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The false economy

Barclays and KPMG involved in $660m tax ‘sham structure’

Gloomy times for BB&T bank, as it misses out on $660m in tax credits. zen Sutherland

What are the chances that in the face of public criticisms, big business would curb its tax avoidance practices? Well, not much, as evidenced by a case decided by the US Court of Federal Claims.

Salem Financial Inc v United States relates to a complex financial transactions known as STARS (Structured Trust Advantaged Repackaged Securities). The case involved Salem Inc, a subsidiary of North Carolina based bank, BB&T.

The scheme was designed by Barclays Bank, a major UK financial institution; KPMG, one of the world’s biggest accountancy firms; and Sidley Austin, a US law firm. At the centre of the dispute is a tax liability of some US$660m.

Through collaboration with Barclays, KPMG specialised in developing transactions that took advantage of differences between international tax systems. Barclays marketed some versions of STARS to a number of corporations, including AIG, Microsoft, Intel, and Prudential. KPMG introduced the STARS transaction to BB&T at a January 17, 2002 meeting and used a slide show to outline the steps necessary for the scheme to work. KPMG had little prior business relationship with BB&T.

Contrived transactions

The key idea of the tax avoidance scheme was to generate large-scale foreign tax credits which could in turn be used to enhance revenue and reduce taxes payable by BB&T in the US. A series of transactions with circular cash flows were designed to create the tax savings.

The court noted that in essence the scheme called for BB&T to establish a trust containing approximately US$6 billion in revenue-producing bank assets. The monthly revenue from the trust was then cycled through a UK trustee, an act that served as a basis for UK taxation. Although the revenue was immediately returned to BB&T’s trust, the assessment of UK taxes generated tax credits that were shared 50/50 between Barclays and BB&T.

A US$1.5 billion loan from Barclays to BB&T was also part of the structured transaction, although the loan was not necessary to the objective of generating foreign tax credits. The Barclays monthly payment to BB&T represented BB&T’s share of the tax credits, and had the effect of reducing the interest cost of BB&T’s loan.

The main question for the 21-day court hearing was whether the STARS transaction had any purpose other than to generate tax savings, and if not, whether penalties should be assessed against BB&T. The 67-page court judgment found in favour of the government and the company has been ordered to pay US$680 million plus penalties of US$112 million.

After examining some 1,250 exhibits the judge referred to the scheme as “an abusive tax avoidance scheme” and said that the “conduct of those persons from BB&T, Barclays, KPMG, and the Sidley Austin law firm who were involved in this and other transactions was nothing short of reprehensible”.

The judge went on: “The professionals involved should have known better than to follow the STARS path, rife with its conflicts of interest, questionable pro forma legal and accounting opinions, and a taxpayer with a seemingly insatiable appetite for tax avoidance”. The whole STARS set-up was described as “a sham structure”.

Controversial pasts

Barclays and KPMG are no strangers to tax avoidance controversies. After lengthy investigations by the US Senate Permanent Subcommittee on Investigations and action by the US Department of Justice, KPMG were fined US$456 million for “criminal wrongdoing” in tax matters and a number of its former personnel were also given prison sentences. The firm has also been the subject of investigation of the UK House of Commons Public Accounts Committee, but this has not dulled its appetite for profits through the sale of tax avoidance schemes.

Barclays relies upon taxpayer guarantees for its core business, but operates a very lucrative tax avoidance business which is estimated to have generated around a billion pounds in fees each year between 2007 and 2010. Last year the UK government had to introduce emergency legislation to negate two avoidance schemes used by Barclays for its own business which could have deprived the UK Treasury of around £500 million. Despite fines and prison sentences major businesses remain addicted to tax avoidance. Public opprobrium has become just another cost of doing business.

It is time to shut down businesses who routinely pick citizens’ pockets through tax avoidance. Their schemes are undermining revenues that are much needed to revive the economy and provide education, healthcare, pensions, security and other public goods that distinguish civilised societies from the rest.

Yet the UK government continues to shower gifts on tax avoiders, KPMG continues to receive public contracts and Barclays is propped up by taxpayer-funded guarantees and loans. Only this week Ed Miliband hired KPMG’s deputy chairman for advice on low pay. Rather than giving them another consultancy job, politicians should be asking KPMG to explain the firm’s role in the erosion of social fabric.

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