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cashinmattress

A Shelter That Could Start A Stampede

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A Shelter That Could Start a Stampede

FINANCIAL engineering — funky mortgages, off-balance-sheet vehicles and complex derivatives — contributed mightily to our current crisis. And the meltdown’s resolution, by no means complete, has already required hundreds of billions in taxpayer commitments.

If the Treasury is ever to replenish its coffers, increased tax receipts will be sorely needed. But these inflows could be reduced if an unusual tax-avoidance transaction — set up to allow losses at one company to offset profits at another — gains acceptance throughout corporate America.

Given the potential tax benefits associated with the strategy (and given the enormous losses that have been generated across industries in recent years), the popularity of the maneuver is almost certain. At least that’s the view of Robert Willens, an authority on taxes and accounting, who spent decades at Lehman Brothers and now runs his own shop in New York.

In an article that was published last week in Tax Notes, a well-regarded publication devoted to tax policy and analysis, Mr. Willens examined a deal that Bank of America completed for a unit of Fairfax Financial Holdings, a Canadian insurance company, and the Odyssey Re Holdings Corporation, a writer of property and casualty reinsurance that had been spun out of Fairfax in 2001.

The complex structure allowed Odyssey to avoid paying taxes on some of its profits by shifting those earnings onto Fairfax’s books. Fairfax had weathered nearly $1 billion in losses accumulated during a previous downturn in the insurance market. So it had losses it could use to offset the Odyssey profits coming onto its books. And the shift saved Odyssey an estimated $400 million in taxes.

The debate over the tax structure is contentious. Fairfax says that the Internal Revenue Service signed off on it and that the company has done nothing untoward. It also disputes Mr. Willens’s impartiality in questioning the transaction, citing his work as a paid consultant for a hedge fund that has targeted Fairfax.

Under tax rules, offsetting losses against gains can occur only among companies operating within the same parent corporation and filing a consolidated income tax return. Therefore, a company hoping to shelter another’s earnings with its own losses must acquire at least 80 percent of the shares in that profitable enterprise. From a tax standpoint, a stake below 80 percent would mean the companies wouldn’t be affiliates.

THE particulars of the Fairfax deal are as follows: Before the Fairfax-Odyssey transaction, which was created in March 2003 and unwound in August 2006, Fairfax held 73.8 percent of Odyssey’s shares. To meet the consolidation threshold, Fairfax had to buy 4.3 million additional Odyssey shares. At the time, that required an investment by Fairfax of around $78 million.

But instead of paying cash for the shares, Fairfax struck a deal with Bank of America, its longtime banker, and issued debt to the bank in exchange for the stock. Fairfax issued two notes to an offshore affiliate of the bank in the amount of $78 million. The notes matured in 2010 and carried an interest rate of 3.15 percent, well below the rate Fairfax would have had to pay if it had issued debt publicly.

Through the affiliate, Bank of America agreed to borrow Odyssey shares from other investors and transfer them to Fairfax. Even though the Bank of America affiliate was short the shares it transferred to Fairfax, it retained several significant attributes of ownership in those shares, Mr. Willens says.

The Internal Revenue Service did not dispute the Fairfax-Odyssey consolidation for 2003 and 2004. Since the I.R.S. declines to discuss specific cases, it is unclear why it has not yet closed the books on 2005 and 2006 when the earlier consolidation was already in place and approved.

As is its custom, a spokesman for the I.R.S. declined to comment.

Still, Mr. Willens argues that the way Bank of America structured the deal — borrowing shares from other investors and transferring them temporarily to Fairfax — made it more of a “synthetic†than genuine consolidation for Fairfax.

“If the I.R.S. countenances this strategy, which involves the use of borrowed stock to achieve affiliation, a fertile new area of tax avoidance will become available,†Mr. Willens wrote, “and tax advisers can be expected to enthusiastically recommend it to their clients.â€

Courts considering whether a stake has indeed been transferred from one party to another look at many factors. They include these: who has the risk of loss, who has the right to share in any gains and who can vote the stock. Fairfax notes that it, indeed, faced the risks of loss on the shares.

But the most important attribute, Mr. Willens says, is who has the right to sell the stake. And in the Fairfax-Odyssey deal, he says, Bank of America’s affiliate held on to that right.

For this and other reasons, Mr. Willens said, he believes Fairfax never secured true ownership of the Odyssey stock and the consolidation existed in appearance only.

A Bank of America spokesman, Lawrence Di Rita, declined to comment about the transaction. A person briefed on the bank’s work for Fairfax, who requested anonymity because of concerns about litigation, said that Fairfax designed the transaction and that it was the only time the bank had crafted such a structure.

Seth Faison, a spokesman for Fairfax, confirmed that the insurer had designed the transaction. He also said that Mr. Willens’s analysis is flawed — including its interpretation of the right to sell. “The transaction in question fully complied with the United States tax laws, and the closing of the 2003 and 2004 tax years by the I.R.S. confirms this conclusion,†he said.

Mr. Faison and Fairfax also contend that Mr. Willens can’t be objective about the transaction because he originally examined it for a hedge fund client that is in a legal dispute with Fairfax. The hedge fund, ICP, filed a whistleblower application with the I.R.S., citing Mr. Willens’s analysis of the Fairfax tax structure.

Mr. Willens has been a respected authority on tax issues for decades, and he notes that his work for the hedge fund client ended last year after a few months. Moreover, while Mr. Willens questions the Fairfax-Odyssey consolidation, it is his view that such deals may become more popular among corporations looking to shelter profits from the taxman.

