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Senators question offshore tax advantages

Copyright:The Deal, LLC. All rights reserved.

The Senate's top tax writer complained Wednesday, Sept. 26, that income deferrals enjoyed by managers of offshore hedge funds are too generous.

"It's a matter of fairness," U.S. Senate Finance Committee Chairman Max Baucus said during a hearing examining hedge funds and insurance companies operating in the Cayman Islands and other offshore locales. "Tax deferred, in a certain sense, is tax not paid."

The Montana Democrat took issue with the way U.S. managers running offshore hedge funds can defer all of their income for an indefinite period, while everyday wage earners don't have that option. "Deferring income means that you pay taxes later, which is the same as a significant tax savings," he said.

Baucus stopped short of threatening new legislation, however.

Managers of offshore hedge funds in places like the Cayman Islands and Bahamas must stipulate in advance what percentage of their income they want to defer in the upcoming year. According to Daniel Shapiro, partner at Schulte Roth & Zabel LLP in London, these managers never defer their income indefinitely. Instead, they defer a certain portion for up to 10 years, Shapiro testified at the hearing. "They say in advance of their payment that 'I'd like to receive only 50% of what I'm entitled to at the end of year, and I'd like to defer [the rest] for five years,'" Shapiro said.

Ending these deferrals, Shapiro warned, would help drive hedge funds to other countries. "If the U.S. wants to preserve this very robust and important industry, it should be careful about changing the rules of the game so drastically," Shapiro said. "U.S. managers are already putting people in other jurisdictions such as London, Switzerland, Monaco, Hong Kong, Singapore, because of tax issues, time zones and other attractive features."

Sen. Byron Dorgan, D-ND., testified on behalf of his bill, S.396, which focuses on profits corporations shelter in low-tax jurisdictions in the Cayman Islands and other offshore jurisdictions. Dorgan's bill would eliminate deferrals for subsidiaries of U.S. companies located in certain jurisdictions if they cannot demonstrate that they have real operations in those locations. "They have to have a real active business in that area to avoid U.S. taxation," Dorgan said. "We have a war but there is a thriving industry finding ways to help corporations avoid paying taxes."

Shifting gears a bit, some lawmakers at Wednesday's hearing argued that university endowments that have benefited from hedge fund and private equity allocations were not putting a sufficient amount of resulting profits toward student aid, professor retention or tuition reductions. Instead they have simply been reinvesting it into their funds. "Our colleges and universities have enjoyed extraordinary returns on their investments, but they appear to be operating less like public charities," said Sen. Jim Bunning, R-Ky. "The aggregate size of universities' endowments has grown to $340 billion at the same time endowment spending on education has declined to an all time low, while tuitions have skyrocketed."

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Jane Gravelle, a specialist in economic policy at the Congressional Research Service, said increased allocations to student aid and tuition savings should not be a threat to endowment performance. She pointed out that endowment disbursements to universities could be tied to the funds' returns.


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