The New York Times  [Printer-friendly version]
August 1, 2006

TAX CHEATS CALLED OUT OF CONTROL

By David Cay Johnston

So many superrich Americans evade taxes using offshore accounts that
law enforcement cannot control the growing misconduct, according to a
Senate report that provides the most detailed look ever at high-level
tax schemes.

Among the billionaires cited in the report are the owner of the New
York Jets football team, Robert Wood Johnson IV; the producer of the
"Mighty Morphin Power Rangers" children's show, Haim Saban; and two
Texas businessmen, Charles and Sam Wyly, who the Center for Public
Integrity found in 2000 were the ninth-largest contributors to
President Bush.

Mr. Johnson and Mr. Saban, who are portrayed as victims in the report,
are scheduled to testify today before the Senate Permanent
Investigations subcommittee. They are expected to say that
professional advisers assured them their deals to avoid taxes were
more likely lawful than not. The Wyly brothers told the committee that
they would invoke their Fifth Amendment right against self-
incrimination and thus were not called to testify. The report
characterizes them as active participants in tax schemes.

Cheating now equals about 7 cents out of each dollar paid by honest
taxpayers, as much as $70 billion a year, the report estimated.

"The universe of offshore tax cheating has become so large that no
one, not even the United States government, could go after all of
it," said Senator Carl Levin, the Michigan Democrat whose staff ran
the investigation.

Senator Norm Coleman, the Minnesota Republican who is chairman of the
subcommittee, adopted the minority report on Sunday as the product of
the full committee.

The report details how the Quellos Group, a tax shelter boutique based
in Seattle, "concocted a tax shelter" using $9.6 billion "worth of
fake securities transactions that were used to generate billions of
dollars of fake capital losses."

Senator Levin said that when investigators asked for trading records
they were first told the trades were private, over-the-counter
transactions. He said investigators asked for trading tickets or other
evidence of who owned the $9.6 billion worth of stock and were told
the stocks were never owned by the parties involved.

"They just wrote down numbers on paper and claimed losses," he said.
"It was just like fantasy baseball, except the taxes not paid were
for real."

Quellos, in a statement, said, "we fundamentally disagree with the
report, which presents a one-sided view." It said the transactions,
which the Senate committee describes as fabrications, were real and
involved "a significant possibility of economic gain and loss."

The investigation, which took 18 months, involved 74 subpoenas, 80
interviews and the collection of more than two million documents, and
yet Senator Levin said "the six cases we present are just examples,
just a pinhole look."

The 400-page report recommends eight changes, some of them aimed at
going after the law and accounting firms, banks and investment
advisers that the report says enable tax schemes that rely on
complexity, secrecy and compartmentalizing information so that
advisers can claim they had no idea that the overall transaction was a
fraud.

"We need to significantly strengthen the aiding and abetting statutes
to get at the lawyers and accountants and other advisers who enable
this cheating," Senator Levin said, adding that "we need major
changes in law to stop the use of tax havens" by tax cheats.

It also recommends new rules that strip away the underlying legal
presumptions that make offshore tax havens like the Cayman Islands,
Nevis, the Isle of Man and Panama attractive places for Americans to
hide assets and income from the Internal Revenue Service.

Senator Levin said the law "should assume that any transaction in a
tax haven is a sham."

He said that during the investigation he grew angry as he learned how
common cheating had become and how existing government rules aided tax
cheats. He said that complex schemes were broken into discrete pieces,
allowing professional advisers working on each piece to assert that
they had no idea that, taken as a whole, a scheme was improper.

"I get incensed by people who use tax havens to not pay their taxes
while the average guy has to pay his taxes because they are taken out
of his pay before he gets it," he said.

Both Mr. Johnson, the football team owner and scion of the Johnson &
Johnson health care fortune, and Mr. Saban, the television mogul, are
portrayed in the report as victims.

The two men, through representatives, said yesterday that they relied
on professional advisers who told them the transactions were lawful,
and that they were now settling with the Internal Revenue Service.

Mr. Johnson, known as Woody, told Senate investigators two weeks ago
that to buy the Jets in 1999 he had to sell assets, incurring the 20
percent tax on long-term capital gains in effect at the time. He said
that a way to defer the tax was proposed by Larry B. Scheinfeld, who
had been his accountant at KPMG until he joined Quellos, where he
worked closely with Chuck Wilk, a tax lawyer.

The technique involved a complex set of circular transactions using
what the Senate report characterized as sham corporations in the Isle
of Man with shell corporations given names like Jackstones. Their
ownership was kept secret.

"Ain't capitalism great!" Mr. Wilk wrote to Mr. Scheinfeld in an e-
mail message extolling the tax benefits of the Johnson deal. Three
weeks later, when the deal was set, Mr. Scheinfeld wrote back: "I
just hope Woody doesn't get cold feet or have the I.R.S. select his
return for an audit!"

The report details a scheme created for Mr. Saban to avoid more than
$300 million in taxes from sale of his half interest in the Family
Channel and related properties.

Mr. Saban told Senate investigators that he never understood the
transactions but undertook them after asking two questions of Mr. Wilk
and his personal tax lawyer, Matthew Krane.

Mr. Saban said he asked whether the deals were legal and whether a
major law firm would certify them as proper. The two lawyers, Mr.
Saban said, answered "yes to both," so he went ahead.

Later, when Mr. Saban learned that he had paid $54 million in fees to
Quellos; Cravath Swaine & Moore, a New York law firm; and others for
what turned out to be what the report described as fake transactions,
he said he felt "misled, lied to and cheated."

Lewis R. Steinberg, who as a Cravath Swaine partner helped design the
deal and wrote an opinion letter attesting that it was more likely
than not to work as a tax shelter, told Senate investigators last week
that he relied on assurances from Quellos and Mr. Johnson that real
transactions took place, not fake trades. Mr. Steinberg, who is now at
UBS Securities, another firm named in the report, is a prominent tax
lawyer and in 2004 was chairman of the tax section of the American Bar
Association.

The report also dissects deals by the Wyly brothers of Texas, showing
how they made at least $190 million through stock option exercises
offshore but had yet to pay taxes on most of the money. They then
borrowed against their offshore accounts to buy jewelry, pay for
portraits of family members, buy homes and operate properties named
Rosemary's Circle R Ranch, LL Ranch, Stargate Horse Farm, Cottonwood
Galleries and 36 Malibu Colony.

Senator Levin said he might propose limiting or barring the
transferring of executive stock options to others, as well as more
disclosure when they are exercised.

The report says that Credit Suisse First Boston, Lehman Brothers and
Bank of America "all knew that the offshore entities"for which they
made trades were associated with the Wylys, but ignored rules
requiring disclosure of these transactions and helped them hide the
true ownership of the assets. Only when Robert M. Morgenthau, the New
York District attorney, issued subpoenas in 2004 did Bank of America
close the Wyly accounts.

William Brewer, a Dallas lawyer for the Wylys, said that while the
Senate report "intends to present a balanced view, the committee
report is reflective of a number of misunderstandings."

"The Wylys believe they have paid all taxes due," he added. "And in
any event, as the report makes clear, the Wylys were counseled by an
armada of lawyers, brokers, financial professionals and offshore
service providers to ensure that they were at all times fully meeting
their obligations."