Island tax havens factor into Romney's business success

LA Times 12/17/07 article reported:
"While in private business, Mitt Romney utilized shell companies in two offshore tax havens to help eligible investors avoid paying U.S. taxes, federal and state records show.

Romney gained no personal tax benefit from the legal operations in Bermuda and the Cayman Islands. But aides to the Republican presidential hopeful and former colleagues acknowledged that the tax-friendly jurisdictions helped attract billions of additional investment dollars to Romney's former company, Bain Capital, and thus boosted profits for Romney and his partners.

Romney has based his White House bid, in part, on the skills he learned as co-founder and chief of Bain Capital, one of the nation's most successful private equity groups. His campaign cites his record while governor of Massachusetts of closing state tax loopholes; his involvement with foreign tax havens had not previously come to light."

Complete article:
Island tax havens factor into Romney's business success

Aide to Illinos Governer Indicted for Unreported Income

"Christopher Kelly, a close advisor to Illinois Gov. Rod R. Blagojevich and chief fundraiser on his two campaigns for governor, was indicted Thursday on federal tax fraud charges, accused of understating more than $1.3 million in personal and business income on tax returns for five years, federal authorities said."

See LA Times article Illinois governor sees a 2nd aide indicted by U.S.

Tax Haven Abuse: Walter Anderson Case

The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), Walter Anderson Case:

Anderson: Hiding Offshore Ownership.

This case history examines actions allegedly taken by a wealthy American to hide hundreds of millions of dollars in stock and cash offshore by disguising his ownership of the corporations that controlled those assets and failing to pay taxes on those assets. Walter C. Anderson was indicted for tax evasion in 2005, and is now awaiting trial. The government has developed evidence that Mr. Anderson took advantage of secrecy laws in multiple tax haven countries to create a structure of offshore corporations and trusts. According to the indictment, through a series of assignments, sales, and transfers, Mr. Anderson placed into these offshore entities about $450 million in cash and stock, including large interests in telecommunications firms. He allegedly disguised his ownership of these assets through a range of techniques including shell companies, bearer shares, and nominee directors and trustees. In one instance, according to the indictment, Mr. Anderson set up an offshore shell corporation in the British Virgin Islands, gave its shares to a second shell corporation he established in the same jurisdiction, and had the second corporation send the shares to a bearer-share corporation in Panama, which he controlled. The government stated that it seized a document granting Mr. Anderson’s mother the exclusive option to purchase, for $9,900, ninety-nine percent of the bearer share corporation which then held assets worth millions of dollars. According to the indictment, Mr. Anderson used these methods to evade more than $200 million in Federal and District of Columbia income taxes.

View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy

Tax Haven Abuse: (Wyly case) (Artwork, Jewelry)

The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), (Wyly Case) Artwork, Jewelry (excerpted pages 287-288):

(7) Spending Offshore Dollars on Artwork, Furnishings, and Jewelry

During the thirteen years examined in this Report, at least $30 million in untaxed, offshore dollars were spent to purchase furnishings, artwork, and jewelry for the apparent personal use of Wyly family members.1142 Although the nominal owners of virtually all of these items were two offshore corporations, the evidence indicates that the art, furnishings, and jewelry were actually selected, held, and used by individual Wyly family members. These purchases are further evidence that the Wylys were directing the use of trust assets, and that the offshore trusts were benefitting U.S. persons.

Background. From 1992 until 2005, numerous expensive works of art, rare documents and books, furniture, and jewelry were purchased with Wyly-related offshore dollars. These purchases included, for example, a $937,500 portrait of Benjamin Franklin,1143 a $13,000 French bronze chandelier,1144 a $162,000 bureau cabinet,1145 $721,000 in official documents from the presidency of Abraham Lincoln,1146 a $622,000 ruby,1147 and a $759,000 emerald necklace.1148

Although a number of Wyly-related offshore entities supplied funds for these purchases, almost all of the items were nominally owned by either Audubon Assets Ltd. (“Audubon”) or Soulieana Ltd. (“Soulieana”). Audubon, formerly named Fugue Ltd., is wholly owned by the Bessie Trust, a 1994 foreign grantor trust set up to benefit Sam Wyly and his family. Soulieana is wholly owned by the Tyler Trust, a 1994 foreign grantor trust set up to benefit Charles Wyly and his family. Both corporations are shell operations, with no employees or offices of their own. Since 1995, many of their transactions have been handled for a fee by the Irish Trust Company, working in tandem with the Wyly family office. The documents show that the key persons who handled these matters for Audubon and Soulieana during the period under examination were Ms. Boucher and Ms. MacInnis from the Irish Trust Company, and Ms. Hennington, Ms. Robertson, Ms. Alexander, and Ms. Westbrook from the Wyly family office.

View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy

Tax Haven Abuse: (Wyly case) (U.S. Real Estate)

The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), (Wyly Case) U.S. Real Estate (excerpted pages 273-276, 287, 360):

(a) Real Estate Transactions in General

From 1992 to 2005, multiple U.S. real estate properties used by Sam and Charles Wyly for personal residences or business ventures were funded in whole or in substantial part with offshore dollars.1084 The properties examined here include a $45 million 244-acre ranch near Aspen, Colorado, known as Rosemary’s Circle R Ranch, containing a half dozen residences built for the Sam Wyly family; a $9 million 26-acre ranch near Aspen, sometimes referred to as the LL Ranch, containing an 8,000 square foot residence used by the Charles Wyly family; a $13 million set of condominiums in downtown Aspen operating as Cottonwood Ventures and containing, in part, art galleries run by Sam Wyly’s daughter; a $12 million 95-acre ranch near Dallas, Texas, known as Stargate Horse Farms, run by Charles Wyly’s daughter; and an $8 million oceanside property in Malibu, California, owned by Sam Wyly until 2002.1085 While each of these real estate transactions had unique characteristics, all had common elements regarding the property’s ownership structure and the financial mechanisms used to obtain offshore funding.

