Fall of the House of Ugland

There was an iciness, a sinking, a sickening of the heart—an unredeemed dreariness of thought which no goading of the imagination could torture into aught of the sublime. What was it—I paused to think—what was it that so unnerved me in the contemplation of the House of Usher? -The Fall of the House of Usher by Edgar Allan Poe

The following story will explore how the Cayman Islands, home to 52,000 people, also houses nearly one foreign corporation per citizen.  It is also home to virtually all of the world’s hedge funds. The Caymans is being used by corporations to avoid U.S. taxes and hedge funds to illegally manipulate global markets. It goes without saying that the average citizen is not benefiting from this. In fact, now is a very critical time in history to expose this fraud. Let’s see why we should be unnerved while contemplating the House of Ugland.

Welcome to the Island of Zero

The house pictured above is home to international law firm Maples and Calder:

PO Box 309, Ugland House
South Church Street, George Town
Grand Cayman KY1-1104
Cayman Islands

This is a house used by 12 of the 30 companies listed in the Dow Jones Industrial Average to avoid U.S. taxes. President Obama referred to Ugland House a few weeks ago:

On the campaign, I used to talk about the outrage of a building in the Cayman Islands that had over 12,000 businesses claim this building as their headquarters. And I’ve said before, either this is the largest building in the world or the largest tax scam. And I think the American people know which it is: The kind of tax scam that we need to end.

Basically everyone has known about this corporate game for decades. Now that the U.S. is strapped for cash this method of tax evasion is coming to the surface. The federal corporate tax rate is 35%. The effective tax rate of U.S. companies that shelter in the Caymans is one to five percent. In 2001, almost half of the money U.S. companies earned outside the U.S.—47 percent—was accounted for in offshore tax havens such as the Cayman Islands, which has no corporate income tax. What’s really unnerving is many corporations don’t pay any federal tax at all.

During last summer’s market mayhem this report didn’t get the traction it deserves. From Reuters:

The Government Accountability Office said 72 percent of all foreign corporations and about 57 percent of U.S. companies doing business in the United States paid no federal income taxes for at least one year between 1998 and 2005.

More than half of foreign companies and about 42 percent of U.S. companies paid no U.S. income taxes for two or more years in that period.

During that time corporate sales in the United States totaled $2.5 trillion, according to Democratic Sens. Carl Levin of Michigan and Byron Dorgan of North Dakota, who requested the GAO study.

Four companies alone have accumulated a combined total of more than $75 billion in earnings untaxed by the U.S.: Hewlett-Packard Co., Merck & Co., Pfizer Inc. and Coca-Cola,

Here is the intro to the report the Government Accountability Office, Congress’s investigative arm, wrote to Senators Levin and Dorgan:

July 24, 2008
The Honorable Carl Levin
Chairman Permanent Subcommittee on Investigations
Committee on Homeland Security and Governmental Affairs
United States Senate
The Honorable Byron Dorgan
United States Senate

In response to your long-standing concerns about whether foreign-controlled U.S. corporations are abusing transfer prices and avoiding U.S. income tax, we compared the tax liabilities of foreign- and U.S.-controlled companies incorporated in the U.S. in three prior reports. We reported that from 1989 through 2000 foreign-controlled corporations were more likely to report zero U.S. income tax liability than U.S.-controlled corporations with a majority of both types of corporations reporting no liability.

Bloomberg recently ran a story about this featuring Seagate Technology, the world’s largest maker of hard disk drives, headquartered in Scotts Valley, California. Yet the documents it files with the SEC list its address on South Church Street in George Town, the capital of the Cayman Islands.

While the U.S. corporate tax rate is 35 percent, Seagate paid an effective tax rate of 5 percent in the year ended June 2008, according to data compiled by Bloomberg.

The Caymans have no corporate income tax for companies incorporated there. The Caribbean island has helped scores of U.S. companies, including Coca-Cola Co. and Oracle Corp., to legally avoid billions in tax payments to the U.S. government, says U.S. Senator Byron Dorgan.

Maples and Calder, owners of Ugland House, incorporated more than 6,000 new companies over the past five years. Back in 2004, the building served as home to 12,748 companies using the same address. This five-story office building on South Church Street is now the official address for 18,857 corporations. About half those Cayman companies had billing addresses in the U.S., according to a 2008 GAO study.

Intel Defense

Intel’s former vice president of tax, licensing and customs, Robert Perlman told the U.S. Senate Finance Committee in March 1999 that Intel would have been better off incorporating in the Cayman Islands when it was founded in 1968.

“Our tax code competitively disadvantages multinationals simply because the parent is a U.S. corporation,” Perlman testified.

He has a point. The U.S. is criticized for having one of the highest corporate tax rates in the world. This can place U.S. companies at a major disadvantage while operating in the same space as highly subsidized foreign competitors.

