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"They charged less than their competition. That's potential tax revenue lost. They are therefore thieves." is the dumbest argument I've ever heard. How is th

by naaaaak 11y ago

"They charged less than their competition. That's potential tax revenue lost. They are therefore thieves." is the dumbest argument I've ever heard. How is this even an issue, let alone the basis for a legal case?

mirimir 11y ago
It makes no sense to me either. Forgone fees go to the fund's investers, who are also its owners. And capital gains by investers are taxed, just as they are for other funds. Maybe they're taxed at lower rates than profits of other funds are taxed. But that's just because the fund manager is a not-for-profit. Right?
- morgante 11y ago
  It's complicated by the fact that a non-negligible portion of the funds are held in retirement accounts where potentially no taxes are paid on the returns.
  - mirimir 11y ago
    Fair enough. But that's why some investors prefer not-for-profit funds, no? There's nothing underhanded going on.
    - morgante 11y ago
      I agree that there's nothing underhanded going on and Vanguard offering lower fees is a net benefit to society. That being said, I sort of see how a legalistic argument could be made.
      - mirimir 11y ago
        It is true that most (maybe virtually all) not-for-profits serve the general public, more or less, and not just their owners.
- zrail 11y ago
  That's the crux of the issue. Vanguard Group presents itself as offering it's services at cost, when in fact it's a for-profit company. As a for-profit company, according the laws that stand today and if you believe the claims of the plaintiff, it has to offer it's services at a competitive market rate. Of course, that doesn't mean it can't rebate the profit back to the funds which could then apply it as a fee rebate. That should be totally legal, as long as it pays taxes on the profit before it issues the rebate. This whole territory has been explored before, by the way. Mutual insurance companies used to have this same problem, and eventually Congress just added another carveout to 501(c) and made the problem go away. That's the other alternative here, and it's definitely cleaner and probably better for society as a whole.
  - pc86 11y ago
    > it has to offer it's services at a competitive market rate. It's asset-weighted fees are approximately 1/6 of its competition. That seems pretty competitive to me. Less bombastically, who decides what a competitive fee is? If they charged 1/2 market rate would this suit have ever been filed? If they were operating at a loss I think it'd be pretty easy to claim they were avoiding taxes and should be operating at break even. But they are operating at break even, so I think it's hard to make the argument that they should be charging more "just because other firms do" and not come off as just some opportunist trying to cash in on a whistle-blower payout.
ghshephard 11y ago
The issue is they are charging themselves a lower fee, instead on an "arms-length" (higher) fee that they would to a third-party. Somewhere in there, I suspect, is an argument that the lower fees are designed to avoid taxes, rather than reduce costs.
- m1sta_ 11y ago
  Avoid taxes = reduce costs, as long as it's legal.
  - ghshephard 11y ago
    Right, the "as long as it's legal" is the interesting part. For instance, what if you have two entities, one of which is a "for profit" which pays full taxes, and then another that is somehow placed in a different preferential tax bracket. By shifting/transferring all of the costs to the higher tax bracket entity, and having it further reduce profits by charging low fees, and moving all of the resulting "profit" that then accrues to the lower-taxed entity. How, and when you can engage in such activity I'll lead to tax attorneys, but it's not a no-brainer "You should always be able to charge lower fees and transfer profits away from one entity to another." There is some nuance.
- deleted 11y ago
  [deleted]
  - morgante 11y ago
    That only applies if it is, in fact, legal. We have specific laws in place to prevent corporate tax evasion through unrealistic transfer pricing, and it's unclear if Vanguard falls afoul of those rules.
    - walshemj 11y ago
      No it isn't transfer pricing is transferring profits from a low to high tax country eg UK-> IE.
morgante 11y ago
> They charged less than their competition It's a lot less crazy than it sounds, because they are wholly owned by Vanguard. So the customer is effectively setting the fees. There are certainly scenarios where you could see how this is clearly abusive. As a contrived example, imagine if Apple moved its legal headquarters to Ireland and made California into a subsidiary. They would still have to pay the California subsidiary for the design services it provides, but they could set those fees at way below market price and thereby shift all tax liabilities to a lower tax jurisdiction. We have transfer pricing rules in place to prevent this. The situation is more complicated than this because the fund (the client) is not a profit-seeking corporation, so it's not arbitrarily moving funds around. It's an odd scenario where the customers are also the owners.
- ryporter 11y ago
  So, shouldn't the investors then owe back taxes based on unpaid expense fees?
  - morgante 11y ago
    No, because it isn't the investors who avoided paying taxes. If they had been expensed at market rate, their return (and therefore tax burden) would have been lower, not higher. That being said, in principle it's all mostly the same since investors own Vanguard.
- madaxe_again 11y ago
  Have you heard of mutual funds? The clue is in the word "mutual". And "funds". Suggest reading the article.
  - morgante 11y ago
    What? I fully read the article and also Matt Levine's take. [0] I'm well aware what a mutual fund is and, for the record, think this case is pretty stupid and unlikely to be won. But it's important to understand that there actually are tax principles in play here. Have you heard of transfer pricing? I suggest reading anything. [0] http://www.bloombergview.com/articles/2015-11-25/calpers-fees-and-culture-consultants http://www.bloombergview.com/articles/2015-11-25/calpers-fee...
lmm 11y ago
An auditor friend told me a story about a company that opened a subsidiary to do all their vehicle leasing for the company cars. By charging the main company only their costs, this subsidiary was able to show 0 profit, and so they avoided paying some higher tax rate on the cars they were leasing. (I've probably simplified the story to the point of nonsense, but that was the basic idea). You can see why that sort of thing would be illegal and that kind of subsidiary would be legally required to charge the market rate for the services they were providing.
- madaxe_again 11y ago
  Yes, but that's not remotely what's happening here. Go read the article, try again!
Shivetya 11y ago
Call it a trial balloon, before someone in Congress brings up similar against Vanguard and others. Would not be the first time a proxy was used to float a silly idea that just picks up steam.

