Burning the midnight oil on tax deals.

Deutsche Bank Had a Lot of Ways to Avoid Paying Taxes

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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If you buy some stock for not very much money, and you hold on to it for a long time, and it ends up being worth a lot of money, then you have a problem. I mean, no, you don't really: You have made a lot of money! That's good. But you also have to pay taxes. That's ... bad? It is always better to make more money than less money, but I guess making money and not paying taxes on it is even better.

One service that Deutsche Bank offered in 1999 and 2000 was that, for a fee, it would make the taxes go away. I mean, that's what the U.S. Attorney for the Southern District of New York says, and I'm inclined to believe him:

In the fall of 1999, Deutsche Bank was looking to profit from deals in which it would deliberately incur income that it could shelter from taxation.

One vice president in Deutsche Bank's Structured Transactions Group found just such a deal for Deutsche Bank: Deutsche Bank would acquire a holding company that held appreciated stock and find a way to obtain the benefit of the stock without paying the large built-in tax.

The holding company was called Charter Corporation, which was owned by Bruce and Richard Gelb, and which in turn owned about 3 million shares of Bristol-Myers Squibb stock, as well as some other stuff. The Bristol-Myers shares were worth about $170 million, and Charter's basis in them was roughly nothing, so it had about $170 million in gains and something like $50 million in tax liability.

So some simple arithmetic would tell you that Charter was worth about $120 million: The $170 million value of the Bristol-Myers shares, minus the $50 million tax bill that was due immediately upon selling those shares. But! If Deutsche Bank could find a way not to pay the taxes, then Charter would be worth $170 million to it. So, and here I am stylizing quite a bit, it could pay $150 million for Charter, which is $30 million more than it was "worth" to a full taxpayer, but $20 million less than it was worth to Deutsche Bank. So it did.

Now the taxes were Deutsche Bank's problem, but that was no problem, because Deutsche Bank had a plan to avoid them. Er. Sort of.

Deutsche Bank initially expected that it would be able to acquire Charter but avoid paying the taxes on the built-in gain of the BMY shares because Deutsche Bank expected to have sufficient losses from other parts of its business to offset the gains.

Good plan! This is the simplest and most fundamental flavor of investment bank tax avoidance strategies: If you have tax losses, you can in essence sell your tax losses to your clients. You buy their appreciated assets in a way that gives you (rather than them) the income, and then you shelter that income with your losses, and you split the tax savings.


At some point in or before March 2000, Deutsche Bank determined that it would not offset the built-in gain associated with the BMY shares with other corporate losses, as it had originally planned to do.

That is the main problem with the strategy: You have to lose money for it to work. But Deutsche Bank had a "back-up plan," which had something to do with a real estate investment trust. This strategy is not described in any detail in the lawsuit, which is a pity, as I suspect it was crazy. "Deutsche Bank subsequently concluded that the REIT strategy was too risky," which, when you consider what they were cool with, is saying something.

So what were they cool with? The back-up to the back-up plan was actually very simple. As the prosecutors describe it:

  1. You get yourself a brand-new shell company, called BMY Corp., with nothing in it.
  2. Deutsche Bank sells the Charter shares to BMY Corp. for about $167 million, of which $145 million is for the Bristol-Myers shares and $22 million is for the other stuff.
  3. BMY Corp. borrows $175 million from Rabobank to fund the purchase.
  4. BMY Corp. pops the Bristol-Myers shares out of Charter and sells them back to Deutsche Bank for $151 million (and pops the non-Bristol-Myers assets out and sells them too).
  5. BMY Corp. pays back the loan to Rabobank, with interest and fees.
  6. BMY Corp. is left with no stock, no cash, and a $60 million tax liability on $170.5 million in gains on the Bristol-Myers stock and the other assets.

Here, Deutsche Bank has pretty minimal tax liability: It bought Charter for $150 million, and sold it more or less immediately for $167 million, for about a $17 million gain on the Charter shares, but the $170 million inside gain on the Bristol-Myers shares is BMY Corp.'s problem, not Deutsche Bank's.