The structures used to acquire and finance the five real estate transactions were designed by legal counsel, in particular Rodney Owens, a partner at Meadows, Owens, Collier, Reed, Cousins & Blau LLP (“Meadows Owens”), a Texas law firm that provided tax and real estate advice to the Wyly family.1086 Meadows Owens told the Subcommittee that the structures were the result of an indepth research effort by Mr. Owens and others to design an innovative means to ensure Wyly access to properties being financed primarily with offshore funds.1087 Numerous emails discussing the real estate transactions refer to Mr. Owens or Meadows Owens, and indicate that legal counsel was being consulted with respect to the real estate transactions.1088 To date, despite Subcommittee requests, the Wylys have not provided a detailed explanation of the legal reasoning behind these real estate structures, and have not provided any legal opinions or analysis, instead asserting the attorney-client privilege.

The common elements in the ownership and funding structures used for the five properties involve a tiered set of shell entities in offshore jurisdictions and the United States. They can be summarized as follows.

The apparent initial step was for one of the Wyly-related offshore trusts to form a new Isle of Man (“IOM”) shell corporation whose sole function was to serve as a funding gateway for offshore dollars to be spent on a designated real estate property in the United States. Next, this IOM corporation and one or more Wyly family members typically established a trust in the United States to manage the designated property. The management trust was established by a
trust agreement signed by the IOM corporation and Wyly family members. This agreement specified that the trust grantors, meaning the IOM corporation and the Wyly family members who signed the trust agreement, were allowed “full and complete Usage” of the property owned by the trust without any obligation by the trustee to monitor such use.1089 These provisions explicitly authorized Wyly family members to make personal and unfettered use of the real estate.

The trust agreement also assigned to each grantor a so-called “Trust Share” reflecting the grantor’s proportional contributions to the trust’s assets.1090 For example, a grantor who contributed ten percent of the trust’s assets acquired a ten percent “trust share.” The agreement further obligated each grantor to pay a portion of the real estate costs reflecting that “trust share,” such as mortgage payments, utilities, operating expenses, and construction costs. In other words, a grantor with a ten percent trust share had to pay ten percent of the real estate costs.

In the five examples examined by the Subcommittee, the IOM corporation typically made a cash contribution to the U.S. management trust resulting in its acquiring a 98 or 99 percent trust share, while Wyly family members made a much smaller contribution resulting in a 1 or 2 percent trust share. Real estate costs were then split on the same basis, with 98 to 99 percent of the costs attributed to the offshore corporation and only 1 to 2 percent attributed to a Wyly family member. This arrangement was apparently intended to enable Wyly family members to obtain full usage of the trust’s real estate, while paying a minimal percentage of the costs.

After the U.S. management trust was established and funded, the final step was for the trust to form a new U.S. partnership or limited liability corporation. This U.S. entity, using funds supplied from the Wylys and from offshore, then acquired the designated property and served as the owner of record for the U.S. real estate.1091

Most of the funds spent to acquire, improve, and operate the real estate moved from an offshore entity to a U.S. entity. The funds typically moved from one of the 58 Wyly-related offshore trusts or corporations in the Isle of Man, to the newly created IOM shell corporation created to serve as the funding gateway for the particular real estate, to the U.S. management trust, and finally to the U.S. entity serving as the owner of record for the property. The property owner then used the offshore funds to pay the acquisition, construction, and operating costs associated with the real estate. On some occasions, Wyly-related offshore entities ignored this funding pathway and wired funds directly to the U.S. management trust or directly to the U.S. property owner. More often, however, perhaps to avoid direct wire transfers from Wyly-related offshore entities to the U.S. property owner, the offshore funds took the longer route, which often required three or more wire transfers to move funds from the originating offshore entity to the final U.S. entity. This multi-step process also made it more difficult for anyone examining the real estate to trace the origin of the funds and determine that they came from an offshore trust related to the Wyly family.

U.S. and offshore financial institutions played a vital role in making these real estate structures work effectively. Lehman Brothers, Bank of America, Bank of Bermuda (IOM), Queensgate Bank and Trust, and other financial institutions routinely authorized the offshore trusts and corporations to wire substantial funds into the United States, with few questions asked. In these five examples, hundreds of thousands and sometimes millions of dollars moved through multiple accounts, across international lines, within days. Securities accounts often functioned as bank accounts, allowing millions of dollars to pass through them without any securities transactions. Without the cooperation of the banks and securities firms that controlled the financial accounts, these complex real estate structures could not have effectively been used to pay the U.S. real estate bills.

Also critical to the functioning of these complex real estate structures were the financial professionals who processed the paperwork, tracked the real estate costs, and identified available offshore funds. Key players included Ms. Robertson and Ms. Hennington from the Wyly family office, Ms. Boucher from the Irish Trust Company, and the IOM offshore service providers who administered the offshore trusts and corporations. Together, they moved tens of millions of offshore dollars into the United States through real estate transactions benefitting the Wyly family.

The five examples examined in this Report show how these complex structures, designed by lawyers and implemented by bankers, brokers, and other financial professionals, were used to supply millions of offshore dollars to pay U.S. real estate costs and, through sham real estate sales and loans, provide additional millions of offshore dollars for the personal use of Wyly family members in the United States. Two of the examples are explained here; the other three appear in Appendix 5.

(d) Analysis of Issues

The five real estate examples examined by the Subcommittee show how $85 million in untaxed, offshore dollars were used to buy residential and commercial property in the United States; pay real estate maintenance, operating, and construction costs; and enable Wyly family members to enjoy, at minimal personal expense, residential and business properties costing millions of dollars. In these instances, offshore dollars paid for 90 percent or more of the real estate costs. For example, of the $45 million spent on Rosemary’s Circle Ranch, all but $434,000 was supplied from offshore. The examples also show how, in some instances, properties were used to justify sham real estate sales and loans that brought millions of offshore dollars into the United States for the Wylys’ personal use.

These real estate transactions provide additional proof that the Wylys and their representatives were directing the use of the offshore assets. In the instances examined by the Subcommittee, the Wylys chose the properties to be purchased or sold, determined the timing of the transactions, supervised construction and renovation projects, and made personal use of the real estate. They built homes, art galleries, and a state-of-the-art equestrian facility. Wyly representatives routinely requested offshore funds to pay the real estate costs, and the Wyly-related offshore trustees routinely complied. The Subcommittee saw no instance in which a trustee refused a request for funds; most funding requests were supplied within days. The Subcommittee also saw no instance in which an offshore trustee initiated a real estate transaction on its own. Instead, the offshore trustees routinely deferred to Wyly representatives, supplying funds whenever asked.

