Harbinger Offshore Manager Tax Settlement: New York Work, Alabama Income

Harbinger Capital Partners Offshore Manager agreed to pay $30 million in a tax settlement over income allocated away from New York despite investment work performed there. The 2018 agreement included admissions about unpaid taxes and an inaccurate account of the company’s New York office. If you know where a fund’s investment decisions happened and what its tax personnel reported, this case connects those two sides of the business.

A whistleblower brought the New York False Claims Act case, the New York Attorney General investigated, and the State and New York City pursued the claims. This settlement covers Offshore Manager’s own admission and deferred fees, distinct from the earlier Harbert Management Corporation agreement, which resolved claims against the management group and other respondents.

The Investment Work Behind the Incentive Fees

Offshore Manager earned its incentive fees for investment work performed in New York City. The State and City’s superseding complaint describes a master-and-feeder fund structure: investors put capital into feeder funds, those funds invested in a master fund, and the master fund invested in the market. Offshore Manager had exclusive authority to invest and reinvest the capital of the master fund and offshore feeder fund.

According to the complaint, the offshore feeder paid Offshore Manager incentive fees equal to 20% of net profits allocated to each common share, subject to recovering prior losses. The trading decisions behind those profits came from the senior managing director and an investment team working in New York City.

The complaint also explains why payroll alone would miss the business relationship. Offshore Manager had no employees of its own, but the investment professionals employed by another entity acted as its agents. Alabama officers and agents handled limited accounting, legal and risk-management functions. The investment-management agreement and the work performed under it connected the fees to the New York office.

The Tax Warning Came Before the Return

The complaint alleges that Offshore Manager chose the Alabama allocation after receiving advice that New York taxes were owed. Its Alabama-based chief administrative officer and controller were primarily responsible for its taxes. In March 2005, an accounting firm told the chief administrative officer that State and City taxes applied to the incentive-fee income.

The chief administrative officer then compared different allocations and called the all-Alabama position “unsupportable,” according to the complaint. His analysis showed that allocating everything to Alabama rather than New York could reduce taxes by more than half. The complaint quotes his email to the controller and other recipients later that day:

The complaint alleges that the controller signed the return the following week, allocating no income to New York for the prior tax year. Offshore Manager also failed to file a City unincorporated business tax return for that year. In the complaint’s account, the unsupportable position made it onto the return.

According to the complaint, the State partnership returns listed only an Alabama office where they should have identified every place the business operated. The returns also denied having income from New York sources, and attachments denied a New York business connection. The complaint further alleges that Offshore Manager did not file State returns for tax years 2006 and 2007.

What Offshore Manager Admitted

Offshore Manager admitted the agreement’s findings about its New York tax obligations and the business activity behind them. It had allocated none of its income to New York State for tax years 2004 through 2009. Its nonresident members consequently did not pay the State income tax they owed, and Offshore Manager failed to pay the estimated taxes required on their behalf. Its New York resident members also overstated credits for taxes paid to Alabama, reducing their New York tax.

The admitted findings separately address New York City’s unincorporated business tax. For tax years 2004 through 2007, Offshore Manager failed to file the returns, allocate income to the City or pay that tax. The State tax on members’ income and the City’s tax on the business reached different parts of the same fee income.

The audit correspondence supplied an unusually concrete admission. During the State tax department’s audit, PricewaterhouseCoopers represented Offshore Manager and submitted a letter saying all its revenue-generating activity in 2009 had occurred in Alabama. The letter described the New York office as used only to receive mail. Offshore Manager admitted the contrary findings: the office housed investment activity that generated its incentive fees, and that work had been performed there since at least 2002. We see a working investment office reduced to a mail drop.

What the Settlement Required

The agreement allocated $13.5 million to New York City, $9.9 million to New York State and $6.6 million to the whistleblower. The whistleblower award formed part of the settlement amount. A separate outstanding City tax judgment totaled $4,115,240. The agreement required its payment separately.

Deferred Incentive Fees Still Owed New York Tax

The settlement also required payment of New York taxes on deferred incentive-fee income earned during 2004 through 2009. Offshore Manager represented that it received that income effective January 1, 2018, that it was taxable for 2017, and that its fair market value at the end of that tax year was no less than $100 million. That deferred income alone was worth more than the settlement itself.

The respondents agreed to allocate 100% of that deferred income to New York State and New York City on the required returns and pay the resulting taxes. They also agreed to provide information about the deferred income’s source, the assets and payments received, and who owned them.

For a fund accountant or operations professional, those terms connect the fee ledger to assets and distributions. Knowing when the fee was earned, how payment was deferred and what eventually arrived can explain a tax entry that looks disconnected from the original investment work.

The Records Behind the Claimed Business Location

The business-location tax allegations reached beyond a return’s address. The complaint alleges that, during an audit, Offshore Manager changed the principal office in its operating agreement from New York to Birmingham and supplied the new version to the auditor. Earlier versions identified New York during the period being examined.

That is where an insider’s knowledge of the business records matters. The investment-management agreement identifies the work generating the fee. The investment team’s location identifies where that work happened. Allocation analyses, returns and audit correspondence show how the business described the same income to tax authorities. We examine those connections with you, including who chose the allocation and who supplied the account of the office.

The 2014 Villanova Law Review article Not Just Whistling Dixie: The Case for Tax Whistleblowers in the States argues that insiders can close information gaps that leave tax agencies unable to collect what is owed. Its assessment of their position is blunt:

Here, the alleged gap was specific: the auditor received an amended agreement while the earlier versions described the New York office. An insider who knew those versions and the continuing investment work could explain the mismatch alleged in the complaint.

The Whistleblower’s Share Came Through a State Case

This was a state tax False Claims Act case, brought by a whistleblower and pursued by the New York Attorney General and New York City. A whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers. We assess how the tax obligation, business records and your knowledge fit together before bringing in tax fraud whistleblower lawyers with the relevant state experience.

You Know Where the Fund’s Work Happened

If you know why a fund’s fee income reached a different state on its tax returns, talk with our Whistleblower Experts about the decisions behind that allocation. We connect your account of the investment work to the tax records, build your strongest tax whistleblower case alongside you and bring in tax fraud whistleblower lawyers who understand investment-management income. We stay with you through the pursuit of the recovery.