Introduction A brief review of the place of tax shelters in the American corporate landscape.

The Treasury's 2003 Offensive There was a kind of amnesty in 2002; and in 2003 the Treasury issued new guidance on tax sheltering.

Tax Shelters In 2005

In February, President Bush’s 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 the 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 was 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 were expected 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 revealed that tax shelters are being “mass marketed by major accounting firms,” and strengthened 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.

Also in February, 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, 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 was 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 at the time, 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 had at that time 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 by March 2005.

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.

Also in March, US Internal Revenue Service chief at the time, 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.

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 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 August, Sen. Carl Levin, D-Mich., and Sen. Norm Coleman, R-Minn. introduced a bill in the Senate to combat what they termed '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 subsequent 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 was 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 few 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 proposed 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.
• 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, Minnesota's Department of Revenue explained at the time. Minnesota expected the program to generate $57 million in additional tax revenue during 2006 and 2007.

The program, which followed 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 could 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 pledged to 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."

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 would have 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 included 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 then 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 had at that point identified more than 4,000 taxpayers involved in the 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, were 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 would otherwise have sought. There was, however, penalty relief for transactions disclosed to the IRS or where the taxpayer got a tax opinion from an independent tax advisor.

In November, 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 were 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 were migrating from the large accounting firms to businesses that specialize in tax matters.

These so-called 'boutique promoters', the GAO observed, were "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 were 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.

Tax Shelters In 2006

In January, 2006, Dennis B. Drapkin, Chair of the American Bar Association's Taxation Section wrote to senior US congressmen to complain about the effects of clauses in the Tax Relief Act of 2005, passed by the Senate late the previous year, which would codify the 'economic substance' doctrine in US tax law.

Mr Drapkin wrote among others to Senators Charles Grassley (Chairman of the Senate Committee on Finance) and Max Baucus (Ranking Member of the Senate Committee on Finance), as well as to House members William Thomas and Charles Rangel.

The letter identified three provisions of the Act which would:

• codify the “economic substance” doctrine and create a 40% penalty for “noneconomic substance” transactions;
• require a 20%, nonrefundable down payment for certain offers in compromise; and
• create increased penalties and restrict access to judicial review in an attempt to reduce frivolous tax submission.

'However well intended,' writes Mr Drapkin, 'these provisions may have significant ramifications for bona fide business transactions that are far removed from the tax shelter transactions that are the intended target of the legislation. Moreover, the concerns that underlie this legislation were recently addressed by the tax shelter provisions enacted in October 2004 as part of the American Jobs Creation Act of 2004'.

The ABA revealed that it supported legislation clarifying that when a court determines that the economic substance doctrine applies, the taxpayer must establish that the non-tax considerations in the transaction were substantial in relation to the potential tax benefits, and supported legislative clarification that in evaluating the potential economic profits of a transaction, all costs associated with the transaction, including fees paid to promoters and advisers, should be taken into account.

'To the extent that the legislation incorporates these concepts,' continues the letter, 'we believe it will improve the state of the law. In other respects, however, as we have previously written, we continue to oppose codification of the economic substance doctrine. We further believe that enactment of the separate penalty scheme tied to satisfaction of the economic substance doctrine would create unnecessary complexity and confusion.'

Mr Drapkin also expressed serious concerns about the requirement for a 20% non-refundable deposit: 'Because the 20 percent nonrefundable down payment requirement could dramatically reduce available outside funding for potential offers, there is a significant risk that the proposal could decrease the number of legitimate offers submitted, the number of offers accepted and the number of individuals reentering the tax system,' says the letter, which recommends that the proposal not be adopted or, at a minimum, that it be deferred for further consideration.

As regards frivolous conduct penalties, the letter suggested that they should be imposed upon taxpayers requesting CDP hearings 'only (i) where the request is based on arguments or positions the IRS has identified as frivolous in published pronouncements and (ii) after the taxpayer has been afforded the opportunity to withdraw the request or supplement it with information that would render the relevant published pronouncement inapplicable.'

Later in January, the US government followed up its tax shelter victory over Big Four accounting firm KPMG by investigating three lawyers at the prominent Dallas-based firm, Jenkens and Gilchrist for their alleged role in certifying abusive tax schemes.

According to a New York Times report, three lawyers at the firm's Chicago practice, the centre of its tax operations, are under investigation for signing off so-called opinion letters testifying to the legitimacy of tax shelters such as COBRA (currency options bring reward alternatives), which was outlawed by the IRS in 2000.

However, the report said that there is no indication that the law firm itself is a target of the criminal investigation, and a spokesman revealed that the company is "cooperating fully" with the investigation.

Often costing $75,000 or more each, investors use opinion letters as an insurance policy if challenged by the authorities, showing they took steps to ensure that a particular transaction was legally watertight.

One of the lawyers under investigation is said to have earned $93 million in fees from 1999 through 2003 by selling opinion letters and by designing and selling certain shelters, the Times reported, citing persons familiar with sealed documents filed in connection with a previous civil case brought by investors against Jenkens & Gilchrist.