In 2001, Sam Wyly decided to sell the Malibu property. Ms. Hennington and Ms. Boucher warned him that unless he sold it for at least $10 million, he would owe money from the transaction, because he would have to repay the first and second mortgages on the property as well as significant real estate taxes.1397 In September 2001, Mr. Wyly apparently signed papers agreeing to sell the house and its furnishings to a third party for $8.1 million. Ms. Boucher described the $8.1 million as “a good price,” but noted “the shortfall from taxes will be tough to cover.”1398 The Malibu sale apparently closed on February 13, 2002, which is also the date when the Sam Wyly Malibu Trust supposedly paid Security Capital $7.8 million to satisfy the outstanding loan.1399

The Malibu property is an example of U.S. real estate that was pledged as security for a loan from a Cayman shell corporation, Security Capital, that sent millions of untaxed, offshore dollars into the United States for Sam Wyly’s personal use. The loan also paid for the Malibu property’s renovation and operating costs for more than two years. In 2002, when the property was sold to a third party, Mr. Wyly sent over $7 million back offshore as repayment of the Security Capital loan. The fact that Sam Wyly was able to obtain an $8 million loan on real estate already encumbered by another loan, and was able to use the bulk of this cash for his personal use, is further evidence of Wyly ability to direct the use of the offshore assets.

View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy

Tax Haven Abuse: (Wyly Case) (Hedge Funds)

The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), (Wyly Case) Hedge Funds (excerpted pages 242-243):

(a) Supplying Offshore Dollars to Hedge Funds

The Wyly-related offshore entities’ invested more than $250 million in untaxed, offshore dollars in two hedge funds known as Maverick and Ranger. Both of these hedge funds were founded and managed for years by Wyly family members. By agreeing to transfer funds to the Wyly-related hedge funds, the Isle of Man (“IOM”) entities ensured that the funds would be further invested under the direction of the Wylys.

(i) Hedge Funds Generally

In the United States, hedge funds are lightly regulated, private investment funds that pool investor contributions to trade in securities or make other investments. Most U.S. hedge funds are structured as limited partnerships, in which the general partner manages the fund for a fixed fee and a percentage of the fund’s gross profits, and the limited partners function as passive investors.913 Investors generally sign a “subscription agreement” specifying the investor’s ownership interest in the fund, which may be in the form of shares, limited partnership interests, or ownership units, all of which are treated as unregistered securities.914 Many U.S. hedge funds sponsor one or more offshore funds, which are administered offshore, keep their subscription agreements and other records offshore, and minimize contacts with the United States, other than typically using the same investment manager as their U.S. counterpart.

Unlike mutual funds, U.S. hedge funds typically are not required to register their securities with the SEC. Instead, as long as the hedge fund does not offer its securities to the public, and has fewer than 100 beneficial owners or accepts only sophisticated investors, such as individuals with at least $5 million in investments, it is exempt from the Investment Company Act of 1940 and the Securities Act of 1933.915 The reasoning behind these exemptions is that “privately placed investment companies owned by a limited number of investors do not rise to the level of federal interest.”916 In December 2004, the SEC issued a regulation requiring persons who direct a hedge fund’s investments to register with the SEC as an investment advisor and disclose a minimal amount of information about the hedge fund; however, this regulation was recently invalidated by the D.C. Circuit Court of Appeals.917

In addition to minimal SEC regulation, hedge funds are currently exempt from U.S. anti-money laundering laws. They are not required to institute an anti-money laundering program, know who their customers are, or report suspicious activity to law enforcement, despite significant money laundering vulnerabilities.918 In 2002, the Treasury Department proposed a rule that would require hedge funds, among other types of unregistered investment funds, to institute anti-money laundering procedures, but four years later has yet to finalize that rule.919

With respect to U.S. taxes, most hedge funds are organized as partnerships, file 1065 informational tax returns with the IRS, and provide information about gains and losses to their partners for inclusion in the partners’ individual tax returns. Some hedge funds organized as corporations must file 1099 forms with the IRS reporting payments made to clients.920 Hedge fund clients are then responsible for including any hedge fund gains in their taxable income. If a U.S. hedge fund sponsors an offshore investment fund, however, that offshore fund is typically structured as a foreign entity outside of U.S. tax law and does not file U.S. tax returns or report payments made to offshore clients. In 1999, the President’s Working Group on financial Markets noted that a significant number of hedge funds operated in tax havens and may be associated with illegal tax avoidance.921

View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy

Tax Haven Abuse: (Wyly Case) (Compensatory Stock Options)

The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), (Wyly Case) Compensatory Stock Options (excerpted pages 163-167, 174, 194-195):

(2) Transferring Assets Offshore

Assets can be transferred offshore in a number of ways. In this case history, the Wyly assets were transferred offshore in three groups of transactions, several years apart. The first group took place in 1992, when the initial offshore trusts were established. The second group took place in 1996, after the foreign grantor trusts were established. The third group took place in 1999 and 2002, surrounding the 2000 sales of Sterling Software and Sterling Commerce. On the first two occasions, the primary mechanism used to move assets offshore were stock option annuity-swaps, in which millions of stock options and warrants were transferred to 20 offshore corporations in exchange for 20 annuity agreements promising to make payments to the Wylys years later. In the third instance, Sam and Charles Wyly transferred millions of stock options directly to several offshore corporations in return for cash. Altogether, from 1992 to 2002, about 17 million stock options and warrants, representing at least $190 million in compensation, were transferred offshore.

All 17 million stock options and warrants transferred offshore had been provided to Sam and Charles Wyly by Michaels, Sterling Software, or Sterling Commerce as compensation for services performed. Wyly legal counsel took the position that the Wylys did not have to pay any income tax on most of this compensation at the time it was sent offshore, because the Wylys had exchanged most of the stock options and warrants for annuity agreements of equivalent value. Wyly legal counsel advised further that the securities had been transferred to independent third parties, even though the corporations who received the securities were owned by trusts established by or for the benefit of the Wylys and allowed the Wylys and their representatives to direct how the securities should be handled. Wyly legal counsel also advised that when the offshore corporations exercised the stock options, the stock option gains did not have to be reported as Wyly income, despite a long-standing IRS requirement that when stock options are transferred to a related party, any stock option gains must be attributed to the original stock option holders as compensation income. Instead, Wyly legal counsel advised that the Wylys were liable for taxes only if and when they actually received annuity payments from the offshore corporations years later. In the meantime, legal counsel advised that the Wylys could transfer their stock option compensation offshore tax-free. This untaxed compensation provided the seed money that enabled the Wyly-related offshore entities to initiate an extensive investment effort.

