Alphabet
Soup
In
February, 2005, the
Treasury Department and the Internal Revenue
Service issued guidance that designated "sale-in/lease-out"
or "SILO" arrangements as abusive tax avoidance
transactions.
According
to the tax authorities, SILO arrangements are
designed to exploit the tax law by shifting
tax benefits from a tax-indifferent party that
cannot use them to a taxpayer that can.
Taxpayers
entering into SILO arrangements cannot claim
tax benefits as the purported owners of property
subject to a lease because they do not acquire
tax ownership of the property.
In
the American Jobs Creation Act of 2004, Congress
enacted limitations on the deductibility of
losses from future SILO transactions. The Notice
informed taxpayers that the IRS would challenge
the purported tax benefits claimed by taxpayers
entering into earlier SILO transactions on a
number of grounds. It further stated that SILOs
are considered ‘listed transactions.’
Taxpayers
who enter into SILOs and who are required to
file tax returns must disclose their participation
to the IRS. In addition, promoters of listed
transactions must keep lists of investors and,
in certain cases, register those transactions
with the IRS.
In
March of that year, the IRS announced that more
than $3.2 billion had been collected from over
1,000 taxpayers who participated in the Son
of Boss tax shelter settlement scheme, a total
that is expected to rise.
The figure included back taxes, fines and interest
paid by the 1,165 taxpayers who had participated
in the scheme at that point, and according to
the IRS, the typical taxpayer payment was almost
$1 million, with 18 taxpayers paying more than
$20 million each. One taxpayer alone was said
to have paid over $100 million.
Son of Boss evolved from an earlier scheme known
as ‘BOSS’ (bond and option sales strategy).
The scheme utilised a complex set of derivative
transactions to reduce tax liability and was
commonly used in the late 1990s to offset large
one-off gains such as the sale of a business.
Under the stringent terms of the settlement
initiative, taxpayers were required to concede
100% of the claimed tax losses and pay a penalty
of either 10% or 20% of the total, unless they
had previously disclosed the transactions to
the IRS.
“This
was a particularly bad shelter, and we’re glad
so many chose to get right with the government,”
commented IRS Commissioner Mark W. Everson.
“Despite
the tough terms we offered, two-thirds of Son
of Boss participants have come forward and paid
up,” he added.
Based on disclosures the IRS has received from
promoter investigations and from investor lists
from Justice Department litigation, the agency
believed that more than 1,800 people participated
in Son of Boss. It is predicted that the total
revenue yield from the settlement scheme would
exceed $3.5 billion.
The Son of Boss ‘amnesty’ also benefited the
coffers of various state governments, with Arizona,
Illinois, Maine, Maryland, Michigan, New York,
Ohio, Utah and Virginia having collected more
than $23.5 million from voluntary state tax
return amendments.
Furthermore, under an information sharing initiative
between the IRS and state tax authorities, an
additional $161 million in disallowed losses,
and assessments of nearly $16 million in taxes,
interest and penalties, were uncovered by the
states of Colorado, Connecticut, Maine, Maryland,
Missouri, North Dakota, Pennsylvania, Utah and
Virginia.
Ever keen to emphasise the agency’s recent hard
line policy on tax shelters, Commissioner Everson
issued a stern warning to those yet to participate
in the Son of Boss settlement initiative.
“For
those who didn’t come forward, we know who they
are (and) we are going after them,” he stated.
In
April 2005, Senate Finance Committee Chairman
Charles Grassley criticized tax legislation
which he helped to write for allowing firms
to take advantage of tax loopholes for an extra
year.
During
a committee hearing focusing on the US 'tax
gap,' which is estimated at $312 billion, Grassley
expressed frustration that the "watered down"
final version of the American Jobs Creation
Act had permitted firms to continue exploiting
large depreciation allowances in leasing arrangements
with state and local governments known as LILOs
and SILOs (lease in lease out, and sale in lease
out).
In
particular, Grassley was angered by a provision
allowing existing leasing arrangements to proceed
if they had been submitted for approval by the
Federal Transit Administration after June 30,
2003, and before March 13, 2004.
"Incredibly,
this provides shelter promoters another full
year to get their deals approved by the FTA.
Treasury's has been forced to grandfather in
these rotten deals because of the bill's effective
dates," Grassley remarked.
