In its attempt to benefit clients by providing a straightforward yet diversified investments service at a low cost, Vanguard may have committed an IRS infraction based on some obscure details in its tax accounting and corporate structure, writes The New York Times.   

In the in depth article, the paper looks into all sides of the issue, illuminating in the process the rather unique structure and procedures of the continuously growing mutual fund company.

Founded in 1975 by John C. Bogle, Vanguard has uncompromisingly reduced costs for fund shareholders by providing its clients with simple index funds and “at cost” operations to the point where they are costing investors only 0.16% annually, significantly lower than the 1.16% average for the industry.

The way Vanguard Group is set-up is that instead of a separate profit-making entity, the mutual fund shareholders are its ultimate owners, while the Group provides services to the individual funds in an agreement approved by the Securities and Exchange Commission.

While the company manages to achieve lower costs through this innovative corporate structure, it is also the root of the tax complaint leveled against the company by a whistle-blower.

“Vanguard was designed to eliminate conflicts of interest,” commented Tamar Frankel, a professor of law at Boston University. “That structure was also one of the ways in which Jack Bogle reduced the cost for investors, and it’s been an absolutely great thing.”

However, while most praise the process, David Danon, a former Vanguard tax lawyer, claims that through its structure Vanguard may have broken some IRS rules. Basically, Danon claims that since the Vanguard Group was not set up as a partnership but a “C corporation,” it can potentially have tax liabilities despite not earning a profit.

Even though it is owned by its mutual funds, it is still required to account for the profits that it could have earned had it charged more in fees which, according to Danon, affirms that Vanguard could owe billions in taxes on uncollected revenue.

“I know that this is a very unpopular position, and that many, many people are shareholders of Vanguard funds,” he commented in an interview. “But the law is the law. Like everybody else, Vanguard should pay the taxes it owes. If it doesn’t, somebody else has to make up the difference, and that’s just not fair.”

The IRS refused to comment on the claims, while John Woerth, a spokesman for Vanguard, stated that “Vanguard believes they are without merit.”