When three Texas oil executives wanted to make plans for structuring their businesses with the lowest possible tax consequences, they turned to a law firm in Houston.
Leaked documents obtained by the International Consortium of Investigative Journalists (ICIJ) through the Pandora Papers leak and reviewed by Tax Notes show how private placement life insurance (PPLI) policies, trusts, bankers in Belize, and section 1035 exchanges helped them implement that plan.
PPLI is often described as an estate planning tool that works like regular life insurance, but when it is bought offshore and used to hold businesses and assets, it can be good for avoiding income taxes and sidestepping IRS scrutiny.
“In many cases, when I see these transactions, they’re just a tax avoidance trip,” said Steven Roth of Wealth Management International Inc. “Why didn’t you just buy insurance from New York Life? What was wrong with MassMutual here in the states? Why’d you have to go to ABC of Bermuda or the Cook Islands?”
The answer is because offshore PPLI policies are being promoted as a way for wealthy individuals to “avoid billions of dollars in taxes on lucrative investments,” according to a Senate Finance Committee Democratic Staff report.
Policies can be used to hold assets and businesses offshore, liquidate them, and repatriate the cash proceeds into domestic life insurance policies without recognizing gains on the liquidation. They can also be used to return appreciated assets to the original policy investor tax free upon the death of another person designated as the policy insured.
A trio of oil executives avoided paying capital gains tax on their business using an offshore plan to place the business in a private placement life insurance policy. A Tax Notes investigation shows how the scheme was able to evade IRS detection because of a lack of reporting requirements and inadequate IRS auditor training.
Texas Hold ’Em
In some cases, PPLI is combined with other tax-advantaged strategies to maximize its benefits.
In the example of the Texas executives, PPLI policies were bought in Belize through domestic irrevocable trusts — trusts often used to protect assets from estate tax and from creditors.
The leaked documents obtained by the ICIJ show that the PPLI policies facilitated both a strategy to arbitrage loan interest rates on letters of credit and the sale of a Nigerian company indirectly held in the policies.
After those transactions were completed in 2014, the assets in all three PPLI policies were liquidated for cash, according to the documents. The Belize PPLI policies were then exchanged for domestic life insurance policies funded with that cash.
The result: New cash-funded policies in the United States sheltered millions of dollars from federal income taxes, with no clear link back to the offshore transactions or activities.
How It Worked
The first step to achieving that outcome was to form the trusts, insurance arrangements, and offshore companies needed to execute the strategies.
The leaked documents show that the three executives set up irrevocable trusts under Texas law — one trust for each. The trusts purchased PPLI policies from now-defunct Belize insurer Paragon International Insurance Ltd., insuring the executives, the documents show.
Paragon was affiliated with a Belize bank — Provident Bank & Trust of Belize Ltd. — and a management company, all housed at the same address on Barrack Road in Belize City. Houston-based attorney Loren R. Cook acted as trustee for the irrevocable trusts and worked with Paragon and related Belize companies to administer the assets of the trusts, including the PPLI policies, according to the leaked documents obtained by the ICIJ in the Pandora Papers leak, which includes nearly 12 million documents from 14 offshore service providers.
The leaked documents show that Cook and his firm directed dozens of fund transfers from and between international business companies (IBCs) held in the PPLI policies.
Irrevocable trusts themselves own trust assets — like the PPLI policies — but control of the assets is vested in the trustee, who often has broad discretion to manage them.
Through the trustee and intermediaries in Belize, the executives formed jointly held IBCs in Belize. One-third of each IBC was held in each of their PPLI policies. The IBCs formed in Belize and held in the policies included F.R. Ltd. and IRF Management Ltd., among others, according to the leaked documents.
F.R. Ltd. became part of a strategy to generate interest payments deductible in the United States while recouping most of the interest paid in the Belize policies, the leaked documents show.
In correspondence with Provident Bank & Trust Ltd. in 1999, Cook proposed “a banking scenario for you and I to explore regarding business ventures for” the three executives, who were named in an email obtained by the ICIJ in the leaked documents. The scenario involved two transactions, only one of which would be executed and documented in the United States.
As proposed, in the U.S. transaction Provident makes a loan to U.S. taxpayers with a stated interest rate. In the non-U.S. transaction, “proceeds from a Provident Bank depositor are pledged and/or used to fund the above loan” and that depositor “receives 95 percent of the interest paid under the loan above, as compensation from the bank, from [sic] supporting the loan.” Provident would retain 5 percent “for administrative handling,” under the proposal.
