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January 28, 2016
David Bowie: Rock Star of Tax Planning
by Ajay Gupta

Full Text Published by Tax Analysts®

David Bowie, who died January 10 of cancer at age 69, was the ultimate rock star, excelling at branding and rebranding himself. In the words of his song with the same title, he was "The Man Who Sold the World." But he did more than that -- he also went on to shield a big chunk of his income from taxes. Here is a look at some of the many ways in which Ziggy succeeded in throwing stardust in the eyes of the taxman.

Tax Exile

Bowie was among the dozens of celebrities who were linked to accounts at HSBC's Swiss private banking arm in documents obtained and made public in February 2015 by the International Consortium of Investigative Journalists (ICIJ) via the French newspaper Le Monde. When asked about that disclosure, Bowie told ICIJ's media partners that he had been a Swiss resident since 1976.

According to the memoirs of his first wife, Angela Bowie, the then-29-year-old Bowie was confronting impending tax disaster. Having moved from his native England to California, Bowie had been living high off the hog, spending what he earned without giving a thought to paying the tax liability that would inevitably come due. "If David were to remain a resident of California he would have to pay a hefty tax bill -- $300,000 was the figure I was told -- with money he didn't have," his ex-wife wrote. Relaying information provided by Bowie's financial advisers, "these were tax debts accumulated over the previous few years, during which time vast quantities of taxable cash he had generated had vanished into various murky areas," she added.

The highest marginal income tax rate in England then was 83 percent, high enough to dissuade Bowie from thinking about returning there. Instead, Angela, who had been educated in a private school in Switzerland, flew there, hired a Swiss lawyer, and negotiated legal residency for the couple in a small municipality in the canton of Vaud. She recounted in her memoirs, "I got what we wanted, and better: legal residency in Blonay, a charming village above Lake Geneva, near Montreux in the French-speaking part of the country." The bottom line was "an almost ludicrously low tax rate of about 10 percent."

The price for that low tax rate was hardly onerous -- a requirement to "spend significant amounts of time" in Switzerland. Bowie was free to travel overseas for work or even holiday, but he had to return to his Swiss "home." Angela described those sojourns as "being on work release from a very nice, court-ordered health resort."

Bowie divorced Angela in 1980 and in 1992 married the Somali-American model Iman, who is known to prefer the hustle and bustle of London and New York to the bucolic charm of the Swiss countryside. But even though the couple lived primarily in England and the United States, Bowie reportedly established legal residency for tax purposes in Ireland by acquiring a 640-acre estate near Dublin.

This would have worked well for Bowie. Ever since 1969, the Irish tax code has exempted royalty earnings of musicians, writers, and other artists from income tax. That provision is credited with attracting writers like Irvine Welsh, DBC Pierre, and Frederick Forsyth to move to Ireland, and persuading local artists like U2, Enya, and Seamus Heaney to remain there. When Ireland began capping the annual exemption in 2007, some artists (including U2) responded by relocating their music publishing businesses to the Netherlands.

Bowie Bonds

Undoubtedly, Bowie's greatest tax planning exercise made him a major player not just in the entertainment and fashion worlds but also on Wall Street -- the issuance on January 31, 1997, of $55 million worth of so-called Bowie Bonds. The first major securitization of intellectual property rights, these bonds were secured by Bowie's back catalog -- future music royalties on recordings of about 300 songs recorded before 1990 and his exclusive IP rights in them. Issuing the bonds enabled Bowie to raise a large amount of money without requiring him to divest ownership of those IP rights.

Bowie's back catalog constituted musical works and sound recordings under the United States Copyright Act of 1976, allowing him to register his exclusive IP rights in them as copyrights with the U.S. Copyright Office. This afforded him protection in the United States, as well as all other countries that have adopted an international copyright convention (the Berne Convention for the Protection of Literary and Artistic Works or the Universal Copyright Convention) or have a bilateral agreement with the United States.

Bowie transferred his copyrights to a special purpose vehicle (SPV) that issued 10-year debt securities against them and offered a 7.9 percent interest rate, which was 1.53 percentage points higher than the yield on 10-year U.S. Treasury bonds at the time. On redemption of the bonds, the copyrights would revert back to Bowie. A group of investors led by Prudential Financial acquired the bonds in a private placement. As a result of a credit enhancement by EMI Music, Moody's Investors Service rated the bonds A3, investment grade.