Then again, many of these companies avoiding taxes were being subsidized by the U.S. government at the same time. Twenty-four of the 100 largest contractors with the U.S. federal government—including Altria Group Inc., Oracle Corp. and Procter & Gamble Co.—have subsidiaries in the Caymans, according to a March 2001 report by the GAO. Those 24 companies received a total of $35 billion from the U.S. government. “They are shortchanging our country even as they profit from it,” says Senator Dorgan.

The Caymans provide near-total financial secrecy for companies, banks and accounts. There are more than 500 banks and trust companies with deposits of more than $1 trillion in the Cayman Islands, according to the Cayman Monetary Authority. That’s more deposits than there are in New York City, and the Cayman Islands are about one-third the size of NYC.

“When $250 billion of the $880 billion in foreign bank deposits within U.S. banks is attributed to the Cayman Islands, to connect the dots you’ve got to ask questions about the extent of tax dodging in that country and other tax havens,” Levin says.

One of the many problems with this behavior is the role of corporations in the U.S. capitalist system. They were designed to replace the need for socialized government welfare programs. The trend of corporations paying fewer and fewer taxes, while offering fewer benefits to their employees, with stagnant wages, is contributing to a breakdown of the free market. Nations are running out of money, corporations are bailing or failing, and real wages have not improved for thirty years. This is a good example of how citizens are being victimized by the system. It is not just the U.S. who is missing tax revenue from this scam.  Instead of enforcing the law and cracking down the political dictate is to spend more. This is a Mafia style business solution.

How Corporations Game Taxes

A practice called transfer pricing may be the key to how U.S. corporations avoid taxes in the U.S. and other countries, Dorgan says. The accounting practice lets companies buy and sell products and services with their own offshore subsidiaries and set prices themselves. Companies abuse transfer pricing by shifting profits overseas to avoid U.S. taxes, Dorgan says. They set artificially high prices for imports and artificially low prices on exports, he says.

In a March report on financial crime and international law enforcement, the U.S. State Department cited examples of transfer pricing abuses, without naming companies. It said one company claimed to import dish towels from Pakistan for $153.72 each; another reported it had imported briefs and panties from Hungary for $739.25 a dozen; a third claimed it had paid $4,896 a unit for metal tweezers imported from Japan. The report also cited a company claiming to export toilet bowls to Hong Kong for $1.75 each. The State Department report called those prices absurd and ridiculous.

The fabricated high prices of imports let companies report artificially high expenses in IRS tax filings. The exaggerated low prices of exports allow companies to report smaller profits to the IRS. “Criminal individuals, corporations and other enterprises engage in abnormal international trade
pricing that transfers value and/or reduces U.S. tax liability,” the State Department report said.

Transfer pricing abuses by corporations cost the U.S. Treasury $53 billion
a year, according to Professor John Zdanowicz of Florida International
University in Miami. He says tracking a product used in transfer pricing
transactions between U.S. companies and their subsidiaries in the Caymans
and elsewhere is difficult. “Where it really comes from and where it’s really going, nobody knows, because of the secrecy,” he says. The $53 billion in lost U.S. taxes results from more than $150 billion of profit from improper transfer pricing, Zdanowicz says. “It’s a $150 billion shell game,” he says. (Bloomberg)

How to Make Money with Terrorists

The laws to prevent abuse are there, but enforcement is virtually non-existent. It’s particularly difficult when they are obstructed by the highest office. In 2004 David Evans wrote a phenomenal piece for Bloomberg called The $150 Billion Shell Game. Here is an excerpt from the most alarming section:

On April 13, 2003, President George W. Bush accused Syria of having weapons of mass destruction. “We believe there are chemical weapons in Syria,” he said on the South Lawn of the White House. Secretary of Defense Donald Rumsfeld, appearing on CBS’s Face the Nation the same day, said busloads of Syrians were sent to Iraq to kill Americans. “Reasonable people don’t want to be associated with a state that’s on a terrorist list,” Rumsfeld said. “Who in the world would want to invest in Syria?”

Six weeks later, on May 31, Devon Energy Corp., an Oklahoma City–based oil and gas producer, entered a partnership with the Syrian government to spend $17 million to search for oil in Syria according to company filings with the U.S. Securities and Exchange Commission. Theodore Kattouf, then U.S. ambassador to Syria, attended the contract signing in Damascus. Devon channeled the business through a Cayman Islands subsidiary.

Devon’s work in Syria didn’t mark the first time a U.S. company won a contract through a Cayman subsidiary in what the U.S. called a terrorist state. A Halliburton Co. subsidiary sold $33.6 million in products and services to Iran in 2001, according to filings with the SEC. Vice President Dick Cheney was chief executive officer of Houston-based Halliburton, an energy services and engineering company, from 1995 to 2000.

Iran is blacklisted by the U.S. as a terrorist state, which means U.S. companies are forbidden from accepting contracts from Iran. The Halliburton unit that won the contract in Iran was incorporated in the Cayman Islands and therefore wasn’t subject to U.S. law, Halliburton says.

