The Vanguard Case Reconsidered

10 Pages Posted: 7 Apr 2016

See all articles by Daniel J. Hemel

Daniel J. Hemel

New York University School of Law

Date Written: March 21, 2016


Recent news reports have suggested that the Vanguard Group family of mutual funds may need to quadruple investors’ fees to cover corporate income tax liabilities. Professor Reuven Avi-Yonah has estimated that Vanguard’s federal tax liability for the 2007-2014 period is roughly $34.6 billion. For the more than 20 million investors in Vanguard funds, the potential financial implications of the tax dispute are significant: Vanguard would presumably pass its tax costs along to customers, leading to higher expense ratios and lower returns. For observers of the IRS, the issue is an important one as well: A $34.6 billion recovery from Vanguard would be multiples more than what the IRS has ever recouped from a taxpayer in a transfer pricing case.

Yet as this article argues, fears that Vanguard fees might quadruple for tax-related reasons are wildly overblown. Moreover, even if one accepts Avi-Yonah’s major premise that Vanguard’s investment management company should pay corporate income tax on transactions with individual funds as if those transactions occurred at an arm’s-length price, Avi-Yonah’s estimate of Vanguard’s potential tax liability is implausibly high. And if the IRS did seek to recoup back taxes and penalties from Vanguard, the mutual fund family might be able to restructure itself to eliminate corporate income tax liability in future years.

None of this is to deny that the IRS may be able to recover a significant sum if it pursues a case against Vanguard and persuades a court to adopt Avi-Yonah’s major premise. Using the best available data, and assuming that an arm’s-length standard should apply, this article estimates that Vanguard’s past due taxes for the 2007-2014 period are in the range of $3.7 billion to $6.5 billion. The imposition of penalties potentially increases those figures by up to 40 percent, but even then, the consequences for Vanguard — and its investors — would not be catastrophic. This article explains the assumptions underlying Avi-Yonah’s calculation and recomputes Vanguard’s federal tax liability using what I argue is a more realistic set of assumptions. The article then evaluates Vanguard’s ability to reduce its tax liabilities in the future through a change in organizational structure. Finally, the article discusses some of the factors that the IRS should consider in deciding whether to seek recovery from Vanguard.

Keywords: tax, transfer pricing, mutual funds, Vanguard

JEL Classification: G2, H2, H25, K34

Suggested Citation

Hemel, Daniel J., The Vanguard Case Reconsidered (March 21, 2016). Tax Notes, Vol. 150, p. 1466, March 21, 2016, Available at SSRN:

Daniel J. Hemel (Contact Author)

New York University School of Law ( email )

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