Tax
Shelters In 2005
In
February, President Bush’s 2006 budget document
contained clauses seeking to restrict the use
of a corporate tax shelter in which companies
attempt to reduce tax by buying back their stock
held by other companies.
The
scheme, known as a ‘cash-rich split-off,’ allows
firms to use cash for up to 90% of the buyback
value, while the remaining 10% can be paid for
by selling a small business asset, which has
to have been operated for five years or more.
However,
under new revenue-raising and tax compliance
measures contained in the 2006 budget proposals,
firms could only use cash for a maximum of half
the value of the buyback, with a significant
asset having to be traded for the remainder.
According
to the Wall Street Journal, the Treasury Department
estimated that the proposed change would raise
$87 million in tax revenue over the next 10
years.
Although
this figure is relatively small, a Treasury
Department official explained to the Journal
that this is because firms are likely to be
deterred from using the structure.
In
the same month, a new report by the Government
Accountability Office found that more than 10%
of Fortune 500 firms bought tax shelter advice
from the same accounting firms they hired to
independently audit their financial statements
over a five year period to 2003.
Using
data compiled by Standard & Poor’s and the Internal
Revenue Service, the GAO found that between
1998 and 2003, 207 of the Fortune 500 companies,
(or 40%) purchased tax shelter services from
a third party, of which 114 obtained them from
an accounting firm, and 61 from their own auditors.
The
findings are likely to intensify calls for tougher
rules to ensure that the independence of financial
auditors is maintained, and that conflicts of
interest are reduced. They also came two months
after the accounting industry regulator, the
Public Company Accounting Oversight Board, released
proposals that would restrict the ability of
auditors to offer tax advice to their clients.
According
to Senator Carl Levin (D – Michigan) who released
the GAO report, the findings reveal that tax
shelters are being “mass marketed by major accounting
firms,” and strengthen the argument that the
PCAOB proposals should be introduced to curb
these conflicts of interest.
“Today’s
GAO report provides further evidence of accounting
firm involvement in tax shelters and why the
new rules are needed. If we are going to restore
public confidence in the financial statements
of our public companies, auditors of those companies
can’t be selling them abusive tax shelters that
distort and misrepresent the companies’ tax
liabilities and income,” Levin commented.
The
PCAOB proposals would bar accounting firms from
obtaining contingent fees from their audit clients,
providing tax services to audit client executives,
and promoting aggressive tax positions to the
public companies they audit.
In
a 13-page letter supporting the proposed rules,
Levin argued that the proposals should be strengthened
so that firms can avoid the appearance of a
conflict of interest as well as actual conflicts.
Levin
also recommended allowing accounting firms to
promote only those tax products which would
be very likely to be upheld in court.
In
March, US Internal Revenue Service chief Mark
W. Everson said that an international tax force
established to monitor tax avoidance by multinational
corporations had provided national tax authorities
with invaluable information on aggressive corporate
tax planning techniques.
The
task force, which came into being in 2004 and
is known as the Joint International Tax Shelter
Information Centre, is an information sharing
initiative involving the governments of the
United States, United Kingdom, Canada and Australia.
The
main focus of the group is the scrutiny of corporate
tax arbitrage and transfer pricing arrangements.
However, it is also examining the role played
by accountants, bankers and lawyers who dispense
advice to multinationals on tax planning issues.
"We
have seen things we either would never have
picked up or would have picked up years down
the road," Mr Everson told the Financial Times.
"We
have seen a series of kinds of transactions,
or in some cases particular transactions, that
merit follow-up by the individual taxing authorities,"
he added.
"There
are some indications in what we are seeing now
that entities are trying to structure transactions
which result in the payment of no tax at all.
That is clearly of concern," Mr Everson observed.
According
to the FT, the initial findings of the task
force would be analysed by the four participating
tax authorities later in the spring, when the
possibility of expanding membership to include
other countries, especially from Europe and
Asia, would also be discussed.
In
August, Sen. Carl Levin, D-Mich., and Sen. Norm
Coleman, R-Minn. introduced a bill in the Senate
to combat what they term 'abusive tax shelters
and uncooperative offshore tax havens used by
businesses and individuals to dodge payment
of their US taxes'.