by naaaaak 11y ago

mirimir 11y ago

It makes no sense to me either. Forgone fees go to the fund's investers, who are also its owners. And capital gains by investers are taxed, just as they are for other funds. Maybe they're taxed at lower rates than profits of other funds are taxed. But that's just because the fund manager is a not-for-profit. Right?

morgante 11y ago
It's complicated by the fact that a non-negligible portion of the funds are held in retirement accounts where potentially no taxes are paid on the returns.
- mirimir 11y ago
  Fair enough. But that's why some investors prefer not-for-profit funds, no? There's nothing underhanded going on.
  - morgante 11y ago
    I agree that there's nothing underhanded going on and Vanguard offering lower fees is a net benefit to society. That being said, I sort of see how a legalistic argument could be made.
    - mirimir 11y ago
      It is true that most (maybe virtually all) not-for-profits serve the general public, more or less, and not just their owners.
zrail 11y ago
That's the crux of the issue. Vanguard Group presents itself as offering it's services at cost, when in fact it's a for-profit company. As a for-profit company, according the laws that stand today and if you believe the claims of the plaintiff, it has to offer it's services at a competitive market rate. Of course, that doesn't mean it can't rebate the profit back to the funds which could then apply it as a fee rebate. That should be totally legal, as long as it pays taxes on the profit before it issues the rebate. This whole territory has been explored before, by the way. Mutual insurance companies used to have this same problem, and eventually Congress just added another carveout to 501(c) and made the problem go away. That's the other alternative here, and it's definitely cleaner and probably better for society as a whole.
- pc86 11y ago
  > it has to offer it's services at a competitive market rate. It's asset-weighted fees are approximately 1/6 of its competition. That seems pretty competitive to me. Less bombastically, who decides what a competitive fee is? If they charged 1/2 market rate would this suit have ever been filed? If they were operating at a loss I think it'd be pretty easy to claim they were avoiding taxes and should be operating at break even. But they are operating at break even, so I think it's hard to make the argument that they should be charging more "just because other firms do" and not come off as just some opportunist trying to cash in on a whistle-blower payout.