It is believed by the Treasury Department that at least $2.4 billion in artificial tax losses have been claimed by clients of the law firm stemming from their use of tax sheltering arrangements.

This was not the first time that Jenkens & Gilchrist had come under the spotlight for its role in formulating and selling tax shelters. In 2004, a federal judge ordered the firm to hand over the names of clients who invested in tax schemes formulated by its Tax and Estate Planning Practice Group and its Structured Investment Practice, between June 1998 and June 2003. It marked the first such summons to have been issued to a law firm to obtain the identities of participants in tax shelters deemed abusive by the IRS.

In April, 2006, the IRS won a significant legal victory in its campaign to deter the use of so-called 'abusive' tax shelter schemes, after the US Tax Court ruled that the 'Son of Boss' scheme is illegitimate.

The ruling by Judge David Laro related to the sale of R. J. Thompson Holdings, a day-trading firm in Omaha, Nebraska, by its founder and former chief executive Randall J. Thompson, for $13 million in cash to TD Waterhouse of Canada in June 2001.

The IRS believed that Thompson used a Son of Boss scheme to create an artificial loss in order to slash the amount of federal taxes he owed on the sale, and disallowed more than $20 million in tax losses. Thompson, through a partnership, decided to challenge the IRS.

Son of Boss evolved from an earlier scheme known as ‘Boss’ (bond and option sales strategy). The scheme utilises 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.

The ruling is significant as it marks the first time that a court has ruled on the Son of Boss scheme, and Judge Laro's decision could have an important bearing on the outcome of the trial of 18 individuals facing criminal charges related to sale of tax shelters by the accounting firm KPMG.

Lawyers for the defendants, 16 of whom were former KPMG executives, argued that their clients did nothing illegal because the tax courts had not hitherto established whether the tax shelters were improper.

The defendants in the KPMG trial faced conspiracy and fraud charges for their role in creating and selling tax shelters viewed by the IRS as close relations to Son of Boss.

In May, in a stunning reverse for the IRS, it was ordered by a US Tax Court Judge to repay millions of dollars in taxes, fines and interest to a group of taxpayers, after officials from the agency were found to have effectively bribed witnesses to win a tax shelter case.

The case centred on the so-called Kersting tax shelter, named after Honolulu businessman Henry Kersting, which allowed airline pilots and their families to purchase stock in one of Kersting's companies. In exchange, the pilots received promissory notes, on which they would have to pay interest, but which allowed them to claim interest deductions on their tax returns.

In the early 1980s, the IRS ruled that the Kersting tax shelter was illegal and began pursuing a number of investors who had used the scheme. Many of these eventually settled with the IRS.

However, according to Colorado Attorney Declan J. O’Donnell, who represented 100 of the 500 taxpayers who settled with the IRS, three witnesses were effectively bribed with cash, pre-paid expenses, tax settlements below par, and ten years of added tax benefits so that they would testify against six pilots.

In its opinion, the United States Tax Court stated that all of the settled cases in the Kersting Tax Shelter program should receive 64% of their monies back as a sanction.

This was perhaps the first time that such a judgment has been made against the federal tax collector, certainly for such a substantial amount of money.

"Fraud on the court is rare and has only occurred a few times in our country’s history," Mr O'Donnell observed in a statement.

"This particular ruling is the only time the IRS has ever been adjudicated with a money judgment against them. All others were either sanctioned or the cases were retried," he added.

Mr. O’Donnell believed that this penalty judgment against the IRS is unique, perhaps the only large money judgment against any national taxing authority ever. His clients and the settled group will receive an estimated $56 million from the IRS in due course.

In June, a federal judge granted final approval to a settlement proposed by accounting firm KPMG to compensate investors who made use of its tax sheltering arrangements.

Under the settlement approved by U.S. District Court Judge Dennis M. Cavanaugh on June 2, the approximately 200 clients would receive $153.9 million to cover transaction costs for the tax shelters, but not back taxes and penalties.

The average payout would be $825,000, with the class-action counsel Milberg Weiss Bershad & Schulman netting $24.6 million.

The proposed settlement was designed to cover former clients of KPMG and the law firm of Brown & Wood (now part of Sidley Austin) who participated in the tax shelters known as Blips, Flip, Opis and Short Option Strategy. These were the shelters that were the subject of KPMG's settlement agreement with federal prosecutors in August, under which KPMG agreed to pay $456 million in penalties, but would not face criminal prosecution as long as it complied with the terms of its agreement.

The settlement was less than the initial proposal which totaled $225 million approved the previous October after about 50 tax shelter clients declined to participate in the deal. These litigants would be permitted to pursue claims against KPMG and the Sidley firm on their own.

Judge Cavanaugh ruled that the offer was "fair, reasonable, and adequate," and was keen to draw a line under the case which he stated could extend "for at the very least another few years.”

In a related case, 19 defendants, including several senior KPMG employees and lawyers with Sidley Austin, faced criminal charges for their roles in selling 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.

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.

Introduction A brief review of the place of tax shelters in the American corporate landscape.

The Treasury's 2003 Offensive There was a kind of amnesty in 2002; and in 2003 the Treasury issued new guidance on tax sheltering.