Levin and Coleman introduced a similar bill
in 2004, The Tax Shelter and Tax Haven Reform
Act, S. 2210, which was read twice and referred
to the Committe on Finance, where it died in
December, 2004. The 2004 bill was very similar
to the new one. Although it was unsuccessful,
some of its provisions made it into law by being
attached to other pieces of legislation, including
stronger penalties for failing to report interests
in foreign financial accounts, civil fines for
tax practitioners such as accountants and attorneys
who violate specified standards of practice,
stronger penalties for failing to register or
provide to the IRS required information regarding
a potentially abusive tax shelter, and stronger
penalties for failing to maintain a list of
participants in potentially abusive tax shelters.
The
2004 bill also sought to stiffen the penalties
imposed on abusive tax shelter promoters from
$1,000 per offense to a penalty equal to 150%
of the promoter’s profits from selling the abusive
shelter. The penalty has since been raised to
50%, but did not go as far as provided in the
Levin-Coleman bill. The Senators said: “The
penalty increase enacted by Congress in 2004
was a significant improvement over prior law,
but letting promoters of abusive tax shelters
keep 50% of their ill-gotten gains doesn’t make
sense. Congress needs to take stronger action
by denying persons who promote tax cheating
not only all of their illegal profits, but also
requiring their payment of a stiff fine on top
of that.”
For the last three years, Levin and Coleman,
the senior Democrat and Chairman of the Senate
Permanent Subcommittee on Investigations respectively,
have been pursuing an investigation into tax
shelters developed, marketed, and carried out
by accounting firms, banks, investment advisors,
and lawyers.
“These
tax advisors are getting hundreds of millions
of dollars in fees, while robbing the U.S. Treasury
of billions of dollars in revenues each year,”
said Levin. “We need to strengthen the laws
and enforcement mechanisms to stop promoters
of abusive tax shelters. We also need to take
stronger measures to stop use of offshore tax
havens for tax dodges.”
“Abusive
tax shelters and uncooperative tax havens undermine
our tax system, forcing honest taxpayers to
pay more than their fair share,” Coleman said.
“We need to give honest, hardworking Americans
a better deal – by cracking down on those who
choose not to pay their fair share in taxes.”
The
Tax Shelter and Tax Haven Reform Act of 2005
proposes the following measures, among others,
to clamp down on tax abusers:
- Increase
penalties to 150% on persons who promote abusive
tax shelters or knowingly aid or abet taxpayers
to understate their tax liability. Currently,
promoters face only a 50 percent penalty,
and aiders and abettors face a maximum penalty
of $10,000.
- Prevent
abusive tax shelters by prohibiting tax advisors
from charging fees linked to alleged tax savings,
mandating examination procedures to identify
banks contributing to abusive tax shelters,
encouraging whistleblowers who report tax
schemes, and authorizing the IRS to work with
federal agencies like the SEC and bank regulators
to strengthen abusive tax shelter enforcement.
- Clarify
and codify the economic substance doctrine
and by strengthening the penalties for tax
transactions lacking economic substance.
- Authorize
the Treasury to publish an annual list of
uncooperative tax havens, and by ending U.S.
tax benefits and requiring greater disclosure
for taxpayers transferring funds to such uncooperative
tax havens.
In
September, Minnesota offered a voluntary compliance
program for taxpayers who had participated in
potentially abusive tax shelters and transactions
as determined by the Internal Revenue Service
(IRS).
By
participating in this program, taxpayers could
avoid substantial new penalties authorized under
a new Minnesota law, said Minnesota's Department
of Revenue. Minnesota expected the program to
generate $57 million in additional tax revenue
during 2006 and 2007.
The
program, which follows similar programs conducted
in California and Illinois, gave residents who
had used abusive tax shelters until Jan. 31
to amend their tax returns without facing new
penalties passed during the 2005 special legislative
session.
Under
the voluntary compliance program, taxpayers
can escape the newly created penalties, which
authorize the department to assess stiff punishment
on taxpayers who participate in, or promote,
tax avoidance schemes. After the six-month window
of opportunity, the department will officially
step up enforcement efforts in the area.
"These
abusive shelters typically have no business
or economic purpose, and are employed only to
reduce taxes," said revenue commissioner Dan
Salomone, in a statement. "If you've participated
in one of these shelters, this is your last
chance to make things right. The stakes will
be much higher later."