The stock option-annuity swaps used in this case history sought to manipulate the unusual tax status of stock options, which are virtually the only type of compensation that is not routinely taxed during the year when received, but is usually taxed during the year in which the stock options are exercised, often years after receipt. The swaps attempted to take advantage of this delay in taxation by transferring the stock options offshore to purportedly independent entities; the Wylys and their representatives then convinced the corporations that originally issued the options not to report any compensation when those offshore entities exercised the options. A number of U.S. executives attempted to defer taxation on their stock option compensation by transferring their options to other persons and entities in various types of transactions. In 2003, the IRS announced that it considered some of these stock option transactions to be potentially abusive tax shelters and offered to settle the tax liability of persons who participated in them with reduced penalties. The Wylys chose not to participate in this settlement initiative.

(a) Stock Options in General

In the United States, over the past ten years, stock options have commonly provided 50 percent or more of the compensation awarded to chief executive officers of publicly traded companies.626 They are also commonly used to compensate the directors of a public company.

Stock options give the stock option holder the contractual right to purchase company stock at a fixed price, called the “strike price,” for a designated period of time. Frequently, the strike price equals the price that the stock is trading on a public stock exchange on the day the stock option is granted. The stock option typically guarantees that the stock option holder can buy the company stock at the designated strike price for a period of years. The expectation is that the executive will then work to increase the company stock price, not only to build a
stronger company, but also to increase the value of the executive’s personal stock option holdings.

Some stock options do not permit the stock option holder to immediately purchase the company stock. Instead, they require the stock option holder to remain with the company for a designated period of time, such as two or three years, before the stock option “vests” and the executive can “exercise” it to buy the company stock. This vesting period is used to encourage the executive to remain with the company.

In some cases, stock options lose value, because the company stock price falls below the strike price. In such cases, some companies “reprice” the stock options, lowering the strike price so that the executive can profitably purchase the company stock, even though the public stock price has decreased. The SEC discourages such “repricing,” since it rewards corporate executives at the expense of investors left holding the higher priced shares.627

Historically, compensatory stock options were typically nontransferable, meaning the executive given the stock option was not permitted to transfer it to a third party.628 The purpose of this restriction is to preserve the incentives for the executive to remain with the company during the stock option’s vesting period and work to increase the company stock price; both employee incentives are reduced if the stock option were transferred to an outside party. Despite this general practice, some companies have allowed stock options to be transferred with the permission of the company’s board of directors; a few have allowed executives to transfer their stock options at will with notice to the company. In addition, in 1996, the SEC relaxed provisions that had made stock option transfers subject to Rule 16 insider trading restrictions; the new rules exempted from Rule 16 all securities provided by an issuer to an officer or director if certain conditions were met, including requiring any stock options to be held for at least six months from the time of award.629

Compensatory stock options are taxed under Section 83 of the Internal Revenue Code. This section, which codified a longstanding IRS position, provides that stock options are generally not taxed when granted, but are instead taxed when exercised.630 When exercised, the difference between the strike price paid by the option holder for the stock and the market price of the stock on the day of the exercise is taxable as ordinary income to the stock option holder. In addition, under Section 83(h), the corporation that granted the stock option is allowed to take a “mirror” deduction for the compensation included by the executive in his or her gross income at the time of exercise.

Treasury regulations in effect since 1978 provide that, if a compensatory stock option were sold to a third party in an arm’s-length transaction, the stock option holder must treat the amount received for the options at that time as taxable compensation income.631 If the sale were to a related party, however, the transfer would not be considered a taxable event; instead, when the stock options were later exercised by the related party, any profit between the option’s strike price and the stock’s market price at the time of exercise would be attributed as compensation to the person who was originally awarded the stock option and who would then be required to pay tax on that income.632 The purpose of this requirement is to prevent sham stock option sales to related parties for less than fair value.

Beginning in the 1990s, some accounting firms began selling a tax shelter to U.S. corporate executives to delay or eliminate the payment of tax on stock option compensation.633 In this tax shelter, an executive typically transferred compensatory stock options to a related person, such as a family member or an entity controlled by family members such as a family-related partnership or corporation. In exchange, the related person typically promised to pay the executive an amount equal to the stock option’s value, using a long-term, unsecured promissory note or some other unsecured, deferred payment plan promising future payments, often 20 or 30 years in the future. Often the related person had few, if any, assets other than the transferred stock options. The tax shelter promoters claimed that, because no payment was made on the transfer date to the executive, the stock option transfer was not a taxable event, and no tax was due until actual payment of the promised sums in the future. In the meantime, the related person could exercise the stock options, buy and sell the company stock, and, if the related person were located in an offshore tax haven, invest the cash tax-free.

For the tax shelter to work, however, the corporation that provided the stock option to the U.S. executive had to assist the transaction. For example, the corporation had to allow normally nontransferable stock options to be transferred by the executive to the related person. The corporation also had to allow the related person to exercise the options and take ownership of the company stock. In addition, the corporation had to agree not to issue a Form1099 or W-2 reporting compensation to the executive from the stock option exercise, and give up the corporate deduction available to it for the stock option compensation on the date of exercise. These actions typically represented an economic hardship to the corporation since it had to forego a valuable tax deduction for the stock option compensation. Nevertheless, many corporate executives were able to convince their corporations to go along.

In 2003, the IRS concluded that this executive stock option transaction had no economic substance apart from tax avoidance, and announced that it considered it a potentially abusive tax shelter.634 In 2005, over 100 executives and corporations accepted an offer by the IRS to settle possible tax liability and penalties related to the executive stock option tax shelter by agreeing to pay back taxes on the stock option compensation, interest, and a reduced amount of penalties.635 The IRS calculated that U.S. corporate executives had used the stock option tax shelter to avoid
reporting nearly $1 billion in taxable income.636

Sam and Charles Wyly used transactions similar to those described in the IRS notice to move their assets offshore. Each brother had millions of compensatory stock options that had been granted to him by the three publicly traded companies they founded or expanded, Michaels Stores, Sterling Software, and Sterling Commerce, for which, at various times, the brothers served as directors, officers, or large shareholders.637 In 1992 and 1996, with the assistance of legal counsel, the Wyly brothers arranged for the transfer of many of these stock options to the offshore entities examined in this Report. In return, they accepted, not promissory notes, but private annuities.