The
Senate version of the bill called for the tax
shelters to be closed down with effect from
November 17, 2003, in a measure which would
have raised more than $40 billion in revenues
over ten years.
However,
Grassley went on to argue that: "There's no
way these deals deserve another year."
Sen.
Grassley also asked the Transportation Department
for details of any corporate tax shelters involving
the leasing of bridges and sewer systems that
might be grandfathered under the American Jobs
Creation Act of 2004.
In
a letter to Transportation Secretary Norm Mineta,
Grassley asked for details of all pending requests
for approval of such tax shelters. Grassley
also urged the secretary to discourage these
deals.
“We
exerted great effort in Congress to shut down
this abuse, but the transition relief in the
American Jobs Creation Act is a sop to shelter
promoters and an insult to the American taxpayer,”
Grassley wrote. “Corporations have no right
to claim tax deductions for bridges, subways,
and sewage pipes that were built with taxpayer
dollars.”
The
text of Grassley’s letter follows:
"On
November 17, 2003, I wrote to you to enlist
the assistance of the Department of Transportation
in the Committee on Finance’s ongoing investigation
of an abusive tax shelter that has come to be
known as LILOs – an abbreviation for “lease-in-lease-out”
transactions, and SILOs – the successor to LILOs
called “service-in-lease-out” agreements. Other
variations on these transactions have involved
qualified technology equipment (QTE). A copy
of our November 17th letter is attached.
"On
January 20, 2004, you responded to our inquiry
by advising us that after the release of Revenue
Ruling 99-14 in March 1999, the Department of
Transportation’s Federal Transit Administration
(FTA) has not received, reviewed, or concurred
in any LILO transaction. You indicated, however,
that LILO promoters mutated those transactions
into SILOs, and the first notice received by
your department that SILO transactions were
under challenge by the Department of Treasury
was a November 26, 2003, letter from Treasury’s
Assistant Secretary for Tax Policy. Presumably,
the Department of Transportation ceased reviewing
and approving SILO transactions on the receipt
of Treasury’s letter, although your response
did not confirm this to be the case. In February
2004, the staff of the FTA provided the Committee
on Finance with a list of leveraged lease transactions
submitted to and reviewed by the FTA from June
1988 though September 2003.
"Subsequent
to our exchange of letters, Congress enacted
the American Jobs Creation Act of 2004, which
outlawed LILOs and SILOs, albeit not without
considerable concessions to the interests of
shelter promoters that were in the process of
setting up these abusive schemes. Under the
Senatepassed version of the American Jobs Creation
Act of 2004, LILOs and SILOs would have been
shut down as of November 17, 2003, the day that
I sent you the letter. For LILOs and SILOs involving
public assets of foreign jurisdictions, U.S.
tax deductions would have ended on February
1, 2004, regardless of whether the foreign lease
was entered into before November 17, 2003. In
conference, however, these tough effective dates
were watered down and delayed.
"The
enacted bill doesn’t take effect until March
13, 2004, nearly 4 months later than the Senate
bill. Incredibly, the enacted bill gave leasing
shelter promoters more than a year to get their
deals-inprocess approved by your department.
The bill grandfathers domestic property leases
if 1) the leases had been submitted for approval
by the FTA after June 30, 2003, and before March
13, 2004; 2) the FTA approves the leasing shelter
arrangement before January 1, 2006; and 3) the
FTA application includes a description and the
fair market value of the property.
"We
exerted great effort in Congress to shut down
this abuse, but the transition relief in the
American Jobs Creation Act is a sop to shelter
promoters and an insult to the American taxpayer.
Corporations have no right to claim tax deductions
for bridges, subways, and sewage pipes that
were built with taxpayer dollars. As part of
our continuing effort to stop this abuse, I
ask that the Department of Transportation submit
to the Committee on Finance copies of all LILOs,
SILOs, QTE leases, and similar transactions
that had been submitted for approval by the
FTA after June 30, 2003, and before March 13,
2004. I also request a list of all such transactions
that have been “approved” by the FTA as of the
date of your response.
"Notwithstanding
the grandfathering provisions of the American
Jobs Creation Act, we would welcome assurances
that FTA no longer approves SILO transactions,
effective as of the date of the letter you received
from the Assistant Secretary of Tax Policy.