The
Internal Revenue Service has determined the
types of transactions and shelters that are
potentially abusive. Taxpayers must disclose
their participation in these transactions and
amend their state returns or face substantial
penalties, including nondisclosure penalties
as high as $100,000 for individuals and $200,000
for businesses.
To
participate in the compliance initiative, taxpayers
must complete Form VCI, Voluntary Compliance
Initiative Agreement, amend their state tax
returns, and pay any additional tax and interest
due. Information on the new legislation and
the voluntary compliance program is available
at www.taxes.state.mn.us.
In
October, the US Internal Revenue Service announced
a broad-based, limited-in-time opportunity for
taxpayers to come forward and settle an array
of transactions the IRS considers abusive.
Taxpayers
who undertook these deals were given until January
23, 2006 to submit their settlement papers to
the IRS.
The
initiative identified 21 transactions eligible
for the program. Consisting of both listed and
non-listed transactions, they include a wide
cluster of schemes involving funds used for
employee benefits, charitable remainder trusts,
offsetting foreign currency option contracts,
debt straddles, lease strips and certain abusive
conservation easements.
All
eligible transactions carry the same settlement
terms except the applicable penalty level.
“People
entered into these deals often at the behest
of lawyers and accountants peddling flaky tax
products,” explained IRS Commissioner Mark W.
Everson, continuing:
“Times
have changed. The IRS has acted to shut down
these deals, as has the Congress, in passing
stiffer disclosure requirements and promoter
penalties last fall. We’re offering taxpayers
a quick, quiet and cost effective way to put
these deals behind them.”
The
IRS has now identified more than 4,000 taxpayers
involved in these 21 transactions, and continues
to uncover additional participants through tax
return examinations and the agency’s promoter
audit program.
Under
the settlement terms, participants, both individuals
and companies, will be required to pay 100 percent
of the taxes owed, interest and, depending on
the transaction, either a quarter or a half
of the penalty the IRS will otherwise seek.
There will, however, be penalty relief for transactions
disclosed to the IRS or where the taxpayer got
a tax opinion from an independent tax advisor.
Despite
the stream of adverse announcements on tax shelters,
the industry is in fact alive and well, and
in November 2005 a report by the US federal
government spending watchdog highlighted the
continuing risk to the tax system of complex,
so-called 'abusive' tax sheltering schemes,
which it noted are now being sold through smaller,
less accountable outlets.
"Recent
trends indicate that the tax shelter population
will continue to expand to small- to mid-sized
corporations where issues will be more difficult
to identify and examine," the Government Accountability
Office observed in a report on its financial
audit of the Internal Revenue Service.
The
GAO went on to note that tax shelter promoters
are migrating from the large accounting firms
to businesses that specialize in tax matters.
These
so-called 'boutique promoters', the GAO observed,
are "less compliant in their business registrations
and less stable in the business operations"
and are consequently more difficult for the
authorities to pursue for information or penalties.
Moreover,
the GAO found that promoters of tax shelters
are continuing to modify their products to stay
one step ahead of the IRS. It also found that
the number of fraudulent tax refund claims continues
to rise and now stands at a five-year high.
"For
the 2005 processing year, the IRS identified
approximately $451 million of fraudulent refund
claims for individuals," the GAO reported.
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
informs taxpayers that the IRS will challenge
the purported tax benefits claimed by taxpayers
entering into earlier SILO transactions on a
number of grounds. It further states 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, 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 includes back taxes, fines and interest
paid by the 1,165 taxpayers who had participated
in the scheme thus far, 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
believes that more than 1,800 people participated
in Son of Boss. It is predicted that the total
revenue yield from the settlement scheme will
exceed $3.5 billion.
The Son of Boss ‘amnesty’ has 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, 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 has 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
May, 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,
contains 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, the new legislation would
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
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.
Tax
Advisers Under Attack
2005
was a year in tax-shelter-land that top accounting
firm KPMG would probably prefer to forget, although
it survived its mauling by the judiciary in
reasonably good shape. KPMG shared its travails
with a number of other firms, and the year would
have to be accounted a success for the government,
while providers and users of tax shelters have
had to become much more circumscribed in their
behaviour.
Still,
nothing is for ever in tax shelters, and the
tax shelter industry can console itself by remembering
that in this 1,000 year war there are good years
as well as bad years.
In
April, the IRS suffered a setback
in its effort to prove that accounting firm,
BDO Seidman marketed questionable tax shelters
after a judge ruled that the company did not
have to turn over documents relating to tax
services sold to its clients.