So this, Deutsche Bank's third tax-avoidance plan, just passed the problem on to BMY Corp., much as the Gelb brothers originally passed it on to Deutsche Bank. But BMY Corp. itself had two clever plans to avoid the tax liability. First, there was some crazy tax shelter that somehow left BMY Corp. with a $173 million tax loss:

The purported $173,448,259.00 loss -- just exceeding the precise amount necessary to offset the reported gain from the sale of the BMY shares and the non-BMY assets -- allegedly arose from a foreign currency loss involving 615,200 Euros with a purported fair market value of $550,455.00 and cost-basis of $171,232,043.00, as well as ...

No, you know what, I'm going to stop you right there, 615,200 euros did not have a cost basis of $171 million. That's $278.34 per euro. Not even the most befuddled tourist has ever paid $278.34 per euro. Whatever was going on here, it was a tax shelter, not an economic loss, and the IRS was not fooled:

On July 16, 2004, the IRS issued a notice of deficiency to BMY Corp., disallowing the purported foreign currency losses for the reasons stated in the notice of deficiency including because the taxpayer did not establish the existence of the losses, the basis of the foreign currency, or that any section of the Internal Revenue Code allowed BMY Corp. to claim these losses.

The IRS demanded its $60 million, plus another $24 million for an "accuracy-related penalty." And "BMY Corp. did not challenge the notice of deficiency," but instead moved on to its Plan B, which was: default on its now $84 million of tax liability.

Which turned out to be no big deal because, remember, BMY Corp. was just an empty box. The ultimate result of all of this was to put the tax liability into an empty box, and then walk away from the box.

Or that is the story that the federal prosecutors tell. They are suing Deutsche Bank for $190 million -- basically the $60 million in taxes that BMY Corp. avoided in 2000, plus 14 years of interest and late fees. There are some oddities in the story that I don't quite understand.

The biggest is: Whose box was this? I was deliberately vague in my description above. The prosecutors sort of hint that BMY Corp. and its shell-company relatives were created by or at the behest of Deutsche Bank, but they don't actually say that. Strictly speaking, BMY Corp. was created by a third-party firm "and two related individuals" that the prosecutors collectively refer to as the "Promoter." That's the sort of word that you typically use about a tax-shelter marketer like a law firm or accountant. If the story is some lawyers marketed a tax shelter to Deutsche Bank, and Deutsche Bank used it, then, sure, that box is Deutsche Bank's box, and it should be liable for the taxes.

But if not, then maybe not? For instance, if another bank set up BMY Corp., then that might make it that bank's problem. After all, this whole thing started because Deutsche Bank marketed a tax shelter to Charter's shareholders, the Gelbs. That doesn't make the box the Gelbs' problem. One simplistic but plausible rule would be: The box is the problem of the last person to touch it who had a balance sheet. Deutsche Bank definitely had a balance sheet. If the Promoter didn't, then I guess the box is Deutsche's problem. But if it did, then shouldn't it be the Promoter's?

There are other oddities. One is that Deutsche Bank contests many of the factual claims in the complaint, so perhaps the story above is not the real story. Deutsche Bank points out some particular oddities:

"We fully addressed the government's concerns about this 14-year-old transaction in a 2009 agreement with the IRS," Rene Calabro, a spokeswoman in New York for Deutsche Bank, said in an e-mailed statement. "In connection with that agreement they abandoned their theory that DB was liable for these taxes, and while it is not clear to us why we are being pursued again for the same taxes, we plan to again defend vigorously against these claims."


  • Why go after a more than 14-year-old deal now? Seems a bit harsh on Deutsche Bank, especially when the $60 million tax liability has snowballed to $190 million with penalties and interest.
  • Why go after a deal that Deutsche Bank already settled with the IRS five years ago? Did the prosecutors just not know about the IRS settlement?
  • And why did the IRS end up not attributing the box to Deutsche Bank? Surely the IRS knows tax law. Perhaps the IRS felt that the box belonged to someone else.

