The IRS is telling its field agents to be on the lookout for cases where banks are using equity swap transactions as a way for their offshore clients to avoid taxes.
In a directive issued Jan. 14, IRS deputy commissioner Lori Nichols noted that so-called total return swaps, or TRS, transactions may have been executed in order to avoid tax with respect to U.S. source dividend income paid to non-resident alien individuals, foreign partnerships, and foreign corporations.
The IRS is particularly concerned that offshore hedge funds and foreign investors may be using the equity swaps as a way to disguise their ownership of shares and thereby avoid paying withholding taxes on stock dividends, according to The New York Times and Reuters. The banks are also able to avoid paying taxes on stock trades when the derivatives are sold.
The SEC has also been making an effort to regulate the transactions, and Congress may give it that authority if it ever manages to pass a financial regulatory reform bill with actual teeth in it. In the meantime, the IRS field agents will be on the prowl for the transactions.
That effort could net them a substantial chunk of tax revenue, as the market for equity-linked swaps and forwards is estimated to be around $1.7 trillion.