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ALERT: Senate Subcommittee to Hold Hearing on Alleged Tax Abuses Involving Dividends Paid to Certain Offshore Entities

posted by Akin Gump

In a July 2007 client alert, we reported on an Internal Revenue Service (IRS) effort to investigate the use of derivative transactions by hedge funds and other foreign investors to avoid U.S. withholding tax on U.S. source dividends and certain other types of income. At the time, the scope of the IRS investigation was unclear, but we noted then that it appeared to be focused on so-called “dividend enhancement” trades, such as total return swaps over U.S. publicly traded stock and similar derivatives. In addition, we noted that it remains to be seen whether the investigation would lead to tax audits of foreign funds that entered into tax-advantaged derivative transactions.

The attack on these types of transactions seems to be intensifying. On September 11, 2008, the U.S. Senate Permanent Subcommittee on Investigations, a subcommittee of the Committee on Homeland Security and Governmental Affairs, held a hearing on the transactions; in advance of the hearing, the subcommittee released a staff report entitled “Dividend Tax Abuse: How Offshore Entities Dodge Taxes on U.S. Stock Dividends.” The report and hearing were the subject of numerous high-profile news articles, including articles in the Wall Street Journal and New York Times. A number of speakers, including IRS Commissioner Douglas Shulman, Professor Reuven S. Avi-Yonah and executives of certain financial institutions and investment funds, testified at the hearing.

See the full alert here.

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