So, like I said, a lot of oddities. But the core of the story is sort of beautiful. Some guys -- the Gelbs -- had appreciated stock. They didn't want to pay taxes. Deutsche Bank told them they didn't have to. And then I count four different ways that someone -- Deutsche Bank, Promoter, whoever -- tried, in sequence, to avoid taxes:

  1. Offsetting the gain with Deutsche Bank's business losses.
  2. Some sort of REIT strategy.
  3. Offsetting the gain with weird fake euro losses.
  4. Taking the taxable gain, but leaving it in a worthless shell at BMY Corp.

Think of all the work that was done on this. This was the simplest thing in the world: The Gelbs had bought stock and made a lot of money on it, so they had to pay taxes. But they didn't want to pay taxes. So Deutsche Bank, and the Promoter, and teams of lawyers and accountants and trustees, all sprang into action and tried four wildly different techniques to avoid those taxes. Three of them failed, and maybe, more than 14 years later, the fourth will fail too. But it was quite an effort.

  1. As my tax professor used to say, and probably still does. He's Michael Graetz, by the way, now at Columbia. I may have the wording slightly wrong, but when I took tax with him his two fundamental rules of tax were that it's always better to have more money than less money, and that it's always better to die later than sooner.

  2. Not, like, always, but investment bank Structured Transactions Groups looking for tax trades like this is definitely a thing. Lots of people are undoubtedly working on it for Yahoo. (Including me!)

  3. I'm conflating time periods here a bit, but in more detail:

    • Charter owned 3,166,142 Bristol-Myers shares (later 3,173,942 shares, for boring reasons, see paragraph 61).
    • The shares were worth around $53.89 on February 25, 2000, when Charter and Deutsche Bank agreed to the deal.
    • So around $171 million total.
    • "Charter had acquired its BMY shares many years earlier, for a very low cost-basis of less than one million dollars."
    • 34.5 percent of $170 million is about $59 million, but there are a bunch of weird little adjustments involved here. The prosecutors get a number of around $52 million of tax liability, in the first instance, and then do various things to it to end up with a $190 million liability. Which seems high.
  4. It paid $149,910,896.36 for Charter, which held some non-Bristol-Myers assets as well.

    Incidentally Charter's shareholders (two individuals, Bruce and Richard Gelb) presumably owed tax on the $150 million that Deutsche paid for their Charter stock. The issue here is one of double taxation. If Charter had just sold its Bristol-Myers shares and made $170 million, it would then have had to pay $50 million in taxes. And then if it had distributed the $120 million to the Gelbs, they would have to pay taxes on that $120 million. (I assume they were taxpayers and their basis was low.) This way, they had to pay taxes on the $150 million they got for their Charter stock, but $150 million minus tax is more than $120 million minus tax, that's the first rule of tax.

  5. Accounting income and tax income are not, of course, the same, but nonetheless I will mention that Deutsche Bank had 6.9 billion euros of pretax income in fiscal 2000, and 6.6 billion euros of income tax benefit, for total net income of 13.5 billion euros.

  6. Really three entities -- BMY Trust, BMY LLC, and BMY Corp. -- that I am conflating here.

  7. See paragraph 50 of the complaint.

  8. None of these numbers quite tie out, which I assume is because people kept taking fees all along the way. Also, there are some collars on the stock at various point, so you're selling less "stock" and more "stock subject to collar," which probably explains why the value of the assets being passed around don't change much even as the price of Bristol-Myers stock changes.

  9. See paragraphs 60, 61 and 76 of the complaint. Total purchase price for all of this stuff was about $170.5 million.

  10. Deutsche Bank previously settled with the Internal Revenue Service, in 2009, for $6 million over this case, and $6 million sounds like roughly the tax on that $17 million gain? I do not know.

  11. I mean, it paid $150 million for the shares, so I guess $20 million of the gain is DB's problem. Depends on the treatment of the collar; presumably DB had a loss on the collar to offset the gain on the shares.

  12. See paragraphs 2 and 32.

  13. One of the entities, BMY Trust, had First Union (now Wells Fargo) as a trustee, though that doesn't mean that First Union was the Promoter.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editors on this story:
Zara Kessler at zkessler@bloomberg.net
Zara Kessler at zkessler@bloomberg.net