ghshephard 11y ago

The issue is they are charging themselves a lower fee, instead on an "arms-length" (higher) fee that they would to a third-party. Somewhere in there, I suspect, is an argument that the lower fees are designed to avoid taxes, rather than reduce costs.

m1sta_ 11y ago
Avoid taxes = reduce costs, as long as it's legal.
- ghshephard 11y ago
  Right, the "as long as it's legal" is the interesting part. For instance, what if you have two entities, one of which is a "for profit" which pays full taxes, and then another that is somehow placed in a different preferential tax bracket. By shifting/transferring all of the costs to the higher tax bracket entity, and having it further reduce profits by charging low fees, and moving all of the resulting "profit" that then accrues to the lower-taxed entity. How, and when you can engage in such activity I'll lead to tax attorneys, but it's not a no-brainer "You should always be able to charge lower fees and transfer profits away from one entity to another." There is some nuance.
deleted 11y ago
[deleted]
- morgante 11y ago
  That only applies if it is, in fact, legal. We have specific laws in place to prevent corporate tax evasion through unrealistic transfer pricing, and it's unclear if Vanguard falls afoul of those rules.
  - walshemj 11y ago
    No it isn't transfer pricing is transferring profits from a low to high tax country eg UK-> IE.

morgante 11y ago

> They charged less than their competition It's a lot less crazy than it sounds, because they are wholly owned by Vanguard. So the customer is effectively setting the fees. There are certainly scenarios where you could see how this is clearly abusive. As a contrived example, imagine if Apple moved its legal headquarters to Ireland and made California into a subsidiary. They would still have to pay the California subsidiary for the design services it provides, but they could set those fees at way below market price and thereby shift all tax liabilities to a lower tax jurisdiction. We have transfer pricing rules in place to prevent this. The situation is more complicated than this because the fund (the client) is not a profit-seeking corporation, so it's not arbitrarily moving funds around. It's an odd scenario where the customers are also the owners.

ryporter 11y ago
So, shouldn't the investors then owe back taxes based on unpaid expense fees?
- morgante 11y ago
  No, because it isn't the investors who avoided paying taxes. If they had been expensed at market rate, their return (and therefore tax burden) would have been lower, not higher. That being said, in principle it's all mostly the same since investors own Vanguard.
madaxe_again 11y ago
Have you heard of mutual funds? The clue is in the word "mutual". And "funds". Suggest reading the article.
- morgante 11y ago
  What? I fully read the article and also Matt Levine's take. [0] I'm well aware what a mutual fund is and, for the record, think this case is pretty stupid and unlikely to be won. But it's important to understand that there actually are tax principles in play here. Have you heard of transfer pricing? I suggest reading anything. [0] http://www.bloombergview.com/articles/2015-11-25/calpers-fees-and-culture-consultants http://www.bloombergview.com/articles/2015-11-25/calpers-fee...

lmm 11y ago

An auditor friend told me a story about a company that opened a subsidiary to do all their vehicle leasing for the company cars. By charging the main company only their costs, this subsidiary was able to show 0 profit, and so they avoided paying some higher tax rate on the cars they were leasing. (I've probably simplified the story to the point of nonsense, but that was the basic idea). You can see why that sort of thing would be illegal and that kind of subsidiary would be legally required to charge the market rate for the services they were providing.

madaxe_again 11y ago
Yes, but that's not remotely what's happening here. Go read the article, try again!

Shivetya 11y ago

Call it a trial balloon, before someone in Congress brings up similar against Vanguard and others. Would not be the first time a proxy was used to float a silly idea that just picks up steam.