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Special Report

December 29, 2000

US Closes Tax Haven Loophole

The above title is the headline of an article, written by Fiona Buffini, which appeared in the December 29, 2000 issue of the Australian
Financial Review. Here is a quote from this article.

"...the United States Internal Revenue Service (IRS) is forcing unco-operative foreign banks to report the identity of every investor in
US securities to the IRS from January 2001, or face a 31 per cent tax on interest, dividends, and the gross proceeds of security sales."

The IRS has long regarded any bank that resided in what is known as a"tax haven" (Cayman Islands, Netherlands Antilles, Nauru, etc,
etc) as being"unco-operative". It is"unco-operative" because it will not identify its clients who trade in the U.S. (whether American or
not) to the IRS. In short, it maintains bank secrecy.

Not any more, if the IRS has its way. Any bank which is not a"qualified intermediary", which means any bank which the IRS does
not approve of, will have to reveal the identity of every client (American or non-American) who trades in any type of U.S. security. If
they don't, the IRS will withhold 31% of all interest, dividends or gross capital gains.

If the bank in question IS a"qualified intermediary", it must do business in an IRS approved country and it must"police" its clients.
That is, it must do the IRS' work for them. It must report its clients and withhold"proper" U.S. taxes on interest, dividends, and
capital gains. And all of this comes into force on January 1, 2001.

The Potential Effects

The IRS obviously has not so much as considered the possibility that this ruling might persuade some foreigners (and Americans) who
presently invest in the U.S. to look elsewhere. They have also not considered that a withdrawal of funds from U.S. investments would
have potentially very adverse (some might say catastrophic) effects on U.S. financial markets and on the Dollar itself.

Consider a statistic reported in the Global Market Report section of the latest issue of The Privateer (#414):

"The rest of the world held $US 7 TRILLION in U.S. financial assets of all descriptions in September 2000....Over the past two
years, foreign holdings of U.S. corporate bonds are up 57% while foreign holdings of U.S. stocks are up 80%."

It is a VERY safe bet that many foreigners who presently hold U.S. investment assets are using banks in"tax havens" to save on U.S.
taxes. How safe is the bet? Well, in 1998, $US 124 Billion in income was paid to foreign investors. The IRS collected $US 2.4 Billion
or 1.9% of that in tax. After January 1, 2001, any foreign investor (or American investor) who uses a"tax haven" bank faces either
being identified to the IRS or having 31% of all income collected from U.S. investments confiscated by the IRS. Neither of these is a
palatable alternative, or the individuals in question would not have obtained the services of the"tax haven" bank in the first place.

Nor is this effect restricted to"tax haven" banks. Consider this Reuters report. Here's a quote:"Citibank said it expects to close about
800 accounts of U.S. citizens at its German retail branch as U.S. authorities increase pressure to comply with tax laws, putting it in
conflict with German bank privacy codes". (emphasis by The Privateer).

Foreign investment has been one of the main contributors to the strength of U.S. stock markets over the past few years. It has also
been the MAIN contributor to the strength of the U.S. Dollar, which lasted until about a month ago. It is absolutely certain that this
ruling by the IRS will, to put it politely,"discourage" this investment - at the same time as foreign investment in the U.S. is becoming
less alluring anyway, due to shaky stock markets and a falling U.S. currency.

Just One Example

Consider the Euro. A month ago, the Euro was trading at about $US 0.82. As of December 28, it was trading at $US 0.9285. There
are very few financial analysts who do not expect the Euro to at least gain parity with the U.S. Dollar over the next year. Goldman
Sachs goes much further. They are predicting an exchange rate of Euro 1.00 = $US 1.22 by the end of 2001. That, if it happened,
would be a 31.4% appreciation of the Euro agains the Dollar over the next year.

This, it is readily admitted, is an extreme prediction. But the attractiveness of the U.S. as a"magnet" for global investment capital is
inexorably lessening anyway. Now, the IRS is about to greatly increase this process by trampling over the top of the privacy of any
potential investor in the U.S., wherever he or she may live.

U.S. markets will enter 2001 sweating on a Fed rate cut. This is"expected" to turn the tide on the struggling U.S. stock markets. What
it will potentially do to an already weakening U.S. Dollar is not even being considered. And inside the U.S., what is not being
considered at all is that foreign investors might have the temerity to decide that they can find better uses for their money either at home
or somewhere else in the world outside the U.S.

What this IRS ruling has the potential to bring about is to turn what might have been the continuation of weak U.S. markets early next
year into a U.S. market ROUT. The ruling has given foreign investors everywhere a VERY GOOD reason to curtail future investment
in the U.S.. It has also given them good reason to SWITCH investments out of the U.S. and into other nations. It may not happen
immediately, since most people inside and outside the U.S. probably don't yet know about this IRS ruling, but the potential for it to
happen is huge. Why? to quote a tax partner with PricewaterhouseCoopers who declined to be named:"a lot of people will wake up
and find 30 per cent being taken out of their dividend payments."

Since the Nasdaq bubble burst in March/April 2000, the U.S. has been slowly but surely losing its attractiveness as a home for global
investment capital. Since the U.S. Dollar began its descent in late November 2000, this process has intensified. Inside the U.S., the
"cure" is expected to be provided by the Fed when it cuts rates on or before the next FOMC meeting scheduled for Jan 30-31, 2001.
Very few inside the U.S. dare to contemplate a situation in which a Fed rate cut does NOT work.

But many outside the U.S. don't expect lower U.S. rates to"work". They know that ANY internationally indebted nation, no matter
how big and powerful it is, cannot indefinitely maintain the value of their currency without taking steps to reduce that indebtedness.
They also know that lowering interest rates is NOT a step which can solve the problem. These people have already begun to cut back
on new investments in the U.S.. They have also begun to switch out of the U.S. Dollar.

Now, to this potentially disastrous mix, the IRS has added a tax ruling that penalizes U.S. investment by Americans and foreigners
alike. In a spectacular display of ignorant arrogance, the IRS has given investors all over the world an excellent reason, not only to
stop pouring more money into the U.S., but to start to pull out the money they already have there.

If that happens, the Fed will be powerless. Rate cuts won't"fix" the situation, they will make it WORSE. The prospects for a"soft
landing" for the U.S. economy in 2001 were already remote. This IRS ruling has the potential to make such prospects all but
impossible. It also has the potential to bring about a CRASH on U.S. markets as foreign investors decide that the IRS is not a U.S.
government agency they care to deal with.


The Australian Financial Review (AFR) article - by Fiona Buffini
Please Note: This article is available to AFR subscribers only - using a username/password. Non-Australians interested in a
subscription please click here. Australians who do not have a print subscription to the AFR can get an online subscription in the
second quarter of 2001.

For North American Privateer Subscribers in particular, we recommend the AFR as a good"outside" source for U.S. and world
financial and economic analysis.




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