Each of the legal opinion letters addressed to the Wylys advised that they could defer the payment of any tax on the $41.8 million in stock option compensation sent offshore in exchange for the private annuities. The letters reasoned that a promise to make lifetime annuity payments had no immediately determinable value, an unfunded and unsecured promise to pay money in the future did not qualify as taxable property, and the stock options themselves had no readily ascertainable fair market value under Section 83 of the tax code, so none of the transactions resulted in an immediate tax liability to the Wylys. The letters also reasoned that, because the value of the private annuity being provided equaled the fair market value of the stock options being contributed in exchange for the annuity, no gift tax would apply. The letters asserted further that the exercise of the stock options would not result in taxable compensation to the original stock option holders, because the stock options had been disposed of in arm’s-length transactions.

The legal opinion letters failed to acknowledge or analyze the key issue of whether the stock option transfers were transfers between related parties and, thus, under Section 83 of the tax code, had to attribute any stock option exercise gains as taxable income to the original stock holders, Sam and Charles Wyly. Instead, each letter simply asserted without explanation that the stock options were transferred in arm’s-length transactions.

Counsel forwarded copies of the letters addressed to the Wylys to Michaels and Sterling Software, presumably to aid both corporations in reaching a decision not to report any stock option compensation for the Wylys either at the time the Wylys initially transferred the stock options to the Nevada corporations or later when the offshore corporations exercised those stock options.664 The evidence indicates that neither Michaels nor Sterling Software, in fact, issued a W-2 or 1099 form reporting the Wyly stock option compensation, either in 1992 or later.665 Apparently both corporations determined that the stock option-annuity swaps, as represented to them, meant that neither Sam nor Charles Wyly would receive any taxable income from their stock options until the annuity payments began years later.

(g) Analysis of Issues

The 17 million stock options and warrants moved offshore over a ten-year period, from 1992 until 2002, represented at least $190 million in compensation provided to Sam and Charles Wyly by Michaels, Sterling Software, and Sterling Commerce.746 Of this $190 million, Sam and Charles Wyly appear to have reported $31 million as taxable income in 2002. Since 2003, another $35 million was transferred to the Wylys in the form of annuity payments, for which taxes were presumably paid. It appears that the remaining $124 million in stock option compensation remains offshore and untaxed.

The U.S. publicly traded corporations that issued the stock options could have reported to the IRS the stock option gains realized when the options were exercised, but chose not to do so. The 20 offshore corporations that exercised the stock options and warrants then sold the shares or used them in securities transactions to produce additional income that was also untaxed.

The offshore transfers at the center of this case history involve sending valuable stock options and warrants to newly created shell entities with no employees, offices, or assets, in exchange for unsecured promises to make annuity payments years in the future. These transactions do not make economic sense, unless the recipients of the assets are understood to be related parties under the direction of the persons who sent the assets offshore.

Also key to understanding these transactions is the immense effort that was undertaken to keep them secret. Securities were directed to shell corporations in Nevada which sent them to IOM corporations bearing the same corporate names. Offshore grantor trusts were established to act as intermediaries for stock options intended to be transferred to still other offshore entities. Public corporations were persuaded not to file W-2 or 1099 forms reporting stock option gains to the IRS. A public corporation that made nearly $74 million in cash payments to offshore corporations was told it had no legal obligation to file forms reporting those payments to the IRS. When the IRS asked CA, in 2002, about Wyly stock option transfers to four offshore corporations, no one disclosed to the IRS that the offshore corporations were owned by trusts benefiting the Wyly family. In short, the extent of the stock option compensation sent offshore was kept hidden from the IRS.

Five publicly traded corporations, Michaels, Sterling Software, Sterling Commerce, SBC and CA, facilitated these offshore transfers and helped the Wylys avoid the immediate payment of taxes on their stock option compensation. Michaels and Sterling Software allowed the transfer of stock options that were supposed to be nontransferable. Four of the five amended their ownership records to accept stock option ownership by the offshore corporations. All five chose not to file 1099 or W-2 forms reporting Wyly stock option compensation to the IRS. All but one gave up taking multi-million-dollar tax deductions for the Wyly stock option compensation. As part of a repricing of all its employee stock options, Michaels even repriced the stock options held by the offshore entities, substantially increasing their value. None conducted a detailed investigation into the true relationship between the offshore entities and the Wylys to determine whether, in fact, they were independent or related parties.

View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy

Tax Haven Abuse: (Wyly Case) (Foreign Trust; U.S. Tax Issues)

The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), (Wyly Case) Foreign Trust Tax Issues (excerpted pages 136 – 139):

(a) Background on Trusts

Trusts are established for a variety of reasons, including by persons seeking to provide for the economic security of family members, manage their estates, or fund charitable works to benefit the public. A trust is created when one person, called the grantor or settlor, conveys a property interest to another person, called the trustee, to be held for the benefit of a party called the beneficiary.517 The grantor is the person who establishes the trust and typically contributes the trust assets. The trustee typically takes title to the assets and assumes a fiduciary obligation to exercise reasonable care over the property and to act solely in the interest of the beneficiary. The beneficiary can be a named individual, a charity, or a class of persons such as the grantor’s children. The grantor, in some circumstances, can also serve as the trustee or as one of the beneficiaries. The grantor can create a trust that is revocable or irrevocable. To establish the trust, the grantor, with the assistance of legal counsel, typically executes a written trust agreement identifying the trustee, the beneficiaries, the initial trust assets, and the terms of the trust.

Under U.S. trust law, grantors can retain significant control over assets conveyed to a trust. For example, the trust agreement can authorize the grantor to manage the trust assets or direct the trustee’s performance of certain duties, or require the trustee to obtain the grantor’s written consent prior to taking certain actions.518 Grantors can spend trust funds, replace the trustee, and reserve the right to revoke the trust altogether. Foreign jurisdictions afford grantors similar authority over trust assets. The Isle of Man, for example, which plays a key role in the Wyly case history, allows grantors to establish trusts giving the trustee wide discretion to invest and distribute trust assets. The grantor may then converse directly with the trustee or provide a “letter of wishes” with specific recommendations on how to administer the trust assets.

