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
estimates 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 can
avoid substantial new penalties authorized under
a new Minnesota law, said Minnesota's Department
of Revenue. Minnesota expects 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, gives residents
who have 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 will have until January
23, 2006 to submit their settlement papers to
the IRS.
The
initiative identifies 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.
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