Copyright 1999 Federal News Service, Inc.
Federal News Service
NOVEMBER 10, 1999, WEDNESDAY
SECTION: IN THE NEWS
LENGTH:
12086 words
HEADLINE: PREPARED TESTIMONY OF
KENNETH
J. KIES
PRICEWATERHOUSECOOPERS
BEFORE THE HOUSE
COMMITTEE ON WAYS AND MEANS
SUBJECT - CORPORATE TAX SHELTERS
BODY:
I. INTRODUCTION
PricewaterhouseCoopers appreciates the opportunity to submit this written
testimony to the Committee on Ways and Means on the subject of "corporate tax
shelters."
PricewaterhouseCoopers, the world's largest professional services
organization, provides a full range of business advisory services to
corporations and other clients, including audit, accounting, and tax consulting.
The firm, which has more than 6,500 tax professionals in the United States and
Canada, works closely with thousands of corporate clients worldwide, including
most of the companies comprising the Fortune 500. These comments reflect the
collective experiences of many of our corporate clients.
Doing something
about "corporate tax shelters" has a certain rhetorical appeal, stoked by the
press, that threatens to overwhelm principles of sound tax policy and
administration. Concerns have been expressed that large corporations routinely
are avoiding taxes by undertaking complex tax-motivated transactions. The
Treasury Department and others claim - without supporting evidence - that the
corporate income tax base is eroding and will continue to erode absent sweeping
tax-law changes and new restrictions on corporate tax executives.
In this
testimony, we provide a detailed, reasoned analysis of the asserted "corporate
tax shelter" problem and the proposed remedies, taking into account actual
experiences of corporate taxpayers rather than theoretical speculation. We
analyze budget and economic data to determine whether there is empirical
evidence supporting the view that the corporate income tax base is being
eviscerated. We explore the efficacy of tools already available to the Treasury
Department and the Internal Revenue Service (IRS) - and to the Congress - to
address abusive transactions. Finally, we consider the potential impact of
proposals that have been advanced to date by Treasury l, the staff of the Joint
Committee on Taxation (JCT)/2, and others.
We conclude that no justification
has been presented that would support enactment of such sweeping tax policy
changes at this time. Economic data does not suggest any systemic erosion of the
corporate income tax base. Current-law administrative tools, if used properly,
are more than adequate to detect and penalize tax avoidance. The legislative
proposals that have been advanced are at odds with sound tax policy principles
and administration, would threaten legitimate tax-planning activities undertaken
by corporate tax professionals, and would exacerbate the complexity of the tax
code.
II. ARGUMENTS AGAINST SWEEPING CHANGES
A. The Myth of the Eroding
Corporate Income Tax Base
Both the Treasury Department and the JCT staff
have cited as justification for their proposals a possible erosion of corporate
income tax revenues attributable to "corporate tax shelters." Neither has
presented any evidence to support this concern. Rather, both have cited - as
their only reference statements made Joseph Bankman of Stanford University that
corporate tax shelters are responsible for $10 billion in lost corporate income
tax revenues each year. Bankman essentially admits he has no data supporting his
$10 billion figure in his Internet tax policy chatroom,/3 where he answers a
question from a reader as to the references for his $10 billion figure as
follows: "The $10 billion figure that I am quoted on is obviously just an
estimate." This unsubstantiated claim hardly represents the type of serious
economic analysis that should be undertaken before adopting sweeping tax policy
changes of the scope envisioned by Treasury and the JCT staff.
An analysis
of actual data shows no evidence of a loss of corporate income tax revenues
attributable to shelter activities. Since 1992, corporate federal income tax
payments have grown by more than 80 percent, from $100.3 billion in fiscal 1992
to $184.7 billion in fiscal 1999 (see Appendix 1). By point of comparison, GDP
has grown by 44 percent over this period. Over the fiscal 1993-1999 period,
corporate tax payments averaged 2.1 percent of GDP; only once in the preceding
1980-1992 period were corporate income tax payments higher in percentage terms
(in 1980).
Despite the high level of tax payments in the post-1992 period,
some commentators have pointed to a two-percent drop in federal corporate tax
payments in fiscal 1999, as compared to the prior year, as possibly indicating
corporate tax shelter activity.4 This claim has been made despite the fact that,
at 2.1 percent of GDP in fiscal 1999 (through June), corporate tax payments
remain higher than the average for the 1980-1999 period (1.9 percent).