We also seek assurances that FTA has not approved
any LILO transaction since the release of Revenue
Ruling 99-14 in March 1999.
"I
also request documentation regarding any other
LILO, SILO, QTE or similar transactions that
have been approved, funded, or otherwise reviewed
by the Department of Transportation from the
date of the FTA’s last response to the Finance
Committee to the date of your response to this
letter, provided that any such transactions
is not otherwise covered by the above request.
"I
appreciate your cooperation in our ongoing efforts
to combat abusive tax shelters and look forward
to receiving these materials within the next
three weeks."
In
January 2007, the IRS won a significant court
victory in its fight to outlaw the use of LILO
shelters.
Judge
Norwood Tilley ruled in the US District Court
in North Carolina that a leasing arrangement
used by financial services firm BB&T Corp.
had no other purpose than to reduce its tax
liability.
BB&T
had used a LILO arrangement to lease wood-pulp
facilities owned by a Swedish company, Sodra
Cell AB. Under LILO arrangements, companies
pay an accommodation fee to lease facilities
from another company or a municipality, but
then claim depreciation on these facilities
to reduce their tax bill.
BB&T
had attempted to claim a tax refund of $3.3
million which stemmed from a 1997 lease transaction,
but the request was denied by the IRS and the
company subsequently went to court to appeal
the agency's decision.
According
to Dow Jones Newswires, BB&T disagreed with
the court's verdict and planned a further appeal.
"We
had hoped to go to trial based on the strength
of our case," spokesman Bob Denham was
quoted as stating.
The
court's decision was welcomed by Eileen J. O'Connor
Assistant Attorney General for the Justice Department's
Tax Division.
"To
have a tax deduction for lease or interest expense,
you must actually incur them. And to incur them,
you must have a genuine lease and genuine indebtedness,
respectively," she said in a statement.
"In
BB&T vs. United States of America, the District
Court found that the Lease-In, Lease-Out tax
shelter involved neither, and therefore does
not result in the tax deductions claimed by
those who participate in it," she concluded.
Also
in January 2007, the Senate Finance Committee
passed a series of measures cracking down on
tax shelter abuses.
As
previously stated, Grassley originally developed
the bipartisan measures when he was chairman;
the Senate passed them before but the House
resisted them and they were never enacted.
“We
need to keep cracking down on tax avoidance
abuse,” Grassley said. “Every taxpayer
who doesn’t pay what he owes makes a sucker
out of everyone who does. It’s appropriate
to shut down abuse and use the money from that
to help small businesses preserve jobs as they
face a minimum wage increase.”
The
committee unanimously passed the tax shelter
loophole closers as part of the Small Business
and Work Opportunity Act of 2007, which extends
tax relief for small businesses in conjunction
with an expected minimum wage increase. The
tax relief includes a tax credit to hire disadvantaged
workers and allows retailers and restaurant
owners to more quickly write off the costs of
remodeling leased buildings.
The
tax loophole closers approved as part of the
package include:
A
further crackdown on leasing tax shelters:
These leases involve companies that pretend
to sell or lease taxpayer-funded public works
systems, such as subways and sewers, and then
lease them back to the cities. The companies
claim depreciation on these taxpayer-funded
assets, while the cities get up-front money
from the tax shelter promoter that Grassley
has called “chump change”, compared
to what the companies get. Under Grassley’s
leadership, Congress in 2004 largely outlawed
tax benefits from these transactions. Grassley
and Sen. Max Baucus have argued that even in
cases of leases entered into before the 2004
law, the holders of the shelters should not
gain future benefits, especially if the lessee
is a foreign person or company, because these
deals are so abusive.
The
2004 law mainly restricts leases entered into
after March 12, 2004. The new legislation prevents
companies from receiving tax benefits for leases
entered into with foreign entities on or before
March 12, 2004.
Further
restriction on 'corporate inversions': In
this practice, US companies relocate nominally
in overseas tax havens to reduce their US taxes.
The 2004 tax law restricted such transactions
after March 4, 2003. The bill approved in committee
Wednesday moves back the effective date to March
20, 2002, when Grassley and Baucus warned companies
considering these deals to proceed at their
own peril. This change is meant to capture any
inversions that occurred in a rush to beat the
new crackdown.
A
prohibition of the deduction of civil regulatory
fines and penalties, as well as punitive damages
from a lawsuit, on federal tax returns: This
grew out of some companies’ attempts to
deduct the expense of settling cases with the
government over wrongdoing.
