Saturday, August 25, 2012

Bain Files: Tax Experts Find Shady, Possibly Illegal, Dealings In Documents Related To Romney's Bain Investments

Tax experts poring over leaked confidential documents from Boston-based Bain Capital in which Mitt Romney and his wife have invested millions of dollars have found the private equity firm used some head-shaking but perfectly legal tax-avoidance techniques as well as at least one that probably is outside the law. Bain manages $65 billion in assets.

Romney, who founded Bain in 1984 and remained with the firm until 1999 or 2001 or 2002, depending on whom you talk to, receives significant income from Bain as part of his retirement package. Some of the investments that are part of this package were created after he left the firm. His financial advisers have also invested additional money from his personal fortune, estimated at a quarter-billion dollars, in the Bain's highly complex instruments.

The 950 pages of documents were posted on line Thursday by the website They include audited financial statements, investor correspondence and other material that outsiders were not supposed to see. A Bain spokesman lamented their disclosure. The documents also contain some new details of Romney's investments. While some of Bain's investments are publicly known, others are not, and Romney has refused to discuss the underlying assets on his federally required public disclosure forms. Gawker did not say where or how it obtained the documents. It asked readers with expertise for help in decoding them.

One of those experts who stepped forward, according to the New York Times, is Victor Fleischer, a law professor at the University of Colorado. On his A Taxing Blog late Thursday, Fleischer wrote about the conversion of management fees into "carried interest" as a means of sharply reducing tax liabilities. That is something Romney did in at least one of the funds included in the documents, Bain Capital Fund VII. Romney has more than $1 million in Fund VII.

Private-equity firm managers get paid two ways, with fees and carried interest. The fees are what the firm charges companies it acquires for overhead, salaries and the like, usually two percent. These are taxed as regular income. When you make what these guys do, that's at the 35 percent rate. Carried interest, however, is taxed at the capital gains rate of 15 percent. So partners sometimes waive the fee, expecting to benefit from future profits. Fleischer:

There are many variations on the theme, but here’s how many deals worked: each year, before the annual management fee comes due, the fund manager waives the management fee in exchange for a priority allocation of future profits.  There is minimal economic risk involved; as long as the fund, at some point, has a profitable quarter, the managers get paid.  (If the managers don’t foresee any future profits, they won’t waive the fees, and they will take cash instead.)   In exchange for a minimal amount of economic risk, the tax benefit is enormous: the compensation is transformed from ordinary income (taxed at 35%) into capital gain (taxed at 15%).  Because the management fees for a large private equity fund can be ten or twenty million per year, the tax dodge can literally save millions in taxes every year. [...]

Unlike carried interest, which is unseemly but perfectly legal, Bain’s management fee conversions are not legal.  If challenged in court, Bain would lose. The Bain partners, in my opinion, misreported their income if they reported these converted fees as capital gain instead of ordinary income.

Bloomberg reported that "the documents also show how deeply embedded Bain has become in the offshore tax-haven world with funds organized in the Cayman Islands."

The entire purpose behind the offshore operations is to allow foreign investors to avoid paying taxes on profits produced by the companies Bain and other private-equity operations manage. During the 15 years Romney claims he was at Bain, the firm took $6.75 billion in return on $1.91 billion invested in some 150 companies, according to Thomson Reuters Corp.’s PeHUB.

A spokesman for the Romney campaign said the candidate and his wife have no control over where their assets are invested because they are held in a blind trust.

However, as Ryan Grim at the Huffington Post reported, if Bain "used improper tax-avoidance techniques, the Romneys would be required to amend their returns regardless of the blind nature of the investments."

That might include amendments because of another questionable technique:

[...] owning U.S. dividend-paying stocks in an offshore account and pretending, for accounting purposes, not to own the stock. Instead, the taxpayer tells the Internal Revenue Service that he owns a derivative product that is identical in every way to the stock—except it isn't the stock, so therefore no U.S. taxes are owed. It's called a "total return equity swap," because the buyer still gets the benefit—the "total return"—of owning the stock, or equity.

"This use of total return equity swaps, such as to avoid the U.S. dividend withholding tax, was very widespread for more than a decade, and may not be dead yet, although the IRS issued a shot-across-the-bow Notice concerning the practice in 2010," writes Daniel Shaviro, the Wayne Perry Professor of Taxation at New York University School of Law. "But taxpayers who engaged in it to avoid the dividend withholding tax were coming perilously close to committing tax fraud, in cases where the economic equivalence to direct ownership was too great."

As if there weren't enough reason to demand that Romney show us his tax returns, the Bain documents show the kinds of things that such disclosure might shed some light on. And these are, of course, just what one website has been able to get its hands on.

Originally posted to Meteor Blades on Fri Aug 24, 2012

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