In February, the U.S. Senate Finance Committee, chaired by Republican Charles Grassley, sent a letter to the Treasury Department asking if Halliburton was being investigated for violating U.S. sanctions. The committee also wrote letters to ConocoPhillips and General Electric Co. asking about their revenue from terrorist states, including Iran and Syria.

Halliburton is the 30th largest military contractor, with fiscal 2001 federal contracts of $534.2 million, according to a March study by the General Accounting Office, the auditing arm of Congress. Halliburton has 13 subsidiaries in the Caymans, two in Liechtenstein and two in Panama.

General Electric, the world’s largest company by market value, has sold locomotives in Syria; in Iran, it sold medical equipment, provided oil and gas services and contracted to build hydroelectric generators, according to the Senate Finance Committee. ConocoPhillips, the largest U.S. oil refiner, runs a gas processing plant in Syria, the committee said. “We comply strictly with U.S. law in sales to Iran,” says GE spokesman Gary Sheffer. “If Congress decides to change the law, we’ll comply.”

“All of Halliburton’s business is clearly permissible under applicable U.S. laws and regulations,” says Wendy Hall, a Halliburton spokeswoman. “If Congress decides to change the laws and provisions, Halliburton will, of course, comply.”

Quick Hedge Fund Facts

So that’s the tip of the iceberg for international corporations legally abusing U.S. tax law. There have been famous cases of illegal abuse such as Enron. Back in December 2001, Enron Corp., the Houston based energy company that went bankrupt, used 441 Cayman affiliates to help hide $2.9 billion in losses.

To delve into what hedge funds do is another giant stinking pit of abuse and secrecy. Out of the total of 9,800 hedge funds operating at the end of the third quarter 2006 worldwide, 8,282 were registered in the Cayman Islands.

In 1993, the decision was made to turn this tourist destination into a major financial power, through the adoption of a Mutual Funds Law. This enabled easy incorporation and/or registration of hedge funds in a deregulated system. From the day of application, it takes two to five days for a hedge fund to be approved and costs $3,600 in total fees.

The number of hedge funds operating in the Cayman Islands exploded from 1,685 hedge funds in 1997 to 8,282 at the end of the third quarter 2006, a fivefold increase. Cayman Island hedge funds are four-fifths of the world total. Globally, hedge funds hold $1.44 trillion in assets under management, but through using leverage of anywhere from 5 to 20 times, they command up to $30 trillion of deployable funds. This equals the size of the NYSE.

CEO to Worker Pay

The point of all of this is to become aware of what is really going on when it comes time to raise taxes on the public.  This is going to happen.  It has to happen, because the U.S. is running out of money.  However, the money is out there.  It’s just not being legally distributed as it should be.  Instead the burden will be unjustly placed on you and me.  As long as the House of Ugland stands, our standard of living will fall.

The last concept related to all of this is the trend in CEO compensation. This is a visual demonstration of how we are being cheated by a corrupt system which is protecting itself to our severe disadvantage. The market collapse is doing nothing to change the gross inequality of the system. What the media typically avoids discussing is the effect inflation has on real wages. Basically, prior to the market crash it was impossible for most people to get ahead and beat inflation. If the market enters a long period of inflation along with higher taxes–forget it.

In 2005, the average CEO in the United States earned 262 times the pay of the average worker, who earned just $5.15 per hour.  This is the second-highest level of this ratio in the 40 years of recorded data. In 2005, a typical CEO earned more in one workday (there are 260 in a year) than an average worker earned in 52 weeks.

This extreme compensation ratio reflects both the extraordinary growth of CEO pay and also the diminishing value of the federal minimum wage that has not been raised since 1997. Adjusting for inflation, the purchasing power of the minimum wage is now at its lowest since 1955. When you hear rhetoric spew about why you have to pay your fair share, remember what you’ve learned here today.  This burden can only be carried for so long.

While I gazed, this fissure rapidly widened—there came a fierce breath of the whirlwind—the entire orb of the satellite burst at once upon my sight—my brain reeled as I saw the mighty walls rushing asunder—there was a long tumultuous shouting sound like the voice of a thousand waters—and the deep and dank tarn at my feet closed sullenly and silently over the fragments of the “House of Usher.” -Edgar Allan Poe

Sources:
London’s Cayman Islands: The Empire of the Hedge Funds
by Richard Freeman
March 11, 2007
Comparison of the Reported Tax Liabilities of Foreign- and U.S.-Controlled Corporations
1998-2005
July 2008
Study says most corporations pay no U.S. income taxes
by Donna Smith
Reuters Aug 12, 2008
Coca-Cola, Oracle, Intel Use Cayman Islands to Avoid U.S. Taxes
By David Evans
Bloomberg May 5, 2009
The $150 Billion Shell Game
By David Evans
Bloomberg Aug 2004
CEO pay: Sky high gets even higher
August 30, 2005
CEO-to-worker pay imbalance grows
CEO-Minimum Wage Ratio Soars
by  Lawrence Mishel