Audits: Vanguard income taxes 'deficient' for 2010-14

Mutual-fund giant Vanguard Group underpaid taxes on its income in Texas for 2010-14, according to records of the Texas Comptroller of Public Accounts. State-sponsored audits found payment "deficiency" for all four years in Vanguard's payments of the state's corporate franchise tax, which charged companies 1 percent percent of a company's sales, minus costs, in the Lone Star State.

The disclosure comes amid review of Vanguard's tax payments by state and federal agencies after allegations by former Vanguard tax attorney David Danon. Danon told agencies that the $3.4 trillion-asset, privately-held company's use of "at-cost" expenses in setting professional-service fees collected from Vanguard-brand mutual funds wrongly ignored federal tax rules, which call for market-rate prices on payments between affiliated companies. Danon alleges that Vanguard's well-known low fees were based on illegal tax avoidance, enabling the Malvern-based company to unfairly win business from rivals. The company has said it complies with the law.

Texas tax officials won't say how much Vanguard owed or repaid after it was caught. But state tax agency documents show Texas agreed in October to award $117,000 to ex-tax-lawyer Danon, who began reporting alleged Vanguard income tax underpayments to federal and state agencies before Vanguard fired him in early 2013. Applying Texas' 1 percent franchise income tax rate, and its 5 percent "informant's recovery payment" ceiling, Danon's award implies Vanguard failed to report a minimum of $234 million in Texas taxable income for 2010-14.

Given Texas' size (home to 1 in 14 Americans), if the federal Internal Revenue Service (which charges corporations up to 35 percent in annual income taxes) and other states were to find that Vanguard had similarly underpaid other income taxes, Vanguard might have underreported more than $3 billion in taxable income, and could owe $1 billion or more in back taxes.

Vanguard officials didn't immediately respond to inquiries seeking comment on Texas' finding.  Vanguard spokesman John Woerth told a Bloomberg LP reporter last week that Vanguard had not paid penalties in settling Texas claims; that payments to Texas had followed a routine audit; and that Vanguard believes it pays "fair and appropriate" taxes.

Earlier this month New York Judge Joan Madden granted Vanguard's request to bar Danon from suing to collect a whistleblower's cut of any back taxes New York State might collect using Danon's information on Vanguard. Madden endorsed Vanguard's argument that Danon as a company employee was barred under New York State attorney ethics rules from expecting to get paid for turning in his employer. Vanguard's Woerth said the company applauded the judge's ruling, which did not address whether Vanguard had paid its taxes improperly or not.

Stephen Sorensen, Danon's lawyer, tells me Danon plans to appeal, arguing that Madden's "decision does not reflect the current state of the law regarding whistleblowing."

Sorensen added that Madden's decision "has no effect on the SEC or the IRS" and their reviews of Danon's allegations. He also said Danon "could still be paid" by New York State, as he was by Texas, if the state ultimately collects back taxes with assistance from Vanguard's information and tax officials decide Danon's information was helpful, even if he was turning in his employer.

Other states including California and New Jersey have also been reviewing Vanguard income reporting and tax allegations, Sorensen confirmed.