A trust agreement can also establish a “trust protector,” a person selected by the grantor with authority to oversee the trust assets and often with the power to replace the trustee. The Isle of Man permits trust protectors to interact with trustees on a daily basis, conveying information and recommendations from the grantor about how the trust assets should be handled, and to replace the trustees at will, including, for example, if a trustee declines to follow the protector’s recommendations.519 At the same time, trust law typically assigns final decisionmaking authority over trust assets to the trustee, requiring the trustee to act with due care and in the sole
interest of the trust beneficiaries.

U.S. tax treatment of trust property depends upon the amount of control the grantor retains over the trust. If the grantor places property in an irrevocable trust and gives up all control over the property and the trust, the trust is generally treated as a separate taxpayer and pays tax on the income from the property.520 When the trust distributes the income to the beneficiaries, it gets a deduction for the amount distributed, but the beneficiaries have to pay tax on the income, so that the income is taxed only once.521 On the other hand, if the grantor directly or indirectly keeps the power to revoke the trust or retains significant control over the trust or trust assets, the trust is considered a "grantor trust" and its income is generally attributed to the grantor for tax purposes.522 In some cases where a grantor has supposedly established an irrevocable, independent trust, but secretly retained control over the trusts assets, courts have ruled that the trust was a sham and attributed the trust assets and income to the grantor for tax purposes.523

Trusts formed in foreign jurisdictions originally operated under a different set of tax rules. Generally, foreign trusts were seen as foreign entities outside the normal reach of U.S. tax law, and foreign trust distributions to U.S. persons were generally untaxed. Over the years, some U.S. citizens began to take advantage of the tax status of these foreign trusts. For example, some U.S. persons formed foreign trusts in tax havens, named themselves as the grantor, named U.S. beneficiaries, and placed U.S. assets in those trusts. They claimed that the foreign trusts could then distribute the trust income to the U.S. beneficiaries tax free, and the trusts could accumulate capital gains tax free, unless and until any appreciated assets were brought back into the United States. Congress and the IRS responded with a series of laws and regulations designed to stop
what were seen as tax dodges unintended by the tax code. In 1976, for example, Congress declared that a foreign trust that was funded by a U.S. person and had U.S. beneficiaries was considered a U.S. grantor trust whose income had to be attributed to the U.S. person who transferred the assets.524

Some U.S. persons responded to these new limitations on foreign trusts by convincing a foreign person (rather than a U.S. person) to act as the grantor of the foreign trust and name U.S. beneficiaries. The U.S. person then transferred assets to this “foreign grantor trust” for later distribution to the U.S. beneficiaries tax free. In 1996, in effort to end this practice, Congress enacted legislation essentially requiring the U.S. beneficiaries to pay tax on any distributions from a foreign trust that was not already taxable to a U.S. grantor.525 In passing this law, however, Congress applied it only to assets transferred to foreign trusts after February 6, 1995; foreign trusts funded with assets prior to that date were allowed to continue operating under earlier rules permitting tax-free distributions to U.S. beneficiaries.526

The Wyly case history, which spans a thirteen-year period from 1992 to 2005, reflects this legal tug of war over foreign trusts. The Wylys created and funded some foreign trusts with U.S. grantors, such as the Bulldog and Pitkin Trusts, and other foreign trusts with foreign grantors, such as the Bessie and Tyler Trusts.527 Some of the Wyly-related offshore trust agreements appear to have been written with the express goal of avoiding U.S. tax rules applicable to foreign trusts with U.S. beneficiaries by naming, for example, only foreign charities as the immediate trust beneficiaries and barring any “U.S. person” from receiving trust assets until two years after the death of the grantor, Sam or Charles Wyly.528 The Wyly case history also illustrates the tensions between trust law, which often allows significant grantor control of trust assets, and U.S. tax and securities obligations which often turn on control issues. It illustrates further the tensions created by offshore secrecy laws that make it difficult to determine who really controls an offshore entity.

View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy

Tax Haven Abuse: (Wyly case) (Beneficial Ownership under Anti-Money Laundering Laws)

The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), Wyly Case, Beneficial Ownership under Anti-Money Laundering Laws (excerpted pages 296 – 300):

Hiding Beneficial Ownership

From 1992 to 2004, the 58 offshore trusts and corporations in the Wyly offshore structure opened numerous accounts at prominent securities firms in the United States, Credit Suisse First Boston (“CSFB”), Lehman Brothers, and Bank of America. They used these accounts to buy and sell securities, make investments, and send multi-million-dollar wire transfers. All three financial institutions knew that the offshore entities were associated with the Wyly family, but in the face of the offshore entities’ refusal to acknowledge who was behind them, none of the institutions ever required the offshore entities to identify their beneficial owners or document their connection to the Wylys.

These offshore corporations and trusts presented a classic case of hiding beneficial ownership. For more than a decade, U.S. banks have been required to “know their customers” to prevent criminals from misusing bank services; part of that obligation has been, when opening accounts for offshore corporations and trusts from secrecy jurisdictions, to identify the beneficial owners behind the offshore entities. Securities firms did not operate under the same legal requirements until enactment of the 2001 Patriot Act which extended anti-money laundering requirements to securities accounts as well. By July 2002, the Patriot Act required securities firms that opened “private banking accounts” with at least $1 million for foreign account holders, to identify both the nominal and beneficial owners of those accounts. By May 2003, SEC regulations required securities firms to identify the beneficial owner of each account they administered.

By the summer of 2003, the Wyly-related offshore entities had moved to Bank of America and opened dozens of securities accounts. Some of their transactions began tripping alarms in the anti-money laundering surveillance system used by the clearing broker, National Financial Services (“NFS”), that administered the Bank of America accounts. NFS insisted that, if Bank of America wanted it to continue to handle the accounts, it needed the information required by law – the names of the beneficial owners behind the offshore corporations and trusts using the accounts. For more than a year, the offshore entities resisted providing the information, and Bank of America tried to convince NFS not to press for it. Finally, in late 2004, after Bank of America received subpoenas issued by the Manhattan District Attorney seeking information about the accounts, Bank of America closed them.

Bank of America knew that the offshore entities were associated with the Wylys. The key broker who handled the accounts, Louis Schaufele, knew that Sam and Charles Wyly were directing the offshore entities’ investment activities. He nevertheless insisted that the offshore entities be treated as independent of the Wylys and fought efforts to identify the Wylys as their beneficial owners. In addition, when, for tax purposes, the offshore entities submitted W-8BEN forms representing that they were independent foreign entities, beneficially owned the accounts assets, and were not subject to IRS requirements for reporting investment income paid to U.S. persons, Bank of America accepted the forms and never filed a 1099 reporting the account income to the IRS.

