While it's said that death and taxes are inevitable, enough money and clever maneuvering can apparently help sidestep the latter.
Witness the so-called dividend arbitrage, which is raising concerns from regulators thanks to its ability to allow big banks to create $1 billion per year in revenue, according to The Wall Street Journal. The banks are making money by helping hedge funds and big clients pare taxes through the complicated strategy, which is being compared to corporate tax inversions. In that scheme, a domestic company merges with a foreign company and moves its headquarters outside the U.S. to avoid taxes here.
How does dividend arbitrage work? Take a hedge fund that owns shares in a dividend-generating stock. When tax time comes around, bank clients can use the strategy to reduce their taxes on a dividend payment to 10 percent or lower. The tactic involves the bank briefly lending the shares to a third party in a country with lower tax rates when the dividend is about to be paid out. When the dust settles, everyone ends off richer, including the third-party middleman who earns a cut. Everyone except for the taxman.
More than $1.5 trillion worth of shares and bonds are on loan at any time for use in the strategy, according to the Economist.
But that's also raising concerns among U.S. regulators, with the Federal Reserve Bank of Richmond recently questioning Bank of America (BAC) on its use of the strategy, The Journal noted. The paper said the questions were related to the reputational and legal risks. The Bank of America and the Richmond Fed didn't immediately return calls seeking comment.
The focus on this strategy comes after the recent rising popularity of the tax inversion aroused the ire of government officials. Tax inversions prompted Treasury Secretary Jacob Lew to question the "economic patriotism" of the companies using the strategy.
Since 1983, 76 U.S. corporations have shifted their tax domiciles out of the country, leading the Joint Committee on Taxation to estimate the tactic will allow U.S. corporations to avoid paying almost $20 billion in taxes over the next 10 years.
With a backlash growing over tax inversions, the Obama administration is putting forward regulations that will make the strategy less lucrative. The new rules will require that the company's former owners own less than 80 percent of the new company.
As for dividend arbitrage, the strategy is mainly run from London, but it's actually not as big a business as it once was. That's because U.S. tax authorities have closed some loopholes, which have made it harder to use the tactic on U.S.-listed stocks.