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.

The Treasury's 2003 Offensive

During 2002 the Internal Revenue Service mounted a Tax Shelter Disclosure Initiative, which it said was a success, leading to 621 disclosures covering 947 tax returns, and involving more than $16 billion in claimed losses and deductions.

The initiative was aimed at corporate taxpayers and wealthy individuals worried that tax shelters which they were using might be illegal, but afraid to come forward. In return for full disclosure regarding the transactions and details of the schemes, the IRS promised to waive accuracy-related penalties which might apply to tax shelter and other questionable items on a return at a rate as high as 20%.

'Hundreds of taxpayers came forward and took advantage of this opportunity to voluntarily disclose questionable tax transactions and submit the names of abusive tax shelter promoters,' said Larry Langdon, the IRS Commissioner of Large and Mid-Size Business.

In May, 2003, the US Treasury Department and Internal Revenue Service released a final version of their new rules designed to curb the promotion and use of abusive tax shelters.

The rules were intended to update earlier tax shelter disclosure laws which were too narrow, and allowed many tax shelter promoters to slip through the net. However, concerns were expressed that they would almost certainly lead to an additional compliance burden for individual and corporate taxpayers, who would likely be asked to disclose details of perfectly legal arrangements.

According to a Treasury statement, six categories of potential tax avoidance transactions were covered. Taxpayers were required to disclose and promoters were required to maintain investor lists for six categories of transactions:

• Listed transactions (i.e., transaction that have been specifically identified by the IRS as tax avoidance transactions);
• Transactions marketed under conditions of confidentiality;
• Transactions with contractual protection;
• Transactions generating a tax loss exceeding specified amounts;
• Transactions resulting in a book-tax difference exceeding $10 million; and
• Transactions generating a tax credit when the underlying asset is held for a brief period of time.

The US Treasury Department also issued new rules covering professional conduct, known as 'Circular 230'. This was circulated in draft in early 2003, and late in the year the Treasury confirmed that the stiff draft rules would be put into force.

Assistant Treasury Secretary for tax policy Pamela Olson explained: "We initially thought we were going to be making a lot of changes” to the draft proposals. "But after reflecting on what we've seen in the last couple of years, we don't think we should be watering these down," added Olson. "We think we should come out with a strong set of rules."

The focus during 2003 was indeed very much on professionals involved in setting up tax shelters, both in terms of attacking them directly, and in terms of trying to force them to disgorge details of shelters they have set up for taxpayers, although the IRS has had only mixed success in this latter endeavour.

In June the IRS issued a summons against a top law firm, ordering it to disclose the names of 600 wealthy clients that the agency alleged were sold tax shelter schemes. Chicago federal judge John W. Darrah approved a request by the Revenue to issue the summons against Dallas-based law firm Jenkens and Gilchrist on the grounds that the firm had supposedly taken around $72 million in fees for tax shelter advice, according to Justice Department papers. Jenkens and Gilchrist declared that it had no intention of compromising client confidentiality and would not divulge details of any of the names contained in the summons.

Then in July a three-judge panel at the United States Court of Appeals for the Seventh Circuit ruled that accounting firm BDO Seidman must turn over the names of investors in tax shelters to the IRS. The court found that under the US tax code, BDO was obliged to keep records on tax sheltering arrangements, and to report to the IRS the indentities of investors in such schemes.

This, the panel explained, meant that investors in the tax shelters did not have 'an expectation of confidentiality in their communications with BDO,' as the accounting firm had argued. And in October a federal court ruled that the Chicago office of law firm, Sidley Austin Brown & Wood must hand over information about clients who have invested in 13 tax minimization schemes since 1996. IRS Commissioner, Mark Everson explained that: "Our actions show that we will require attorneys who act as promoters to comply with the law's requirement that they maintain lists of investors for certain abusive transactions and furnish those lists, upon request, to the IRS."

On the other hand, one of the IRS's most prominent targets, KPMG, scored a success in October when a specially appointed Master recommended to a federal court that the company did not have to hand over all the documents requested by the IRS, according to a Wall Street Journal report. The IRS was seeking to enforce 25 summonses that it had sent to KPMG demanding tax sheltering documentation. The firm had handed over hundreds of boxes of paperwork, but had also withheld many documents, arguing that to lay them open to scrutiny would be to breach client privilege. Consequently, in December 2002, the Washington DC federal court appointed retired US Magistrate Judge Patrick Attridge to appraise KPMG's claim and examine the documents in question. In his judgement delivered on October 8, Judge Attridge ruled that whilst KPMG must hand over some of the documents, those that contained material covered by client-attorney privilege may be retained by the firm.

Congress was also been playing its part in the tax-shelter crack-down in 2003. In December, Charles Grassley, Chairman of the influential Senate Finance Committee, announced that he wanted to accelerate legislation that would crack down on so-called LILO (lease in, lease out) tax shelters which had become a popular tax saving vehicle with many corporations.

Under the leasing schemes, municipalities are paid an up-front accommodation fee to lease their infrastructure to a corporation. Grassley says that the cash received by the municipality, however, pales in comparison to the federal tax benefits received by the corporations, which are able to depreciate taxpayer-funded bridges, subways, and rail systems as a result of the lease.

"The shelter promoters are hiding behind the cities and are sending them to Capitol Hill to talk about what an important source of funding this is. This has nothing to do with a ‘public-private' partnership. This is just good, old-fashioned tax fraud," Grassley announced in a statement.

Hearings into tax sheltering held by the Senate Permanent Subcommittee on Investigations in November, 2003, also gained a lot of publicity, although they did not lead to much legislation since they were organised largely by Democrat senators.

The Senate subcommittee came to the following conclusions: "First, the investigation has found that the tax shelter industry is no longer focused primarily on providing individualized tax advice to persons who initiate contact with a tax advisor. Instead, the industry focus has expanded to developing a steady supply of generic “tax products” that can be aggressively marketed to multiple clients. In short, the tax shelter industry has moved from providing one-on-one tax advice in response to tax inquiries to also initiating, designing, and mass marketing tax shelter products."

"Secondly, the investigation has found that numerous respected members of the American business community are now heavily involved in the development, marketing, and implementation of generic tax products whose objective is not to achieve a business or economic purpose, but to reduce or eliminate a client’s US tax liability. Dubious tax shelter sales are no longer the province of shady, fly-by-night companies with limited resources. They are now big business, assigned to talented professionals at the top of their fields and able to draw upon the vast resources and reputations of the country’s largest accounting firms, law firms, investment advisory firms, and banks." Well, what a surprise!

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.