Had the offshore entities acknowledged that the Wylys were the beneficial owners of the offshore trusts and corporations for anti-money laundering purposes, and allowed their connection to these entities to be documented at Bank of America, it would have been harder for the Wylys to deny their connection to these entities for tax and securities purposes.

(a) Background on Beneficial Ownership

For decades, U.S. banks have had an obligation to “know their customers,” to understand the natural persons behind offshore corporations and trusts, to ensure that bank services would not be misused for illegal purposes. U.S. banks have also operated for years under legal obligations to report suspicious transactions to law enforcement to prevent money laundering.

In contrast, until recently, U.S. securities firms did not operate under the same know-your-customer obligations. For many years, brokers were required to evaluate their customers to ensure that they were selling them suitable investments – for example, selling high risk securities to persons with a high tolerance for risk and not to an elderly person on a fixed income – but this obligation was not equivalent to performing a due diligence review to guard against opening an account for a questionable person. Some securities firms set up voluntary anti-money laundering (“AML”) programs, but it was not until passage of the Patriot Act in 2001 that all U.S. securities firms became legally obligated to establish AML programs and to identify and verify the identity of their customers.

Beneficial Ownership under Anti-Money Laundering Laws. Three key laws set out the obligations of U.S. financial institutions to know their customers and guard against misuse of their accounts, the Bank Secrecy Act of 1970, the Money Laundering Control Act of 1986, and the 2001 Patriot Act, which amended both prior laws. These and other anti-money laundering (“AML”) laws have, over time, tightened requirements for banks and other financial institutions to evaluate clients, monitor transactions, and report suspicious activity.

The 1970 Bank Secrecy Act was the first to require U.S. financial institutions operating in the United States to undertake AML efforts, authorizing the Treasury Secretary to issue regulations requiring financial institutions to establish AML programs meeting certain criteria. In 1986, the Money Laundering Control Act was the first in the world to make money laundering itself a crime, prohibiting persons from knowingly engaging in financial transactions involving criminal proceeds. In 1996, the Treasury Secretary began requiring banks to file Suspicious Activity Reports on client transactions raising red flags of possible misconduct. In 1997, the Federal Reserve issued special guidance warning banks catering to wealthy individuals through “private banking accounts” of the need to install controls to detect and report possible money laundering. In 1998 and 2000, federal bank regulators issued guidance on spotting suspicious transactions and strengthening regulatory reviews of banks’ AML programs.

In 2001, after the terrorist attack of September 11th, President Bush announced an intensified effort to uncover and stop terrorist financing, and Congress enacted the Patriot Act which, in part, greatly strengthened federal AML laws. Among other provisions, the Patriot Act required all U.S. financial institutions, including securities firms, to establish AML programs, verify the identity of their account holders, and exercise due diligence when opening and administering private banking accounts for foreign persons. It also required securities firms to begin filing Suspicious Activity Reports.

The Patriot Act imposed a special set of requirements to prevent misuse of “private banking accounts” by foreign account holders. “Private banking accounts” are accounts opened by banks, securities firms, or certain other financial institutions that require a minimum of $1 million in funds or assets, are opened for individuals with a “direct or beneficial ownership interest” in the account, and use an employee, such as a private banker or account officer, to act as a personal liaison between the financial institution and the “direct or beneficial owner.” 31 USC § 5318(i)(4)(B). The law required all financial institutions that opened such private banking accounts for foreign account holders to “ascertain the identity of the nominal and beneficial owners” of the account. 31 USC § 5318(i)(3)(A). This provision included, for example, the requirement that financial institutions ascertain the beneficial owners of accounts opened in the name of foreign corporations or trusts. This provision became legally binding in July 2002.

The Patriot Act also directed the Treasury Secretary to promulgate regulations further delineating the due diligence obligations of financial institutions, and further defining which account holders have “beneficial ownership of an account.” Section 312(b) of the Patriot Act; 31 USC § 5318A(e)(3). In response, Treasury issued proposed regulations in May 2002, an “interim final rule” in July 2002, and a final rule in January 2006. Each of these rules repeated the legal obligation of financial institutions to ascertain the nominal and beneficial owners of private banking accounts.

The U.S. accounts opened by the Wyly-related offshore entities must be viewed through this history of evolving AML laws. In the United States, the offshore entities opened securities accounts, rather than bank accounts, which prior to the Patriot Act operated under fewer legal requirements and less scrutiny. When they opened accounts at CSFB in 1992, for example, know-your-customer practices at securities firms were voluntary, and the SEC exercised no routine oversight. When the accounts moved to Lehman Brothers in 1995, the regulatory environment was little changed. By the time the accounts moved to the securities divisions of Bank of America in 2002, however, the Patriot Act had been enacted, AML concerns had heightened, due diligence regulations were being drafted, and U.S. securities firms should have been on full alert about their obligation to know their customers.

View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy

Tax Haven Abuse: (Wyly Case) (Beneficial Ownership under Anti-Money Laundering Laws)

The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), Wyly Case, Beneficial Ownership under Anti-Money Laundering Laws (excerpted pages 296 – 300):

Hiding Beneficial Ownership

From 1992 to 2004, the 58 offshore trusts and corporations in the Wyly offshore structure opened numerous accounts at prominent securities firms in the United States, Credit Suisse First Boston (“CSFB”), Lehman Brothers, and Bank of America. They used these accounts to buy and sell securities, make investments, and send multi-million-dollar wire transfers. All three financial institutions knew that the offshore entities were associated with the Wyly family, but in the face of the offshore entities’ refusal to acknowledge who was behind them, none of the institutions ever required the offshore entities to identify their beneficial owners or document their connection to the Wylys.

These offshore corporations and trusts presented a classic case of hiding beneficial ownership. For more than a decade, U.S. banks have been required to “know their customers” to prevent criminals from misusing bank services; part of that obligation has been, when opening accounts for offshore corporations and trusts from secrecy jurisdictions, to identify the beneficial owners behind the offshore entities. Securities firms did not operate under the same legal requirements until enactment of the 2001 Patriot Act which extended anti-money laundering requirements to securities accounts as well. By July 2002, the Patriot Act required securities firms that opened “private banking accounts” with at least $1 million for foreign account holders, to identify both the nominal and beneficial owners of those accounts. By May 2003, SEC regulations required securities firms to identify the beneficial owner of each account they administered.