If the ultimate beneficial owners of the U.S. taxpayer borrowers and the depositor funding the loan were the same, the effect of Cook’s proposal would allow those owners to deduct 100 percent of the interest payments on their U.S. taxes while getting 95 percent of that money back.
A Hypothetical Scenario
The leaked documents show the three executives implemented a transaction nearly a decade later like Cook’s hypothetical scenario.
Moneda Holdings LLC, formed in Nevada and ultimately owned by the executives, obtained a line of credit from Provident beginning at $2 million in 2008 and increasing to $16 million by 2013. Moneda agreed to pay 6.5 percent annual interest on the $16 million credit line, according to the leaked documents.
The initial line of credit amount and each increase to it were matched by contemporaneous purchases of certificates of deposit in the same amounts — a $3 million line of credit increase, for instance, was accompanied by purchases of CDs that also totaled $3 million. The CD funds were deposited at Provident Bank and its successor Heritage International Bank & Trust Ltd. by F.R. Ltd. — a Belize IBC ultimately owned by the three executives’ trusts through their PPLI policies — and paid a return of 5 percent, the leaked documents show. The cash deposits were directed by Cook’s firm and were documented as security guaranteeing the Moneda line of credit.
The bottom line: The executives were able to deduct the full 6.5 percent interest Moneda paid on their U.S. income taxes and receive back just over three-quarters of that interest paid through F.R. Ltd. into the PPLI policies, according to the documents. There is no indication in the leaked documents that the U.S. taxing authorities were aware of this mismatch.
F.R. Ltd. provided similar CD funding and guarantees for a $5 million line of credit to PPI Mechanical Testing Services LLC, a Texas company that was also beneficially owned by the three Texas oil and gas executives. The line of credit term sheet for PPI Mechanical Testing Services LLC was signed by two of the three Texas executives on behalf of that company in 2013. Like the Moneda arrangement, the line of credit bore a 6.5 percent interest rate and was supported by F.R. Ltd. CDs earning a 5 percent return.
In an interview with Tax Notes, Cook disputed that these transactions were a variation on the hypothetical described in his email, pointing out that the split wasn’t 95 percent and 5 percent and that the cash deposits were pledged as security for the credit line. His proposal, however, discussed the cash deposits as “pledged and/or used to fund the loan.” Cook described the loan transactions as a “normal financial transaction” and declined to provide further information that would distinguish the hypothetical transaction structure from the executed loan transactions.
Selling Off
The PPLI policy structure was also used to sell a Nigerian subsidiary in 2014 and transfer the proceeds into U.S. policies.
According to the leaked documents, PPI Technology Services Nigeria Ltd. was owned by Petroleum Services Ltd. and IRF Management Ltd. — both Belize IBCs that were owned in the Belize PPLI policies insuring the Texas oil and gas executives.
PPI Technology Services Nigeria Ltd. was sold to a multinational group in March 2014 as part of a larger acquisition of companies owned by the three executives. The purchase agreement, included among the leaked documents, lists a price of $40.5 million for the Nigeria company. The agreement names Petroleum Services Ltd. and IRF Management Ltd. as the sellers but empowered a “sellers’ representative” to negotiate on the sellers’ behalf, receive notices, and make all important decisions for the sellers under the agreement.
The sellers’ representative was a Texas limited partnership ultimately owned by the three executives, and one of them signed the Nigeria purchase agreement on its behalf. All three were designated as notice recipients under the purchase agreement.
Assets placed in PPLI policies are treated as insurance premiums paid by the investor. The assets are held in a separate account, segregated from the insurance company’s other accounts, but are technically owned by the insurer, not the policyholder. That ownership is critical to the arrangement being respected for tax purposes as life insurance and getting the resulting tax benefits — including accumulation of investment gains on a tax-deferred or tax-free basis.
Under an informal rule known as the “investor control doctrine,” if a policyholder exercises too much control over the assets — making specific investment decisions or continuing to run a business held in the policy, for example — the policyholder can lose the tax benefits of life insurance treatment. The rule was described and defined specifically for PPLI policies in Webber v. Commissioner, 144 T.C. No. 17 (2015).
