The US Internal Revenue Service has said it will continue to block "overly aggressive" US financial companies from using Ireland as an offshore tax loophole after two US corporations made a groundbreaking multi-million dollar settlement on a tax scheme involving unnamed Dublin companies.
The two corporations, the Diversified Financial Corporation, an affiliate of The Diversified Group Inc in New York and AVM L.P in Florida, agreed to pay at least $10 million in settlement after the IRS claimed they were engaged in illegal tax avoidance schemes through Dublin corporations.
The system had saved the companies tens of millions in dollars of US taxes. The IRS refused to name the Dublin companies involved, or to clarify their relationship with the companies who made the settlement.
Both of the US companies were brokering "residuals" in investment schemes known as real estate mortgage investment conduits (REMICs). They sold the residuals on to a Wyoming corporation, which turned out to be a front for two Dublin corporations.
However, under the United States tax code, foreigners are not allowed to buy such residuals.
Analysts say the settlement is one of the first ever to deal with residuals - which are "phantom incomes", or taxable income that only exists on paper. Later, a residual on one of these mortgage schemes becomes a loss and are sold on and the loss written off against tax.
The IRS only uncovered the full extent of the extremely complex system after it took the two corporations to tax court in May, 2003. IRS spokesperson, Mr John Lipold, said that the IRS has accepted a collective eight-figure sum from the two corporations but did not divulge the exact amount.
The companies have further agreed not to get involved in similar schemes in the future, pay a 20 per cent penalty, and agreed to allow the IRS to disclose limited details of the case to the media.
Mr John Bancroft, editor of Inside Mortgage Finance Publications, said the settlement was the first he had heard of in relation to REMIC schemes.
"Selling off negative residuals is a bit like selling off hazardous waste; you're actually paying someone to buy it and then writing if off against tax. It turns the market force upside down," he said.
"The IRS felt that this scheme was just too aggressive and was, in fact, over-stepping the law."
IRS chief counsel, Mr Don Korb, warned that the agency would not tolerate offshore tax schemes that did not comply with US law. "We have demonstrated, without litigation, that taxpayers must be prepared to pay the price for aggressively interpreting the law even if it is unrelated to a listed tax shelter transaction," he said.
