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Stars in the gutter

26 September 2011 By Martin Hutchinson

A global SWAT team is needed to close tax loopholes. Tax-based financing deals like those between U.S. and UK banks being targeted by U.S. authorities use legal mismatches to reduce tax bills. They are lucrative, but have no economic value. Such questionable arrangements might be best tackled in a focused multilateral forum.

One class of transactions currently being targeted by the U.S. Internal Revenue Service, known as structured trust advantaged repackaged securities or Stars, involved several American banks which, with the help of Barclays in the UK, established trusts and several special-purpose vehicles to take advantage of differences between UK and U.S. tax law and thereby maximize interest deductions in both jurisdictions.

In the past, structures with similar objectives have employed other methods, for instance preference shares routed through either Ireland or Germany. Typically, cash flows in such deals are largely circular and the economic consequences are minimal – except for major tax savings for those involved and large fees for their designers.

The IRS’s legal reasoning against these structures includes examining the substance of the transactions, with the idea of showing that they had no purpose other than reducing tax by arbitraging two systems. This approach has two disadvantages. It does not always work, because courts have to consider the letter of the law. And if it does work, the subjective judgment involved greatly increases the uncertainty surrounding many other international financing transactions previously – and often justifiably – assumed to be legitimate.

The problem may be best solved by approaching it directly, seeking to minimize the gaps between different tax systems without the need for interpretive leaps from legal wording to substance. This might be done through the G20 inter-government forum, which could appoint a team of tax specialists to examine weaknesses and inconsistencies between different major economies’ tax laws and suggest ways to eliminate them.

As with many other facets of financial regulation, global coordination is needed to shut off cross-border tax arbitrage, something that would be particularly valuable at a time when national budgets are under strain. It would also increase the certainty of international tax arrangements – a useful result in an uncertain world.


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