Monday, April 11, 2016
Daniel Hemel (Chicago), The Vanguard Case Reconsidered, 150 Tax Notes 1466 (Mar. 21, 2016):
Recent news reports have suggested that the Vanguard Group family of mutual funds may need to quadruple investors’ fees to cover corporate income tax liabilities. Professor Reuven Avi-Yonah has estimated that Vanguard’s federal tax liability for the 2007-2014 period is roughly $34.6 billion. For the more than 20 million investors in Vanguard funds, the potential financial implications of the tax dispute are significant: Vanguard would presumably pass its tax costs along to customers, leading to higher expense ratios and lower returns. For observers of the IRS, the issue is an important one as well: A $34.6 billion recovery from Vanguard would be multiples more than what the IRS has ever recouped from a taxpayer in a transfer pricing case.
Yet as this article argues, fears that Vanguard fees might quadruple for tax-related reasons are wildly overblown. Moreover, even if one accepts Avi-Yonah’s major premise that Vanguard’s investment management company should pay corporate income tax on transactions with individual funds as if those transactions occurred at an arm’s-length price, Avi-Yonah’s estimate of Vanguard’s potential tax liability is implausibly high. And if the IRS did seek to recoup back taxes and penalties from Vanguard, the mutual fund family might be able to restructure itself to eliminate corporate income tax liability in future years.
None of this is to deny that the IRS may be able to recover a significant sum if it pursues a case against Vanguard and persuades a court to adopt Avi-Yonah’s major premise. Using the best available data, and assuming that an arm’s-length standard should apply, this article estimates that Vanguard’s past due taxes for the 2007-2014 period are in the range of $3.7 billion to $6.5 billion. The imposition of penalties potentially increases those figures by up to 40 percent, but even then, the consequences for Vanguard — and its investors — would not be catastrophic. This article explains the assumptions underlying Avi-Yonah’s calculation and recomputes Vanguard’s federal tax liability using what I argue is a more realistic set of assumptions. The article then evaluates Vanguard’s ability to reduce its tax liabilities in the future through a change in organizational structure. Finally, the article discusses some of the factors that the IRS should consider in deciding whether to seek recovery from Vanguard.
Prior TaxProf Blog coverage:
- Former Vanguard Tax Lawyer Files Whistleblower Suit Alleging Mutual Fund Giant Became Low-Cost Leader by Evading $1 Billion in Taxes (July 26, 2014)
- Experts Assess Whistleblower's Lawsuit Challenging Vanguard's Tax Structure (July 30, 2014)
- Who Is the Vanguard Tax Whistleblower? (Aug. 25, 2014)
- Vanguard Seeks to Dismiss Whistleblower Suit by its Former Tax Lawyer (Oct. 27, 2014)
- Tax Whistleblower Claims Vanguard Tried to Silence Him (Dec. 1, 2014)
- Vanguard Tax Whistleblower's First Day in Court (Feb. 21, 2015)
- IRS Review of Vanguard's Tax Structure at Heart of Whistleblower's $1 Billion Tax Claim (Feb. 23, 2015)
- Avi-Yonah: Vanguard Owes $35 Billion In Back Taxes (Sept. 24, 2015)
- Avi-Yonah: Too Big to Tax? Will The IRS Enforce The Arm's Length Standard Against Vanguard? (Oct. 6, 2015)
- NY Court: Ethics Rules Bar Whistleblower Suit By Former Vanguard Tax Lawyer Alleging Mutual Fund Giant Evaded $1 Billion in Taxes (Nov. 19, 2015)
- Johnston: Vanguard Investor Fees Could Quadruple If Tax Whistleblower Prevails (Dec. 4, 2015)
- CBS News: Vanguard Investors, Your Fund Fees Could Quadruple If Michigan Tax Prof Reuven Avi-Yonah Is Right (Dec. 22, 2015)
- Hemel: Taxes To Cause Vanguard Fund Fees To 'Quadruple'? Not So Fast. (Dec. 28, 2015)