US to crack down on offshore tax loophole

The US government is to crack down on a controversial tax avoidance scheme believed to be worth hundreds of millions of dollars a year to US and foreign financial groups.

The move by the Internal Revenue Service, the US tax agency, could force big groups such as Wachovia, the fourth-biggest US bank, to forgo substantial tax savings and hit the investment banks and law firms that create these complex structures, including Barclays Capital of the UK.

The proposed rules, which could become effective this year, come as the IRS is under pressure from the US Congress to close loopholes and increase revenues to reduce the budget deficit and stave off tax rises.

The US tax authorities want to target "special purpose vehicles" set up by US financial institutions outside the country in partnership with local banks in order to reduce their tax bill.

These entities, which hold assets contributed by both the US and foreign partner, pay tax in the country where they are registered.

To avoid double taxation, the US companies get a US tax credit for the foreign tax payment. The foreign partners also get a tax credit in their home country - a benefit that encourages them to lend money to the US institution's SPV at below-average interest rates.

Under the proposals - to be debated in a public hearing in Washington on July 30th - US companies would no longer be able to claim a tax credit for such an "elaborately engineered structure", the IRS said.

Tax lawyers believe the rules would significantly reduce the attractiveness of these schemes, which are estimated to save US companies hundreds of millions of dollars in taxes a year.

- (Financial Times service)