By the summer of 2003, the Wyly-related offshore entities had moved to Bank of America and opened dozens of securities accounts. Some of their transactions began tripping alarms in the anti-money laundering surveillance system used by the clearing broker, National Financial Services (“NFS”), that administered the Bank of America accounts. NFS insisted that, if Bank of America wanted it to continue to handle the accounts, it needed the information required by law – the names of the beneficial owners behind the offshore corporations and trusts using the accounts. For more than a year, the offshore entities resisted providing the information, and Bank of America tried to convince NFS not to press for it. Finally, in late 2004, after Bank of America received subpoenas issued by the Manhattan District Attorney seeking information about the accounts, Bank of America closed them.

Bank of America knew that the offshore entities were associated with the Wylys. The key broker who handled the accounts, Louis Schaufele, knew that Sam and Charles Wyly were directing the offshore entities’ investment activities. He nevertheless insisted that the offshore entities be treated as independent of the Wylys and fought efforts to identify the Wylys as their beneficial owners. In addition, when, for tax purposes, the offshore entities submitted W-8BEN forms representing that they were independent foreign entities, beneficially owned the accounts assets, and were not subject to IRS requirements for reporting investment income paid to U.S. persons, Bank of America accepted the forms and never filed a 1099 reporting the account income to the IRS.

Had the offshore entities acknowledged that the Wylys were the beneficial owners of the offshore trusts and corporations for anti-money laundering purposes, and allowed their connection to these entities to be documented at Bank of America, it would have been harder for the Wylys to deny their connection to these entities for tax and securities purposes.

(a) Background on Beneficial Ownership

For decades, U.S. banks have had an obligation to “know their customers,” to understand the natural persons behind offshore corporations and trusts, to ensure that bank services would not be misused for illegal purposes. U.S. banks have also operated for years under legal obligations to report suspicious transactions to law enforcement to prevent money laundering.

In contrast, until recently, U.S. securities firms did not operate under the same know-your-customer obligations. For many years, brokers were required to evaluate their customers to ensure that they were selling them suitable investments – for example, selling high risk securities to persons with a high tolerance for risk and not to an elderly person on a fixed income – but this obligation was not equivalent to performing a due diligence review to guard against opening an account for a questionable person. Some securities firms set up voluntary anti-money laundering (“AML”) programs, but it was not until passage of the Patriot Act in 2001 that all U.S. securities firms became legally obligated to establish AML programs and to identify and verify the identity of their customers.

Beneficial Ownership under Anti-Money Laundering Laws. Three key laws set out the obligations of U.S. financial institutions to know their customers and guard against misuse of their accounts, the Bank Secrecy Act of 1970, the Money Laundering Control Act of 1986, and the 2001 Patriot Act, which amended both prior laws. These and other anti-money laundering (“AML”) laws have, over time, tightened requirements for banks and other financial institutions to evaluate clients, monitor transactions, and report suspicious activity.

The 1970 Bank Secrecy Act was the first to require U.S. financial institutions operating in the United States to undertake AML efforts, authorizing the Treasury Secretary to issue regulations requiring financial institutions to establish AML programs meeting certain criteria. In 1986, the Money Laundering Control Act was the first in the world to make money laundering itself a crime, prohibiting persons from knowingly engaging in financial transactions involving criminal proceeds. In 1996, the Treasury Secretary began requiring banks to file Suspicious Activity Reports on client transactions raising red flags of possible misconduct. In 1997, the Federal Reserve issued special guidance warning banks catering to wealthy individuals through “private banking accounts” of the need to install controls to detect and report possible money laundering. In 1998 and 2000, federal bank regulators issued guidance on spotting suspicious transactions and strengthening regulatory reviews of banks’ AML programs.

In 2001, after the terrorist attack of September 11th, President Bush announced an intensified effort to uncover and stop terrorist financing, and Congress enacted the Patriot Act which, in part, greatly strengthened federal AML laws. Among other provisions, the Patriot Act required all U.S. financial institutions, including securities firms, to establish AML programs, verify the identity of their account holders, and exercise due diligence when opening and administering private banking accounts for foreign persons. It also required securities firms to begin filing Suspicious Activity Reports.

The Patriot Act imposed a special set of requirements to prevent misuse of “private banking accounts” by foreign account holders. “Private banking accounts” are accounts opened by banks, securities firms, or certain other financial institutions that require a minimum of $1 million in funds or assets, are opened for individuals with a “direct or beneficial ownership interest” in the account, and use an employee, such as a private banker or account officer, to act as a personal liaison between the financial institution and the “direct or beneficial owner.” 31 USC § 5318(i)(4)(B). The law required all financial institutions that opened such private banking accounts for foreign account holders to “ascertain the identity of the nominal and beneficial owners” of the account. 31 USC § 5318(i)(3)(A). This provision included, for example, the requirement that financial institutions ascertain the beneficial owners of accounts opened in the name of foreign corporations or trusts. This provision became legally binding in July 2002.

The Patriot Act also directed the Treasury Secretary to promulgate regulations further delineating the due diligence obligations of financial institutions, and further defining which account holders have “beneficial ownership of an account.” Section 312(b) of the Patriot Act; 31 USC § 5318A(e)(3). In response, Treasury issued proposed regulations in May 2002, an “interim final rule” in July 2002, and a final rule in January 2006. Each of these rules repeated the legal obligation of financial institutions to ascertain the nominal and beneficial owners of private banking accounts.

The U.S. accounts opened by the Wyly-related offshore entities must be viewed through this history of evolving AML laws. In the United States, the offshore entities opened securities accounts, rather than bank accounts, which prior to the Patriot Act operated under fewer legal requirements and less scrutiny. When they opened accounts at CSFB in 1992, for example, know-your-customer practices at securities firms were voluntary, and the SEC exercised no routine oversight. When the accounts moved to Lehman Brothers in 1995, the regulatory environment was little changed. By the time the accounts moved to the securities divisions of Bank of America in 2002, however, the Patriot Act had been enacted; AML concerns had heightened, due diligence regulations were being drafted, and U.S. securities firms should have been on full alert about their obligation to know their customers.

View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy

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.