For the first time, bankers are revealing the techniques behind beating the Revenue

Sand, sea and a double-dip : all you need to avoid millions in tax offshore

Structured finance

Sand, sea and a double-dip : all you need to avoid millions in tax offshore

* The Guardian, Friday 13 March 2009

If you look up "structured finance" in a business dictionary, you’ll be told it is a sector of the banking industry created to help transfer risk by using complex financial instruments. But what structured finance has in fact mostly meant, as authorities around the world are only now beginning to understand fully, is tax avoidance.

Tax "saving" is the phrase preferred by the bankers themselves, and they insist that saving tax is only one of their overall commercial purposes.

These operations by big banking have been so secretive that an OECD taskforce admitted being unable to penetrate them. It said banks had a significant role in developing aggressive tax-planning strategies, with single deals involving billions of pounds and tax profits to the banks of hundreds of millions.

But as major institutions here and in the US quietly dismantle large parts of the structured finance departments that got them into such trouble, insiders have been coming forward to describe to the Guardian just how the arcane world of structured finance really works.

It is a world of jargon unintelligible to outsiders : "de-consolidation", "double-dipping". What one banker calls "a bog-standard structured transaction" turns out to involve a string of offshore companies, a £1bn investment and a "double dip" that manages to claim tax allowances twice for the same £1bn.

Tax deals would start with working out the bank’s "tax capacity" - the term for the amount of tax the bank is due to pay on profits, and which it would like to reduce by manufacturing tax losses elsewhere or by buying them in from someone else. "We’d be in constant touch with our bank’s back office to see what tax capacity we have available," says the banker. "The back office would release tax capacity of, say, £2bn, and we’d do a deal with that."

For a UK/US "double-dip" tax transaction, the bank would look at setting up a series of "special purpose vehicles" - companies specifically set up to shift huge sums between two or more institutions in an elaborate circle, often moving it offshore before bringing it back with tax benefits attached.

Key to the tax saving will often be a "hybrid entity", a company that can magically be owned by more than one party, so that it comes under the tax rules of the UK at one point, but under the different tax rules of, say, Luxembourg at another convenient point. Further companies may need to be invented to unwind the deal and move the cash back onshore without attracting tax.

The first step for the structured finance team is to go to another large bank or financial institution - a "counterparty" - and offer to pay them to join the deal. Both sides get together with teams of lawyers - seven or eight on each side are said to be common. They advise how to exploit technical loopholes while remaining within the law.

The teams thrash out how the money will move between them, who will own what in what form at what point, how it will be lent back, what kind of collateral the other side will put up against it, whether they need to create an income stream, say from securitised mortgages, that attracts tax in one place in order to pass tax credits on, what interest rates they’ll pay each other, and what accounting dates will be used.

Each side’s cut of the anticipated tax profits will be negotiated. The leading bank will typically take 70-80%, depending on the complexity of the deal, and the counterparty will take 20-30%, perhaps hidden in a particularly favourable interest rate on a loan between the parties. The banks’ risk committees would want a "clean tax opinion from a lawyer" before signing the deal off. US lawyers, according to our sources, tended to be particularly anxious to add some conventional commercial transaction to the operation.

Each deal would then have a "bible" created for it : hundreds of pages recording its details and how to unwind it.

Deals that had started out relatively small, at £300m, got much bigger as the world’s liquidity bubble grew. "£1bn seemed a huge deal a few years ago, but then they went up and up and in the heyday, around 2004, £5bn was common," says one banker.

From the authorities’ point of view, the complexity of these deals, and their use of secretive jurisdictions offshore, often made them impenetrable. A source close to the US tax authorities compares unpicking such a tax deal with trying to do a 1,000-piece jigsaw, "but you’ve only been given half the pieces and the bankers have taken away the picture on the box".

The biggest players in structured finance were making about £1bn a year per bank in tax profit at the peak, one expert told us, with about 20 financial institutions active in the market. The loss to exchequers around the world has been huge. A senior source close to the UK Revenue told us that the banks’ profits from tax deals were "certainly billions and billions and billions".

Cayman break : Allure of the islands

How many deals ?

Thirteen RBS tax avoidance deals over the last five years involved capital of £25bn. Losers in seven of them are countries other than the UK. One deal is still "live" - a £500m trade with Swiss Re. This does not appear to cause tax losses to the UK.

Why are the sums so huge ?

Big loans are needed for the banks to make a worthwhile profit, which they share between them. Interest received on a £1bn loan might be £40m a year. UK corporation tax saved on that profit, at 30%, would be £12m a year.

What is the point of the deals ?

Some "commercial reason" for the loans is generally claimed. But RBS does not deny that each one makes money by creating a tax loss.

Why the Caymans ?

Not because of the Caribbean islands’ notorious zero tax rate. The deals are deliberately UK tax resident. The attractions are the secrecy, and the lax rules that allow share deals to be easily "unwound".

Voir en ligne : The Guardian

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