Deutsche Bank and Barclays helped 13 hedge funds to avoid paying billions of taxes during a 15 year period, says a US Senate’s subcommittee investigation.
Deutsche Bank and Barclays sold basket options of a total $100 billion volume to the 13 hedge funds from 1998 to 2013. Hedge funds recorded those as long-term capital gains although they were in 97% of the cases held for periods shorter than half a year. On those long-term capital gains a tax rate of 15-20% is applicable instead of 39% on short-term gains.
Moreover, the basket options were held in the bank’s accounts. This was done to evade leverage limit regulations. By placing the options in the bank’s accounts but letting the hedge funds execute the trades, control the assets and receive the profit, banks were lending up $20 per dollar of equity. According to regulations banks cannot lend more than two dollars per dollar of equity to funds.
The fund Renaissance Technologies was profiting most from this system. It made about $34 billion in profits with the basket options and avoided about $6.8 billion of taxes.
Banks did profit as well by receiving fees for the executing trades. While Deutsche Bank stopped selling new basket options and only administers the remaining ones, Barclays continues with selling them.
According to the banks and hedge funds, the usage of basket options is “fully compliant with applicable law, regulations and guidance”. Still, the Senate’s subcommittee advices the Internal Revenue Service (IRS, US tax authority) to collect the due taxes and improve regulations in a way that make this way of tax evasion unlawful.