For U.S. bankruptcy law purposes, the transfer of copyrights from Bowie to the SPV was structured as a "true sale," so that the copyrights would not be included in Bowie's estate should he become insolvent. Nonetheless, for U.S. tax law purposes, the transfer was structured as a loan or financing rather than as a sale, rendering it a nontaxable event.

As debt obligations of a legal entity that were collateralized by receivables, the Bowie Bonds were considered "pay-through notes" for U.S. tax purposes. Deemed the owner of the underlying receivables and charged with actively managing cash flows to ensure that its debt securities will be paid at their scheduled maturities, the SPV was generally responsible for the income earned on the receivables. To avoid separate entity-level taxation, the SPV is usually structured as either a single-purpose subsidiary of the originator or as a partnership. But because the originator in this case, Bowie, was a nonresident individual, the SPV had to be set up as a trust to avoid separate-entity-level taxation.

The purchasers of the debt securities issued by the SPV were taxed like any other holders of debt, with the interest paid on securities treated as ordinary income, and payment of principal generally treated as nontaxable return of capital.

New Mode of Financing

The success of the Bowie Bonds opened up a whole new avenue of financing for entertainers: securitizing future royalty income. This mode of financing promises the entertainer greater liquidity and increased diversification and offers the financiers a higher rate of return.

The bond structure also enables the entertainer and financier to carve up risk according to their preferences. The entertainer retains ownership of the IP rights, and all increases in their value continue to inure to his benefit. Conversely, in the event of a default on the bonds, the holders can recover only against those IP rights. By comparison, the conventional means of financing -- commercial bank loans -- is generally full recourse loans. Thus, a securitization transaction shifts the risk of poor recording sales to the bondholders while allowing the entertainer to retain the entire upside.

The bondholders benefit from the bankruptcy-remote nature of the SPV. As a result, no liens can attach to the IP rights in the back catalog if the entertainer becomes insolvent, is sued, or gets divorced.

In addition to offering more efficient risk sharing, the structure offers compelling tax benefits. Even if the entertainer is a U.S. resident, he can monetize the value of his back catalog while deferring all taxes until the song recordings are sold and royalties actually earned. The entertainer may also be able to deduct the interest paid on the bonds if he is deemed to be engaged in a trade or business and the loan proceeds are used for a business purpose. Alternatively, if he uses the loan proceeds to generate investment income, he may deduct the interest on the bonds up to the amount of that investment income. Finally, if the royalty stream exceeds the interest and principal payments made to amortize the loan, the entertainer can use the excess to pay the income taxes on the royalty payments.

Also attractive to domestic entertainers is the benefit of better estate planning. Securitizing royalty income can provide sufficient funds for the estate of a deceased entertainer to pay estate taxes without having to sell the IP rights. Moreover, once the IP rights pass to an heir, taxes on any appreciation during the term of the loan would not just be deferred but may even be wiped out by a step-up in basis.

The issuance of Bowie Bonds was rightly seen as cutting-edge, and the investment banker who set it up claims to have created similar deals for other artists, including James Brown, Ashford & Simpson, and Marvin Gaye.

But in forging ahead with the Bowie Bonds, Bowie's greatest success appears to have been his ability to time the market. Seemingly, he could foretell the emergence of streaming, peer-to-peer networks, and online music sharing, all of which have played havoc with the music industry and weakened royalty revenues. In a 2002 interview with The New York Times, Bowie ominously warned that copyright would cease to exist in 10 years' time and that music would likely become a commodity "like running water or electricity." Indeed, in March 2004, Moody's downgraded Bowie Bonds to one notch above junk status, noting that revenue from Bowie's back catalog was lower than expected because of "weakness in sales for recorded music." In consummating the Bowie Bonds deal when he did, not only was Bowie able to reap tax savings, he divested himself of his back catalog's market risk.

In any event, there was no reported default on the Bowie Bonds. Prudential Financial and the other original investors seem to have held on to them until redemption, when they were presumably paid in full. Moreover, the IP rights in Bowie's back catalog must have reverted to him free and clear at redemption. So apparently, the Bowie Bonds performed as envisaged, with both Bowie and the investors achieving their objectives.

Press reports pegged Bowie's net worth at $230 million at the time of his death. In show business since the age of 15, Bowie had been continually reinventing himself. After tasting initial success following a rocky start, in a BBC interview Bowie characterized his varied performances as alternatively those of a mime, songwriter, and singer, and traced his motivation: "I didn't want to be a trend. I wanted to be the instigator of new ideas." Those new ideas extended beyond music and fashion to encompass pioneering financial engineering and tax planning.

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