Today’s catch is from Linda M. Beale at A Taxing Matter, and what she’s caught is John Paulson:
… the notorious hedge fund manager who got a CDO built to his desires with a bunch of iffy subprime mortgages and then took the short side of the bet, making a fortune off the bet against subprimes in the mortgage crashes underlying the 2007-8 Great Recession. What has Paulson done? He established a new “reinsurance company” in Bermuda in April, that turned around in June and put the money invested in it back into Paulson’s hedge funds in New York, as a portfolio of insurance “reserves” to be held to pay off insurance risks that go bad. The result is tax deferment for Paulson and other executives of his hedge fund along with recharacterization of ordinary compensation income as preferentially taxed capital gains.
My emphasis there. This is partly a great catch because it’s a sneaky trick I hadn’t heard of, but mostly for the long, wonkish and very well-supported description of the process and the implications which follows the punch. She cites James Baker:
The problem … is that insurers are exempt from registering as investment companies….These reinsurers do not have to make annual distribution of profits as mutual funds do and they are not taxed by the Internal Revenue Service as investment vehicles. …In short, the activity … is a method for wealthy investors to reduce their tax burden as a result of a tax loophole. Since these insurance companies are mixing insurance business with investment business, they need more supervision.
This is especially true when hedge funds are involved.
In case you’re in any doubt as to this being dubious practice:
The IRS has already noted that offshore arrangements using reinsurers for hedge fund managers may be shams that are subject to challenge on audit.
Hey, TEA-Party types? You ran your guy last year on a platform calling for the fixing of tax-loopholes. Ms. Beale has one for you right here!
There’s also a delightful sting in the tail of the article, drawing attention to one of the flaws in the moralistic arguments in favour of rank plutocracy that have been all the rage since about 1980:
By the way, if you think these hedge fund managers who are making multi-millions and billions from managing other people’s assets and hardly paying any U.S. taxes on those huge compensation payments are incredibly smart people who add to the economy’s well-being and therefore merit that kind of out-sized pay or because of the returns they bring to people that then invest them in needed projects in the good ole US of A, you need to rethink that. Hedge funds typically pay out very poor returns, when all the expenses and profits to managers are taken into account.
“Roughly speaking, if the typical fund manager worked for free, and if the investment firms didn’t charge, these masters of the universe would still have underperformed a balanced index since 2003, by roughly 2.5 per cent per year.” Andrew Hallam, Think you’re smarter than a hedge fund manager?, The Globe and Mail (Feb. 19, 2013) (emphasis added by ataxingmatter).