In
a judgement dated March 31, Judge James F. Holderman,
of the Federal District Court for the Northern
District of Illinois wrote that the IRS had
failed to prove that Chicago-based BDO Seidman
had acted illegally by selling the tax services
in question, and therefore was not required
to hand over the 267 documents requested by
the government.
In
doing so, judge Holderman agreed with the firm’s
argument that the documents were protected by
attorney-client privilege, work product privilege
and tax practitioner privilege under a 1998
law giving accountants the same confidentiality
protection as lawyers.
The
case centred on a tax shelter known as ‘Cobra’
or ‘currency options bring reward alternatives’
which the IRS formally outlawed in 2000.
In
June, a US appeal court ruled that a group of
investors cannot sue an accounting firm over
the sale of a tax shelter outlawed by the Internal
Revenue Service in 2000. The ruling means that
the investors must seek arbitration instead.
The
nine plaintiffs, led by Thomas Denney, a New
York state property developer in upstate New
York claimed that they were misled into buying
the illegal tax shelter, known as COBRA, or
'currency options bring reward alternatives',
and sued on the grounds of fraud and breach
of fiduciary duty.
The
COBRA shelter generates artificial losses through
offsetting trades of currencies that are channeled
through partnerships. The Internal Revenue Service,
banned the shelter five years ago and has subsequently
assessed the nine investors for millions of
dollars in unpaid taxes, plus penalties and
interest.
In
April 2004, Judge Shira A. Scheindlin of Federal
District Court in Manhattan ruled that the investors
were not bound by the arbitration agreements
they had signed with the accounting firm, because
the tax shelters were not valid.
However,
this decision was overturned by Judge Jose A.
Cabranes of the United States Court of Appeals
for the Second Circuit on Tuesday. According
to Judge Cabranes, there was no evidence presented
that the firms in question, accountants BDO
Seidman and Deutsche Bank, had deliberately
set out to dupe the investors. Evidence of fraud
would have meant that the investors had no need
to seek arbitration.
According
to the New York Times, David Deary, a lawyer
for Mr Denney, stated that he intends to pursue
a lawsuit against Deutsche Bank.
In
July it was reported that several US law firms
were embroiled in a spat over the representation
of plaintiffs in an ongoing tax shelter class
action.
Legal
Week revealed that leading plaintiff firm, Milberg
Weiss Bershad & Schulman had been accused by
rival firms Bernstein Litowitz Berger & Grossmann
and Patton Roberts McWilliams & Capshaw of trying
to edge them out of the so-called 'cookie cutter'
tax shelter case.
According
to an emergency motion filed in June in the
Western District of Arkansas, KPMG, one of the
defendants in the case, is attempting to make
a deal with the legal team expected to agree
the most favourable settlement, a process otherwise
known as a 'reverse auction'.
The
motion reportedly suggested that: "By dealing
with friendly lawyers who have assumed no duty
to achieve the maximum possible recovery for
the class, KMPG could minimise its exposure
and quietly sweep away these problems."
Also
in July, it emerged that KPMG was fighting fire
with fire in a number of civil lawsuits being
brought against it by former tax shelter customers,
arguing that they must also bear some of the
responsibility for their failure to meet their
tax liabilities.
According
to a Washington Post report, which cited an
anonymous source close to the firm, plaintiffs
in the cases facing KPMG in the civil courts
had been asked to provide explanations as to
why they failed to declare the tax sheltering
arrangements on their tax returns, and have
also been asked what they knew about the shelters,
and what they hoped to gain from them.
The accounting firm announced in June that it
"deeply regrets" the sale between 1996 and 2002
of unlawful tax sheltering arrangements such
as Bond Linked Premium Structures (BLIPs) and
Foreign Leveraged Investment Programmes (FLIPs).
It has been estimated that the sale of such
schemes to customers brought the firm around
$150 million, whilst depriving the US government
of some $1.4 billion in lost revenue.
In
a statement released at the time, KPMG commented
regarding the ongoing Department of Justice
investigation that: "It
has been public knowledge that since February
2004, (that) the Department of Justice has been
investigating certain tax services that were
offered by the firm during the 1996 – 2002 time
period. This is part of a larger tax shelter
investigation into the role of accounting firms,
law firms, large banks and taxpayers who participated
in the development, promotion and implementation
of tax shelters."
