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.
KPMG
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.
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
January 2007, New York District Judge Loretta
Preska agreed to dismiss a deferred criminal
charge against KPMG resulting from the settlement
reached by KPMG and the Justice Department over
the sale of improper tax shelters in 2005.
Former
executives of KPMG who are facing separate criminal
charges attempted to prevent the dismissal,
claiming that KPMG's refusal to pay their legal
fees amounted to a breach of KPMG's agreement
with the government; but the judge did not agree.
In
August 2005, KPMG agreed to pay $456 million
in penalties to cover former clients who participated
in the tax shelters known as Blips, Flip, Opis
and Short Option Strategy. Under the agreement,
prosecution was deferred, with the government
agreeing to drop charges after 31st December
2006 if KPMG submitted to outside monitoring
and discontinued some types of tax-related activity.
The
trial of the former employees is currently delayed
after the trial judge cited concerns over the
dispute concerning who should pay the defendants'
lawyers. In an order made public in November,
US District Judge Lewis A. Kaplan stated that
questions over whether KPMG should pay legal
fees for the former executives probably wouldn't
be resolved before the criminal trial's scheduled
start date in January.
"Given
all of the current uncertainties, it is impossible
now to predict with confidence when the charges
in the indictment may be tried," he said.
Consequently, the judge delayed the trial date.
Later it was set for September, 2007.
The
16 former KPMG employees and two others are
accused of selling tax shelters which were deemed
"abusive" by the Internal Revenue
Service. The agency has estimated that the tax
shelters helped investors avoid some $2.5 billion
in taxes.
However,
the trial bogged down when in June, Judge Kaplan
found that prosecutors violated the constitutional
rights of the former KPMG partners by pressurising
them to cut off payment of legal costs to the
defense. The former executives then filed a
civil complaint against KPMG seeking advancement
of defense costs.
A
trial on the fee issue was scheduled for October,
but KPMG appealed Kaplan's ruling, saying the
matter should be dealt with by arbitrators rather
than the Courts.
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 ago, that was responsible
for developing the transactions in question.
"None of the individuals was part of the
firm’s management," it said.
“Ernst
& Young has cooperated with the government
from the beginning of its investigation. We
have voluntarily made many changes and enhancements
to our tax practice. We have also made other
changes to our tax practice pursuant to our
2003 agreement with the IRS, which the IRS Commissioner
called a "model for agreements with practitioners,"
the statement added.
In
February 2008, it emerged that US federal prosecutors
had widened their criminal investigation into
the alleged sale of questionable tax shelters
by the accounting firm Ernst & Young, adding
two outside defendants.
The
new indictment, filed in US District Court in
Manhattan, included charges against new defendants
David Smith and Charles Bolton, who both worked
for outside firms, and are accused of participating
in an alleged tax-shelter fraud.
Additional
charges were also laid against the other four
defendants, who included: Robert Coplan, a former
E&Y tax partner; Martin Nissenbaum, an E&Y
partner and the National Director of E&Y's
Personal Income Tax and Retirement Planning
practice; Richard Shapiro, an E&Y tax partner;
and Brian Vaughn, a former E&Y tax partner.
According
to the original indictment unsealed in the US
District Court in Manhattan in May 2007, between
1998 and 2004 the defendants and their co-conspirators
concocted and marketed tax shelter transactions
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 to the IRS.
The
new indictment added fraud charges against the
original four defendants, and accused Smith
and Bolton of conspiring with them to create
and market tax shelters known as CDSs, or contingent
deferred swaps.
Ernst
& Young itself was not named as a defendant
in the case.
Then
in March 2008, it was reported that the US government
was attempting to revive its case against 13
former partners of accounting firm KPMG, who
stood accused of facilitating the use of illegal
tax shelters which allegedly cost the Treasury
billions in tax revenues.
The
case, billed as the largest criminal prosecution
in US legal history, was thrown out by US District
Judge Lewis Kaplan in July 2007, after he concluded
that the government had denied the defendants
their constitutional right to counsel by pressuring
their former employer to cut off payment of
legal fees.
But
at a hearing in the US Second Circuit Court
of Appeals, the government argued that it had
not brought any pressure to bear on KPMG to
stop paying the defendants' legal fees, and
that any violation of their rights had only
been temporary.
While
it was normal practice for KPMG to pay the legal
costs of former employees accused of wrongdoing,
it reversed its policy in this case, fearing
that, by being seen to be helping the defendants,
it could bring about an indictment on the company
itself.
According
to the so-called 'Thompson Memorandum,' written
in 2003 by then-Deputy US Attorney General Larry
Thompson, prosecutors may consider a company's
payment of legal fees for "culpable employees
and agents" when deciding whether to indict
the company.
The
defendants, of which there were initially 19,
were accused of helping to structure and sell
the tax shelters, which were deemed abusive
by the Internal Revenue Service. The agency
has estimated that the tax shelters helped investors
avoid some $2.5 billion in taxes.
However,
in August 2005, KPMG avoided indictment by agreeing
to pay $456 million in penalties to cover former
clients who participated in the tax shelters,
known as Blips, Flip, Opis and Short Option
Strategy.
Four
of the original 19 defendants were scheduled
to go on trial later that year.
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