“This creates unlimited possibilities for other like-minded taxpayers to exploit the losses of companies with which they have no relationship,†Mr. Willens said. “If you don’t really have to own the shares to consolidate, it makes things quite easy.â€

If Mr. Willens is right, covering losses incurred on the Treasury’s bailout programs may take even longer than expected. And won’t it be maddening if individuals’ taxes go up because receipts from profitable corporations are going down?

Will this be the way in the UK? Is it happening in the UK? Enlightened forum members, please give us your thoughts.

Michael Hudson speaks about this on Max Keisers 'On the Edge'. Watch at 4:00

There is no justice.

Edited by cashinmattress

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The Ango-American empire is falling, its the end..............China is using North Korea as a warning to America NOT to try anything "Silly". Russia has hired a team of "Hitmen" to raid the Comex, its the start of the end game.

Mike

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A Shelter That Could Start a Stampede

Will this be the way in the UK?

Michael Hudson speaks about this on Max Keisers 'On the Edge'. Watch at 4:00

There is no justice.

I'd have thought the last thing the US economy needs is to offer another tax shelter to corporations. The tax take will already be massively reduced putting pressure on PSBR so why further undermine the tax take? I realise that there's a balance to be achieved between giving the economy a kick-start through tax-breaks and funding public expenditure through taxation, but is this really the way to go about achieving that balance? It looks like another scheme whereby the rich get richer (corporations) and the poor get poorer. But what do I know?

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A Shelter That Could Start a Stampede

Will this be the way in the UK? Is it happening in the UK? Enlightened forum members, please give us your thoughts.

Michael Hudson speaks about this on Max Keisers 'On the Edge'. Watch at 4:00

There is no justice.

Of course not.

You are either in the club - in which case excuses will be made and laws bent and broken or you are not in the club, in which case rules will be made up and selective applied so that you are in effect livestock working to feed those in the club.

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Of course not.

You are either in the club - in which case excuses will be made and laws bent and broken or you are not in the club, in which case rules will be made up and selective applied so that you are in effect livestock working to feed those in the club.

So who has been the Judas goat? Gordon Brown?

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So who has been the Judas goat? Gordon Brown?

Most of your neighbours, fanmily and friends, sadly.

Most people believe such shite. Then insist it is true with all the emotional pressure they can muster.

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Most of your neighbours, fanmily and friends, sadly.

Most people believe such shite. Then insist it is true with all the emotional pressure they can muster.

Well, I guess the goal from here on in is to get into the 'club'. Either that or spend the rest of our lives as debt ridden serfs in a hellish kleptocracy.

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Either that or spend the rest of our lives as debt ridden serfs in a hellish kleptocracy.

On the plus side there Britains Got Talent on TV.

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Well, I guess the goal from here on in is to get into the 'club'. Either that or spend the rest of our lives as debt ridden serfs in a hellish kleptocracy.

Having hordes of people wanting to get into the club is the main way the club stick around, I would imagine.

Don't worry - they are going to collapse. They can't have what they want because it isn't actually possible.

King Canute like they are staring at the debt and self interest of the majority and failing to move either with just words.

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Having hordes of people wanting to get into the club is the main way the club stick around, I would imagine.

Don't worry - they are going to collapse. They can't have what they want because it isn't actually possible.

King Canute like they are staring at the debt and self interest of the majority and failing to move either with just words.

Hmmm. Well, Britain does not have a good history of the serfs overthrowing the feudal masters.

The Yanks have their guns and constitution, the French have their passion and guillotine....

We have crumpets, apathy, and constant fear.

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MPs expenses. may have awoken an apathetic public....maybe....maybe...the rest of the broken system will be taken down piece by piece....fingers crossed.

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Hmmm. Well, Britain does not have a good history of the serfs overthrowing the feudal masters.

The Yanks have their guns and constitution, the French have their passion and guillotine....

We have crumpets, apathy, and constant fear.

Our "upper class" have always given in long before revolution happened.

They are experts at giving just enough back to stop whatever movement is afoot short of getting to a dangerous size. This time, however it's their own failings and the lunatic systems they put in place in the past that's doing for them. It's not like some new uber group is vying for power - those at the top have arsed it up completely and are now trying to make sure it doesn't end their reign.

Orwell has some good stuff on it in his lines on the party - "anyone dangerous to the party is drafted in, anyone who can think sidelined"..something like that.....

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A Shelter That Could Start a Stampede

Will this be the way in the UK? Is it happening in the UK? Enlightened forum members, please give us your thoughts.

Michael Hudson speaks about this on Max Keisers 'On the Edge'. Watch at 4:00

There is no justice.

It would require the IR to allow a company to pay no tax, so no, it won't happen here.

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It would require the IR to allow a company to pay no tax, so no, it won't happen here.

Well, that's the danger. Any UK based company who is able to set up headquarters within the US regulatory system will leave. Why stay when you can avoid taxes elsewhere?

Double whammy for the citizens of the UK.

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Of course not.

You are either in the club - in which case excuses will be made and laws bent and broken or you are not in the club, in which case rules will be made up and selective applied so that you are in effect livestock working to feed those in the club.

Having hordes of people wanting to get into the club is the main way the club stick around, I would imagine.

Don't worry - they are going to collapse. They can't have what they want because it isn't actually possible.

King Canute like they are staring at the debt and self interest of the majority and failing to move either with just words.

reminds me of this:

When you see that trading is done, not by consent, but by compulsion - when you see that in order to produce, you need to obtain permission from men who produce nothing - when you see that money is flowing to those who deal, not in goods, but in favors - when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you - when you see corruption being rewarded and honesty becoming a self-sacrifice - you may know that your society is doomed.

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