"KPMG
takes full responsibility for the unlawful conduct
by former KPMG partners during that period,
and we deeply regret that it occurred."
According to a report in the UK's Independent
newspaper in August, leading banks such as UBS
and Deutsche Bank were being drawn into the
US federal investigation into the sale of abusive
tax shelters by accounting firm, KPMG.
The
Independent revealed that prosecutors are examining
the role played by the banks in the sale of
the shelters, following the release in April
of a Senate Permanent Subcommittee on Investigations
report which stated that an unnamed UBS 'insider'
had alerted the bank's management to the potentially
abusive nature of the transactions.
Although
UBS stopped all trades relating to the tax shelters
in question for some months, it later resumed
selling the products, leading the Senate subcommittee
to observe that:
"The
UBS documents show the bank was well aware that
Flip and Opis were designed and sold to KPMG
clients as ways to reduce or eliminate their
US tax liability."
Meanwhile,
speaking to the New York Times last week, sources
close to negotiations between KPMG and federal
prosecutors confirmed that the accounting firm
is likely to avoid prosecution over its sale
of the tax shelters.
Althought
it is not yet officially known whether the DoJ
intends to push ahead with a criminal prosecution,
observers have suggested that political pressure
may mean that the Department opts for a deferred
prosecution agreement, in order to avoid further
reducing the 'Big Four' accounting firms in
the United States to the 'Big Three'.
An
unnamed source briefed on the progress of the
talks certainly appeared to confirm this last
Thursday, telling the NY Times that: "The discussions
have all been directed at a negotiated resolution,
not an indictment."
According
to the NY Times report, whilst avoiding prosecution,
it seems likely that the accounting firm will
be obliged to pay up to $500 million in fines,
and will need to clearly acknowledge its culpability
in the matter and consent to the putting in
place of an idependent monitor to ensure that
it abides by US tax rules in the future.
In
September,
the Justice Department and Internal Revenue
Service announced that five persons associated
with Innovative Financial Consultants (IFC)
had been convicted of tax crimes in connection
with the promotion of a tax evasion scheme utilizing
abusive trusts called “pure trust organizations.”
IFC,
a consulting company based in Tempe, Arizona,
advanced its scheme through several avenues,
including domestic and offshore seminars; a
promotional website; and an interactive telephone
conference line.
“People
in the business of encouraging others to evade
their tax obligations and to hide income and
assets from the IRS can expect to be prosecuted
and convicted,” said Assistant Attorney General
Eileen J. O’Connor of the Justice Department’s
Tax Division.
“Attorneys
with the Justice Department’s Tax Division are
working tirelessly to investigate and prosecute
the promotion and use of tax evasion schemes,"
she added.
According
to evidence the government presented at trial,
from 1996 through early 2003 the defendants
received $4.7 million dollars in fees from their
sale of 2,000 “pure trusts,” falsely claiming
that their customers could lawfully avoid income
taxes by placing their income and assets into
either an “onshore” or “offshore” trust package.
Evidence
introduced at trial showed that IFC’s trusts
enabled customers to retain the use, control,
and dominion of any income and assets they placed
into their respective trusts, while making it
difficult for the IRS to track the true ownership
of assets or income assigned to the “trusts”
or deposited into trust bank accounts.
The
evidence revealed that the defendants charged
IFC customers approximately $10,500 for the
offshore trust package and approximately $4,154
for the onshore trust package. Trial evidence
showed that IFC was a prominent vendor with
the Institute of Global Prosperity (IGP). At
offshore seminars hosted by IGP, defendant Dennis
Poseley promoted IFC’s trust schemes to thousands
of people.
“The
IRS has ramped up its enforcement efforts, particularly
in the area of offshore and domestic trusts
established for the purpose of escaping tax
obligations,” said Nancy Jardini, IRS Chief,
Criminal Investigation.
“We
will continue to pursue promoters of this unlawful
activity to assure the taxpaying public that
when they pay their taxes, they can be confident
that neighbors and business competitors are
doing the same," she added.
The
defendants were also convicted of willful failure
to file tax returns reporting the substantial
amount of gross income they received from the
sale of their trust schemes.
“I
applaud the efforts of these Department of Justice
attorneys. By working diligently on prosecuting
these types of complicated tax cases, they allow
us to dedicate our resources here in Arizona
to prosecute more violent crimes,” said Paul
K. Charlton, U.S. Attorney for the District
of Arizona.