Cook said that at the time this transaction happened, he didn’t provide any tax advice to the investors and wasn’t concerned about investor control. According to Cook, it was another attorney, Walter C. Wilson, who performed the tax planning for the transaction. Cook said he was working at the investors’ company at the time as a controller and that he later performed contract work for a few months at Wilson’s office.
Wilson told Tax Notes that he “may have” set up the irrevocable trusts for the executives but he denied setting up the PPLI policy.
Glenn D. Godfrey of Glenn D. Godfrey & Co. LLP — a Belize attorney who is listed as director of Paragon in leaked documents obtained by the ICIJ, along with his wife, Joy E. Godfrey — said his “only U.S. client in this matter was Mr. Walter Wilson” and that he only advised Wilson on Belize insurance law. Because Wilson was his client, Godfrey — a former attorney general of Belize — said their conversations are privileged under Belize law.
A leaked document obtained by the ICIJ reflects an agreement between Walter C. Wilson of Houston and Glenn D. Godfrey & Co. “for a 50 percent commission payment for new business/client and partnership fees” in effect from 1998. The memorandum is from Joy Godfrey and is dated January 10, 2001.
Wilson said his firm doesn’t accept commissions.
Materials from Paragon, obtained by the ICIJ in the leaked documents, indicate that Paragon’s policies were designed to meet insurance requirements under IRC section 7702.
The Godfreys told Tax Notes in an email that Paragon is no longer in business and that they are unsure how many policies were issued to U.S. insureds. Neither Paragon nor its affiliates were ever contacted by the IRS about PPLI policies issued by Paragon, they said.
Cook acted as trustee for more than a dozen irrevocable trusts that held Belize PPLI policies issued by Paragon, the documents show. One of those policies owned Joro Resources Ltd., a Belize company that was involved in payday lending in the United States. Several states obtained cease-and-desist orders against Joro’s related companies in the United States and their payday lending operations. Some of those orders named Cook’s firm as well. Cook said his firm was named in the orders only because he was listed in public records as an incorporator of domestic entities on behalf of his clients.
Cook said he was advised by another law firm to file foreign bank account reports for the executives’ trusts and report the PPLI policies, and to include the policy number and the face value of the policy.
Cook said he didn’t get an updated accounting from Paragon each year to report on FBARs and that the IBCs in the policies weren’t companies that he “accounted for” and probably weren’t companies Paragon accounted for. He said he probably didn’t include the value of the IBCs on FBARs because “there’s no value to [a business] until someone buys it.”
Cashing Out
A few weeks after the Nigeria subsidiary was sold, the trusts established by the three executives used section 1035 exchanges to transfer a total of $40.5 million — the same amount listed as the base purchase price for that subsidiary — out of their Belize PPLI policies and into policies with Zurich American Life Insurance Co., an insurer in the United States.
Each of the three new policies was funded with $13.5 million from the corresponding Belize policy, the leaked documents show.
Section 1035 allows a taxpayer to exchange an existing life insurance policy for a new one, transferring assets supporting the original policy to the new policy without being taxed on the transfer.
In January 2015 the executives closed the lines of credit to their U.S. companies, and the Belize IBCs collected the returns on the CDs at Heritage Bank. The IBCs — F.R. Ltd., IRF Management Ltd., and others were then liquidated and dissolved, yielding more than $38 million in cash.
The executives then used section 1035 exchanges to transfer $37.5 million into additional new life insurance policies in the United States. Each trust transferred just over $12.5 million from its Belize PPLI policy to its new policies at AXA Equitable Life Insurance Co. and Nationwide Life Insurance Co.
After those transfers, the Paragon policies in Belize were closed, and Paragon was paid nearly $482,000 in asset management fees associated with the policies.
All the U.S. policies were funded with cash and no longer showed any connection to the Belize IBCs or the Nigerian subsidiary. Once located in the domestic policies, the cash could be invested using traditional asset management practices less likely to draw attention from the IRS and take advantage of the favorable treatment of life insurance policy assets in the United States.
The executives couldn’t be reached for comment.
Do you have a tip for our reporters? Reach the Tax Notes investigations team at tips.investigations@taxnotes.com.
Other Coverage in This Series:
Inside How Private Placement Life Insurance Slips Through the Cracks
High-End Life Insurance Policies Lured Offshore by Relaxed Rules