Enhanced dividends

By Ryan J. Donmoyer

Dec. 8 (Bloomberg) -- The Internal Revenue Service has made a priority of cracking down on derivatives created by banks such as UBS AG and Citigroup Inc. that are designed to help offshore hedge funds avoid a 30 percent dividend tax.

IRS Commissioner Doug Shulman said the tax-collecting agency today designated the derivatives a “Tier 1” issue, requiring auditors to flag the transactions when they encounter them during examinations, examine how they are structured, and report them to the national office to be catalogued.

The agency was criticized in September by the Senate’s Permanent Subcommittee on Investigations for looking the other way while securities firms sold complicated financial products designed to skirt laws requiring them to withhold U.S. taxes on stock dividends paid to offshore investors.

The Senate panel’s report said Citigroup, Morgan Stanley, and Deutsche Bank AG also profited by creating and selling “dividend-enhancement” products with no legitimate investment purpose besides enabling investors to avoid taxes.

Morgan Stanley

Morgan Stanley’s dividend-enhancement products generated $25 million of revenue for the company in 2004 alone, and cost the U.S. government more than $300 million in unpaid taxes from 2000 through 2007, the report said.