Encouragement
of tax whistleblowers: These further
refinements will help make sure the Internal
Revenue Service fully encourages whistleblowers
to come forward with information about tax cheats.
Grassley sees this as an effort to help close
the approximately $350 billion gap between taxes
owed and taxes paid.
Grassley
said the loophole closers are a logical follow-up
to the American Jobs Creation Act of 2004, which
under his authorship in the Senate offered the
strongest crackdown on tax shelters since 1986.
“It’s
only fair to fight tax avoidance abuse while
giving continued tax relief to encourage job
retention and creation,” Grassley said.
“Those who play by the rules deserve consideration,
and those who abuse the tax code deserve a crackdown.”
However,
in April 2007, it emerged that the provisions
had been omitted from tax cut legislation moving
through Congress.
"Tax
gap measures are yesterday’s news. Corporate
inversion and leasing deal crackdowns are in
the dust bin," Grassley remarked in response
to an House-Senate tax agreement, which aims
to provide tax relief to small businesses affected
by the proposal to increase the federal minimum
wage to $7.25 per hour from $5.15.
"It’s
a real headscratcher. The Democratic leaders
say they want to shut down tax shelters but
when they have a chance to do it, we get a package
that’s the toast of tax shelter hucksters,"
he added.
Included
in the pre-conference Senate bill, which Grassley
was instrumental in drafting, were the aforementioned
offset provisions which would have closed loopholes,
shelters and offshore arrangements such as sale-in
lease-out (SILO) shelters on foreign properties.
It also included measures against offshore corporate
inversions, and a doubling of some fines, penalties
and interest on underpayments related to certain
offshore financial arrangements.
However,
these have been omitted from the provisions
agreed by the leaders of the Senate Finance
Committee and the House Ways and Means Committee
as part of a military spending package.
In
May 2005, measures to stamp out some corporate
tax shelters were added to a $295 billion highway
bill pending in the Senate.
The
180-page bill, which included items dealing
with excise taxes, alcohol tax and fuel taxes,
contained just under $20 billion in revenue
raising items added by the Senate Finance Committee
in order to boost highway spending without adding
to the budget deficit.
The
most crucial of these measures is the "economic
substance" doctrine to prevent firms from entering
into transactions that have no economic basis,
used solely in order to produce a tax gain.
According
to Charles Grassley, who has led the charge
against corporate tax sheltering in recent times,
particularly on the issue of SILOs (sale in
lease out) arrangements, the new legislation
will end "an exceedingly generous transition
rule permitting leasing tax shelter abuse in
the transportation sector."
The
bill also modifies the tax treatment of contingent
payment convertible debt instruments, raising
$462 million through 2015. This is designed
to curtail a financial product tax strategy
that allows debt issuers to claim an enhanced
interest deduction.
Other
measures will compel company bosses to sign
a declaration that the firm's tax return is
fully compliant with the law, and create a 'whistleblower's
office' at the Internal Revenue Service allowing
the agency to deal more effectively with those
volunteering "valuable information about tax
violations."
This
latter provision will raise an additional $407
million in revenues through 2015.
In
July 2006, an US appeals court overturned a
previous ruling in favor of Coltec Industries
Inc, a former subsidiary of Goodrich, a major
manufacturer of aircraft landing systems.
In
a ruling representing a victory for the IRS,
the three judges on the US Court of Appeals
for the Federal Circuit panel agreed with the
tax authority that Coltec had used a transaction
known as a contingent liability deal to artificially
generate capital losses which the firm then
used to offset capital gains from the sale of
a business unit in 1996.
Applying
the much-debated 'economic substance' test,
the judges wrote that the law as it stands "does
not permit the taxpayer to reap tax benefits
from a transaction that lacks economic reality”.
The judges went on to write that a lack of economic
substance "is sufficient to disqualify
the transaction without proof that the taxpayer’s
sole motive is tax avoidance”.
Their
decision overturned a judgment by Judge Susan
Branden in the US Court of Federal Claims in
2004, which rejected the IRS’s argument
that the transactions had no economic purpose.
Branden stated that, in her opinion, Coltec
had complied with all the statutory requirements
laid down by Congress and awarded the company
an $82.8 million refund.
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