The Senate's Subcommittee on Investigations held a hearing on how foreign investors dodge taxes on U.S. stock dividends with the help of U.S. banks and investment houses.

"The focus today is not on U.S. citizens, but on non-U.S. persons who are supposed to be paying taxes on the dividends they receive from U.S. corporations, but don't," said committee chair Carl Levin (pictured), D-Mich. "They don't pay those taxes, because major financial institutions like Lehman Brothers, Morgan Stanley, Deutsche Bank, UBS, Merrill Lynch, Citigroup and others have created financial gimmicks whose primary purpose is to enable clients to dodge U.S. taxes owed on U.S. stock dividends, but which are dressed up with phrases like 'dividend enhancement,' 'yield enhancement' and even 'dividend uplift.' Using stock swaps, stock loans and exotic financial instruments, the financial institutions have built a series of financial black boxes, surrounded by mind-numbing complexity, designed to keep their clients' money tax-free."

The committee issued a report on the problem that found many financial institutions treated nonpayment of dividend taxes as a tax risk and set a "risk limit" on the aggregate amount of tax withholding avoidance that could be incurred by the institution. Some financial institutions agreed to indemnify clients against any tax liability arising out of a stock loan transaction that the institution claimed had eliminated the need to withhold dividend taxes.

"U.S. financial institutions offered abusive dividend tax transactions to their offshore hedge fund clients, not only to attract and retain their business, but also to profit from the fees," said the report. "In one instance, for example, a Lehman Brothers employee hailed the 2004 announcement of a special dividend to be paid on Microsoft stock and declared, 'the cash register is opening!!!!' A senior Lehman official responded: 'Outstanding. ... Let's drain every last penny out of this [market] opportunity.'"

A Lehman executive defended the financially troubled investment house in his prepared testimony. "Lehman has worked diligently to follow the letter and spirit of the law governing both equity swaps and stock loan agreements," said global tax director John DeRosa.

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