AIG's Bonus Unit Now in IRS's Sights

Source: Wall Street Journal

AIG's Bonus Unit Now in IRS's Sights

By JESSE DRUCKER in New York and CARRICK MOLLENKAMP in London

Some of the same banks that got government-funded payouts to settle contracts with American International Group Inc. also turned to the insurer for help cutting their income taxes in the U.S. and Europe, according to court records and people familiar with the business.

The Internal Revenue Service is challenging some of the tax deals structured by AIG Financial Products Corp., the same unit of the New York company that has caused political ire over $165 million in employee bonuses.

The company paid $61 million last year in disputed taxes stemming from the deals but sued the U.S. government last month in federal court in New York, seeking a refund, according to filings in the case.

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In general, AIG's tax deals permitted U.S. companies and foreign banks to effectively claim credit in their home country for a single tax payment, partly through the use of an offshore AIG subsidiary. In its lawsuit against the government, the insurer said it was told by the IRS that AIG hadn't shown that the transactions "had sufficient economic substance and business purpose" to justify tax benefits. The IRS declined to comment.

The tax-structuring operation started by AIG in the 1990s was even bigger than AIG's credit-default-swaps business, according to a person familiar with the matter.

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Cross-border tax transactions are drawing increased scrutiny from U.S. and European tax officials, who are seeking to limit deals that help firms to play one nation's tax laws against another.......

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The foreign-tax-credit transactions took numerous forms. In one version, an offshore AIG subsidiary would borrow money from an overseas bank and also earn investment income overseas. The AIG unit would pay foreign taxes on that investment income and earn a foreign tax credit in the U.S., according to court records involving companies using these deals that have been challenged by the IRS and people who have worked on such deals.

Another AIG unit would then pay interest to the foreign bank, deducting those payments from its U.S. taxes. Meanwhile, the foreign bank was exempt from tax on that interest because overseas tax authorities treated the bank as simultaneously owning the AIG subsidiary. That effectively gave the foreign bank credit for taxes paid by the AIG subsidiary.

Because the foreign bank got a tax exemption overseas, it could charge lower interest costs on the cash loaned to AIG, according to people familiar with the transactions.

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A key force in the AIG tax unit was David Ackert, a former lawyer at Sullivan & Cromwell LLP and banker at Goldman Sachs Group Inc., say four people familiar with the business. While at Goldman, Mr. Ackert helped devise a tax shelter for drug giant Merck & Co. that was eventually part of a $2.3 billion IRS settlement in 2007. That was one of the largest publicly disclosed tax resolutions in U.S. history. Mr. Ackert and Goldman weren't accused of any wrongdoing.

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