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In-house legal counsels gear up to fight New York state tax investigation

Posted by: Laurence Simons 10/09/12

There's nothing top earners and corporate behemoths alike enjoy more than paying tax, and that's a fact. That's a damn fact. So who knows what Eric Schneiderman is playing at this week?  

Schneiderman, the spellcheck-troubling Attorney General for New York, has just launched a full-scale investigation into the billing practices of a number of high-profile corporate firms, including Romney-founded Bain Capital, Kohlberg Kravis Roberts & Co., TPG Capital, Sun Capital Partners and Apollo Global Management, among around a dozen others. They all turned up to work this week with subpoenas on their desk and a looming sense of the "uh oh".

So what is the alleged practice for which they are being subpoenaed? The alleged practice is this: allegedly, some firms have been converting certain fees collected for account management services (taxed at 35 per cent) into fund investments (taxed at 15 per cent), meaning a lower tax rate is paid on a certain proportion of a client's bill. Allegedly. Is this practice illegal? Not according to reports. Is it morally okay? Well, now we are entering a grey area.

But illegal or not (or morally okay or not okay), Schneiderman is cracking down on the practice. Although the round of subpoenas issued this week might turn out to be no more than muscle-flexing, it does at least show that authorities have noticed this thing happening and are going after financial settlements if the dozen or so firms so far identified as leading the practising pack are found to be in breach of any law. But it's a big if.

"It would not seem to be what they call a high-yielding kind of inquiry," said New York accounting and tax expert Robert Willens, in comments to Reuters. In fact, it could be very low-yielding: the whole point of (alleged) disguised income is that it is disguised, allegedly, and although a leaked document online suggests Bain Capital - one of the major targets of the investigation - had accumulated at least $1 billion in fees that would have ordinarily been taxed at the 35 per cent rate, that's just a leaked document online. Of the rumoured $200 million of outstanding federal income tax and $20 million of Medicare tax, it's unclear how much might be recouped if the company is found guilty of any wrongdoing. Even the Internal Revenue Service (IRS) refused to rule on whether such waivering strategies were actually in defiance of tax law when pressed by the news agency.

But what is pretty clear is there should be a few late nights for those holding in-house legal counsel jobs for the accused firms. And any further companies issued by Schneiderman with a subpoena may be calling on their legal help.