A tax settlement of $7 billion, which may be the largest in history, has been reached between the hedge fund Renaissance Technologies and the Internal Revenue Service (IRS) after a long-running dispute about back taxes and interests.
James Simons, the founder of Renaissance Technologies who is often hailed as the pioneer of quantitative hedge funds, will make an “additional settlement” payment of $670 million to the IRS, and will also pay back taxes related to his gains, according to a letter sent by Renaissance’s Chief Executive Peter Brown to the investors which was obtained by Reuters.
After engaging with the IRS for several years about the Appeals process, the letter concluded that it was better to agree on the settlement “rather than risking a worse outcome, including harsher terms and penalties, that could result from litigation.”
Renaissance dispute with IRS
The dispute was about Renaissance’s key fund called Medallion, its trades from 2005 to 2015 and if investors should be taxed on the short-term capital gains which have a higher tax rate. Renaissance made certain moves on this fund during this time to convert short-term capital gains into long-term capital gains which have a lower tax rate. The Medallion fund is solely managed internally by Renaissance for friends and family, reported the Wall Street Journal.
Thanks to the colossal amounts involved in the dispute, the agreement was closely followed in the political and financial worlds. Renaissance’s top executives and leaders are some of the largest political donors in the US. Simons, who stepped down as chairman of the quantitative hedge fund in January, is a major Democratic donor while Robert Mercer, a senior executive, is known for backing Republican candidates, including former President Donald Trump.
When did it all begin?
Renaissance’s settlement with the IRS comes after former US Senator Carl Levin led an investigation into tax evasion as the head of the powerful Senate Permanent Subcommittee on Investigations in 2014.
After a year-long probe into evasive practices by the hedge fund, Levin found that Deutsche Bank AG and Barclays Plc helped several hedge funds, including Renaissance to treat short-term capital gains as longer-term profits, which attracted a lower tax rate. Short-term gains made from trading assets that are held for less than a year have a higher tax rate and the report concluded that the banks sold the hedge funds certain options to achieve lower tax rates, reported Financial Post.
Senator Levin passed away in July at the age of 87, but Elise Bean, his long-time aide told Reuters, “I wish Senator Levin were here, seven years after he first exposed its outrageous tax scam, to see RenTec (Renaissance Technologies) finally held accountable.”
In 2015, after the US Senate subcommittee reported that hedge funds were using this tactic to avoid federal taxes, the IRS issued guidance that hedge funds using “basket options,” i.e. the options sold by Deutsche Bank and Barclays, had to be reported on their tax returns.
“It’s good to see that, despite a years-long knock-down bare-knuckles battle, the IRS prevailed in compelling at least one set of billionaires to pay the taxes they owe,” said Bean.
Renaissance’s $7 billion settlement dwarfs a dispute involving GlaxoSmithKline in 2006, which famously concluded with the drug giant paying $3.4 billion to the IRS.
Quantitative hedge funds
Traditional hedge funds are investment funds that typically have less regulation and more flexibility and base their entire investment strategy on fundamental research and human intuition.
Every hedge fund has its own investment manager and its own philosophy which determines the type of investments it makes and the strategies it uses, according to the prominent Wall Street job board, Street of Walls.
A quantitative hedge fund on the other hand removes the human element completely and relies solely on mathematical and statistical modelling, according to Yahoo! Finance. It uses algorithmic and systematic strategies to make trading decisions rather than rely on discretionary decisions. All hedge funds can be classified into a Quant Hedge Fund or a non-Quant Hedge Fund.
