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February 24, 2006

Many tax shelter transactions in the 1990s depended on a certain suspension of disbelief. Taxpayers would weave an elaborate web of deals and entities to, say, move income offshore or generate artificial losses, and then try to say with a straight face that this stuff happens all the time, and they just needed an offshore partner in the Netherlands and the Caymans to borrow money just the right way. The paper trail was carefully marked with a pretend business purpose for the real transactions. With all of the transactions actually taking place, there was at least something to argue about.

But what if the real transactions with a pretend non-tax purpose were themselves imaginary? That's the intriguing implication of a story in this morning's New York Times. The story says Deutsche Bank, which played a prominent role in the shelters that are the subject of the KPMG indictments, is negotiating a settlement of criminal charges related to the Justice Department:

For Deutsche Bank, the path toward a settlement may be rockier, in part because it had a much larger role in the creation of some questionable tax shelters and the transactions underpinning them, investigators have said. A potentially larger obstacle, say the people briefed on the case, is that Deutsche Bank appears unable to account for a number of those transactions.

In the past, Deutsche Bank has described the transactions it arranged for tax shelters, including ones known as blips and cobra, as regular and ordinary.

But Deutsche Bank has been unable to provide to federal prosecutors in Manhattan paper documents detailing some transactions for these shelters, according to the people briefed on the case.

If the transactions never actually took place, that would make it hard to say that people are just being prosecuted for savvy tax planning.

Previously undisclosed internal documents that were provided by a lawyer involved in civil litigation against the bank raise questions about some Deutsche Bank transactions.

An October 2001 e-mail message written by Andrew Baxter, a trader on Deutsche Bank's derivatives desk, to a Jenkens & Gilchrist lawyer suggests that the bank did not extend actual loans to an investor in a cobra tax shelter. For the shelter, the investor had "borrowed" $20 million from the bank and "bought" options worth $20.125 million. Mr. Baxter, whose e-mail message was titled "cash flows," wrote, "Do you want the monies to actually flow into the account or is it sufficient for the client to net pay" the $125,000. "It makes a big difference to our back office."

Wow. If that stuff is true (and these are assertions from people suing KPMG, so they aren't impartial), then the tax shelter industry doesn't even live up to my already low opinion of it.

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