“This
type of relationship allows more cases to be
brought to justice in our district," he added.
In
June 2007, it emerged that the United States
government had charged four current and former
partners of big-four accounting firm Ernst and
Young with tax fraud conspiracy and related
crimes arising out of tax shelters promoted
by the firm.
According
to the indictment, the defendants and their
co-conspirators concocted and marketed tax shelter
transactions based on false and fraudulent factual
scenarios to be used by wealthy individuals
with taxable income generally in excess of $10
or $20 million to eliminate or reduce the taxes
they would have to pay the IRS.
The
indictment charged four individuals in 8 separate
counts, including conspiracy to defraud the
IRS, tax evasion, making false statements to
the IRS, and impeding and impairing the lawful
functioning of the IRS. The government stressed
that at this stage, E&Y itself was not under
investigation.
All
four individuals allegedly worked in a group
set up by E&Y in 1998 to develop tax shelters,
which was first named VIPER (Value Ideas Produce
Extraordinary Results), and later renamed SISG
(Strategic Individual Solutions Group)
The
four individuals named in the indictment include:
Robert Coplan, a former E&Y tax partner
who was the leader of the VIPER/SISG group,
and the former National Director of E&Y’s
Center for Wealth Planning; Martin Nissenbaum
an E&Y partner who was a member of the VIPER/SISG
group, and the National Director of E&Y's
Personal Income Tax and Retirement Planning
practice; Richard Shapiro, who was a member
of the VIPER/SISG group, and an E&Y tax
partner; and Brian Vaughn a former member of
the VIPER/SISG group, and a former E&Y tax
partner.
The
charges allege that from 1998 through 2004,
the four defendants and others participated
in a scheme to defraud the IRS by designing,
marketing, implementing and defending fraudulent
tax shelters. The conspirators also sought to
deceive the IRS about the bona fides of those
shelters and the circumstances under which the
shelters were marketed and sold to clients.
The
charges allege that in order to encourage clients
to participate in the shelters, and to shield
the clients from substantial penalties that
could be imposed if the IRS disallowed the claimed
tax benefits, the defendants worked with law
firms to provide E&Y's clients with opinion
letters that claimed the tax shelter losses
or deductions would "more likely than not"
survive IRS challenge, or "should"
survive IRS challenge.
The
government said that the defendants and their
co-conspirators were motivated by taking a slice
of the highly lucrative tax shelter market in
which other accounting firms were already participating,
and to prevent its high-net-worth clients from
taking their business - including, potentially,
the highly prized audit business associated
with some of these individuals - to its competitors.
Among
the alleged fraudulent tax shelter transactions
designed, marketed, and implemented by the defendants
and their
co-conspirators were CDS (Contingent Deferred
Swap); COBRA (Currency Options Bring Reward
Alternatives); CDS Add-On; and PICO (Personal
Investment Corporation).
The
indictment also charges Coplan, Nissenbaum and
Shapiro with implementing a tax shelter in 2000
to evade their own taxes, and with arranging
for eight of their E&Y partners to participate
in the tax shelter transaction with them. The
use of that tax shelter enabled the group to
eliminate a total of approximately $3.7 million
in taxes, the indictment said.
"This
prosecution further demonstrates our commitment
to hold accountable tax professionals whose
deceit costs this country untold millions in
tax revenues," commented Michael J. Garcia,
United States Attorney for the Southern District
of New York. "The conduct charged in this
Indictment far exceeds the bounds of legitimate
tax planning and reflects flagrant disregard
of the law," he added.
Acting
IRS Commissioner Kevin Brown stated: "According
to today's indictments, these individuals conspired
to defraud the government through a series of
fraudulent tax shelter products. They sold these
products to high-income clients seeking to
diminish or eliminate their tax liabilities.
The IRS and the Department of Justice will continue
efforts to combat illegal tax shelter activity
and ensure the integrity of our tax system."
Garcia
added that the investigation into E&Y's
role in devising and selling tax shelters was
continuing.
Coplan,
Nissenbaum and Shapiro were each freed on $1
million bail, while Vaughn was freed on $300,000
bail. All pleaded not guilty to the charges.
In
a statement, Ernst & Young said the four
indicted men were part of a small group within
the firm, disbanded years | 
