisms used in this case history raise serious tax, securities, or other concerns, including the stock option-annuity swaps; pass-through loans using an offshore vehicle; securities traded by offshore entities associated with corporate insiders; and the use of hedge funds and other investment vehicles to control use of funds placed offshore. Sam and Charles Wyly reaped a number of benefits from their offshore activities, including attempted deferral of taxes on their stock option compensation, nonpayment of taxes on hundreds of millions of dollars in offshore capital gains by entities they directed, a ready source of capital for their business ventures in the United States, and a ready source of funds to finance their personal interests. Among those impacted by the Wyly offshore activities are the U.S. Treasury, U.S. taxpayers who have to make up the lost revenue, and the investing public who were kept in the dark about the offshore stock holdings and trading activity of entities controlled by the directors of three publicly traded corporations.
View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy
Tax Haven Abuse: the Enablers, the Tools and Secrecy (Findings)
U.S. Senate (8/1/06 Report) Report Findings
1. Control of Offshore Assets. Offshore “service providers” in tax havens use trustees, directors, and officers who comply with client directions when managing offshore trusts or shell corporations established by those clients; the offshore trusts and shell corporations do not act independently.
2. Tax Haven Secrecy. Corporate and financial secrecy laws and practices in offshore tax havens make it easy to conceal and obscure the economic realities underlying a great number of financial transactions with unfair results unintended under U.S. tax and securities laws.
3. Ascertaining Control and Beneficial Ownership. Corporate and financial secrecy laws and practices in offshore tax havens are intended to make it difficult for U.S. law enforcement, creditors, and others to learn whether a U.S. person owns or controls an allegedly independent offshore trust or corporation. They also intentionally make it difficult to identify the beneficial owners of offshore entities.
4. Offshore Tax Haven Abuses. U.S. persons, with the assistance of lawyers, brokers, bankers, offshore service providers, and others, are using offshore trusts and shell corporations in offshore tax havens to circumvent U.S. tax, securities, and anti-money laundering requirements.
5. Anti-Money Laundering Abuses. U.S. financial institutions have failed to identify the beneficial owners of offshore trusts and corporations that opened U.S. securities accounts, and have accepted W-8 forms in which offshore entities represented that they beneficially owned the account assets, even when the financial institutions knew the offshore entities were being directed by or were closely associated with U.S. taxpayers.
6. Securities Abuses. Corporate insiders at U.S. publicly traded corporations have used offshore entities to trade in the company’s stock, and these offshore entities have taken actions to circumvent U.S. securities safeguards and disclosure and trading requirements.
7. Stock Option Abuses. Because stock option compensation is taxed when exercised, and not when granted, stock options have been used in potentially abusive transactions to defer and in some cases avoid U.S. taxes.
8. Hedge Fund Transfers. U.S. persons who transferred assets to allegedly independent offshore entities in a tax haven have then directed those offshore entities to invest the assets in a hedge fund controlled by the same U.S. persons, thereby regaining investment control of the assets.
Report Recommendations
1. Presumption of Control. U.S. tax, securities, and anti-money laundering laws should include a presumption that offshore trusts and shell corporations are under the control of the U.S. persons supplying or directing the use of the offshore assets, where those trusts or shell corporations are located in a jurisdiction designated as a tax haven by the U.S. Treasury Secretary.
2. Disclosure of U.S. Stock Holdings. U.S. publicly traded corporations should be required to disclose in their SEC filings company stock held by an offshore trust or shell corporation related to a company director, officer, or large shareholder, even if the offshore entity is allegedly independent. Corporate insiders should be required to make the same disclosure in their SEC filings.
3. Offshore Entities as Affiliates. An offshore trust or shell corporation related to a director, officer, or large shareholder of a U.S. publicly traded corporation should be required to be treated as an affiliate of that corporation, even if the offshore entity is allegedly independent.
4. 1099 Reporting. Congress and the IRS should make it clear that a U.S. financial institution that opens an account for a foreign trust or shell corporation and determines, as part of its anti-money laundering duties, that the beneficial owner of the account is a U.S. taxpayer, must file a 1099 form with respect to that beneficial owner.
5. Real Estate and Personal Property. Loans that are treated as trust distributions under U.S. tax law should be expanded to include, not just cash and securities as under present law, but also loans of real estate and personal property of any kind including artwork, furnishings and jewelry. Receipt of cash or other property from a foreign trust, other than in an exchange for fair market value, should also result in treatment of the U.S. person as a U.S. beneficiary.
6. Hedge Fund AML Duties. The Treasury Secretary should finalize a proposed regulation requiring hedge funds to establish anti-money laundering programs and report suspicious transactions to U.S. law enforcement. This regulation should apply to foreign based hedge funds that are affiliated with U.S. hedge funds and invest in the United States.
7. Stock Option-Annuity Swaps. Congress and the IRS should make it clear that taxes on stock option compensation cannot be avoided or deferred by exchanging stock options for other assets of equivalent value such as private annuities.
8. Sanctions on Uncooperative Tax Havens. Congress should authorize the Treasury Secretary to identify tax havens that do not cooperate with U.S. tax enforcement efforts and eliminate U.S. tax benefits for income attributed to those jurisdictions.
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