stlutz wrote:After reading a few different articles, I think I have it figured out. What Vanguard should be doing tax-wise is charging the funds market prices for the services it provides, paying taxes on those profits, and then distributing those profits back to the funds. In fact, it is doing neither. On one hand it is charging below market prices to avoid paying taxes but on the other hand it has accumulated $1.5B in profits over the years that have not been distributed back to the owners (i.e. the funds). It has to be one or the other.
Can any of the tax/legal experts confirm if I have that right?
You are correct. Vanguard s charging allegedly below-market rates to the funds, ergo avoiding profits and taxes on those profits. It has simultaneously accumulated $1.5 billions in profits that it allegedly should have paid taxes on. I suppose the theory is that if vanguard charged market rates for the services it provides to the funds, it would have a lot more than $1.5 billion in profits. But the $1.5 billion in profits is a separate issue from under charging the funds for services. Also, the $1.5 billion has been accumulated over time, not all in one year.
How this would affect us as investors is: if vanguard were forced to charge the funds higher fees, then vanguard would have profits and have to pay part of those profits to the government. The rest of the profits could be distributed to the funds, but the funds would have lost the money paid as a tax expense. So, in order for the funds to make up for the tax expense, we get higher e/r. Still, worst case scenario you're looking at a 50% increase in e/r, which is very cheap compared to a lot of funds.
I see this as an attack on the very concept of a mutually held company. If your owners and customers are by definition the same class of people, then you can't operate for the maximum benefit of your ownership without operating for the maximum benefit of your customers. The only other option is for the taxing authority to come in and make business decisions, which is antagonistic to the very concept of capitalism (owners make their own choices with as little government interference as possible) and the foundation of corporate law (that ownership and control can be separated, but the owners choose the controllers).