Banks trade barbs with U.S. Senate panel in tax avoidance probe

By Douwe Miedema

WASHINGTON (Reuters) - Deutsche Bank and Barclays on Tuesday locked horns with a U.S. Senate committee that has accused them of selling option products to hedge funds to help them avoid taxes.

Renaissance Technologies, a hedge fund, defended the so-called basket options it used, saying at a hearing of the Senate Permanent Subcommittee for Investigations that they served legitimate business purposes.

The hearing follows the publication of a study this week by Senator Carl Levin, the Michigan Democrat who heads the panel, which said the two banks helped Renaissance and other hedge funds to avoid billions of dollars in taxes.

"Renaissance ... purchased (basket) options ... for substantial non-tax business reasons," Renaissance Capital Chief Financial Officer Mark Silber said. "We would have purchased these options regardless of their tax treatment."

The two banks enabled at least 13 hedge funds to conduct $100 billion in securities trades, Levin's report found. Deutsche sold the products to 13 hedge funds, while Barclays had only Renaissance as a client.

In the case of Renaissance alone, the fund paid an estimated $6.8 billion less in taxes than it should have done, the report said, by booking short-term trading profits as long-term capital gains, which are taxed at a lower rate.

Presiding over the near five-hour meeting with minimal assistance from fellow panel members John McCain and Ron Johnson, both Republicans, Levin dwelled on who controlled the option accounts: the bank or the hedge funds.

Levin in one instance accused Gerard LaRocca, a senior Barclays executive, of "waffling" when answering a question.

Other witnesses on occasion also struggled.

"In this circumstance, I think you're correct," said Silber, the Renaissance executive, when asked by Levin to confirm that a vehicle Renaissance controlled, and which had no employees, could never have disagreed with any Renaissance investment decisions.

A 2002 contract between Deutsche and one of the Renaissance subsidiaries, signed by Silber, did state that this was the case and the lack of independence is a crucial element in Levin's attack on the option products.

The U.S. tax authority, the Internal Revenue Service, said in 2010 that basket options do not function like an option and should not be treated as such. The opinion has no status as a rule and the IRS has not pressed any cases.

Renaissance has been debating the issue with the IRS for six years, and the procedure is still going on. The two banks have stopped offering the products, the panel said.

Basket options are based on a basket of equities in an account that are nominally held by the bank, but in fact controlled by the hedge funds, which bought and sold the assets, and profited from the trading, the report said.

The hedge fund then paid the lower tax rate on long-term capital gains, arguing that profits came from exercising the option, rather than from the underlying trades. But Levin's report said the options were fictional.

(Reporting by Douwe Miedema; Editing by Grant McCool)