> 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.

Customers being owners is not that odd; it's called vertical integration.

In the context of B2B it's not at all odd, you're right. (In fact, that's the whole reason transfer pricing rules exist.)

In the current era, it is however uncommon for consumers to simultaneously own and (exclusively) be the customers of a company. (Historically, that is of course the entire principle of mutual funds.)

This is what co-ops are, and as far as I know they do not face special tax reporting or payments.

Depending on structure, co-ops often do face special tax reporting requirements.

Moreover, in this case the fact that Vanguard is a co-op is a redeeming factor. If it were a typical corporation charging itself below-market transfer prices, that would likely be illegal.

Honest question: if the California subsidiary is able to provide those services at the set fees (i.e. pay salaries, etc.), how can it be considered "below market price"? Is it required by law to make a profit?

It's fairly nuanced and there are different standards used, but one key one is arm's length pricing. You need to charge what you would charge an arm's length customer (ie. market price).

Another standard does, in fact, set a minimum level of transactional profit based on comparable businesses. [0]

[0] https://en.wikipedia.org/wiki/Transfer_pricing#Comparable_pr...

So, shouldn't the investors then owe back taxes based on unpaid expense fees?

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.

Please stop being rude in Hacker News comments. This comment breaks the HN guidelines in more ways than one.

https://news.ycombinator.com/newsguidelines.html

https://news.ycombinator.com/newswelcome.html

Apologies, and thanks for calling me out on this rather than "go directly to hellban, do not pass go, do not collect $200".

Crappy morning lead to unwarranted piss-poor attitude. No excuse, but wanted you to know that I appreciate rehabilitation rather than punishment!

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-fee...

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.

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?

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.

> 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.

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.

Fair enough. But that's why some investors prefer not-for-profit funds, no? There's nothing underhanded going on.

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.

It is true that most (maybe virtually all) not-for-profits serve the general public, more or less, and not just their owners.

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.

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.

No it isn't transfer pricing is transferring profits from a low to high tax country eg UK-> IE.

Yes, in general that's the goal of transfer pricing. However, the way the rules are written it's not clear if they also apply to this case, particularly because the IRS does not recognize intent as a factor in transfer pricing rules.

To be clear, I do think this should be legal and kosher. But I sort of see how the argument could be made.

Avoid taxes = reduce costs, as long as it's legal.

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.

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.