A
possible explanation for this drop is a relative decline in corporate profits
attributable to depreciation deductions associated with increased equipment
investment and the increase in employee compensation relative to corporate
profits.5 The Congressional Budget Office in its mid-session review in July
noted these as among the factors putting downward pressure on corporate
profits.6 It also should be noted that the slight falloff in corporate profits
was not unforeseen - the Office of Management and Budget (OMB) at the beginning
of this year projected that corporate income tax payments would fall in FY 1999,
before rising again in FY 2000.7 It should be further noted that actual
corporate income tax payments for FY 1999 exceeded the January forecast by more
than $2 billion.
In this section of the statement, we examine whether the
recent dip in corporate income tax payments provides any evidence that
"corporate tax shelter" activity is proliferating. After a thorough review of
the data, including data from the IRS, the Bureau of Economic Analysis (BEA),
and corporate financial statements, we find no basis for assertions that
increased shelter activity has caused corporate tax burdens to fall.
1.
Corporate tax liability and the timing of tax payments
Corporate tax
payments received by the IRS during a given year fail to reflect that year's tax
liability for several reasons. First, large corporate taxpayers frequently have
five to ten "open" years for which final tax liability has not been determined.
Thus, current corporate tax payments may include deficiencies (plus interest and
penalties) for a number of prior tax years. Similarly, current corporate tax
payments may be reduced by refunds arising from overpayments of corporate tax in
a number of prior tax years. In addition, current tax payments may be reduced by
previously unused net operating losses and tax credits that are carried forward
from prior years. Thus, current data on corporate income tax payments received
by the IRS are not a reliable indicator of current year tax liability; rather,
current year tax receipts reflect a blend of current and past year tax
liabilities, and are reduced by carryforwards of unused losses and credits from
prior years.
Corporate tax payments
Monthly information on receipts
of corporate income taxes by the U.S. Government is published by the Financial
Management Service of the U.S. Treasury Department? The Treasury defines net
corporate receipts in any month as gross receipts less refunds. Net corporate
tax receipts were $185 billion in calendar year 1998, and are estimated to
remain flat (at $184.6 billion) in 1999, based on annualized results for the
first nine months (see Appendix 2). Gross corporate tax receipts in 1998 were
$213.5 billion, and based on the first nine months of 1999, gross receipts are
estimated to increase by more than one percent to $216.4 billion. The slight dip
in net corporate receipts over the last two years is almost entirely due to an
increase in refunds. Refunds can increase as a result of overpayments of
estimated tax (which may occur when profits turn out to be lower than expected)
or as a result of amendments to prior year tax returns (for example, when
current year losses or credits are carried back to a prior tax year). Until the
IRS tabulates tax return data for 1998 and 1999, it is not possible to determine
the reason for the recent increase in refunds.
Corporate tax liability
For purposes of the National Income and Product Accounts, BEA makes current
estimates of corporate tax liability based on IRS and other data. The IRS
calculates annual corporate income tax liability by tabulating corporate tax
returns (before audit). The most recent publicly available corporate income tax
return information is for IRS years 1996 (i.e., tax years ending after June 1996
and before July 1997).9
In summary, it is important to distinguish between
corporate tax liability and corporate tax receipts. Because corporate tax
receipts are a mix of estimated tax payments for the current year as well as
adjustments (both up and down) to taxes paid with respect to prior years, a drop
in corporate tax receipts does not imply a drop in corporate tax liability. For
example, in 1985, corporate tax receipts increased over the prior year at the
same time that corporate tax liability decreased (see Appendix 2).
2.
Effective Tax Rates: Commerce Department Data
Corporate tax liability can be
broken down into two components: (1) a reference measure of profits arising in
the corporate sector; multiplied by (2) the effective tax rate (which is equal
to corporate tax divided by reference profits). A decline in corporate tax
liability can occur as a result of lower profits or, alternatively, as a result
of a lower effective tax rate. A decline in corporate tax liability due to a
fall in real corporate income is not, of course, evidence of tax shelter
activity. By contrast, a decline in the effective tax rate may warrant
investigation to determine if there is tax avoidance not intended by lawmakers.
Calculation of the effective corporate tax rate requires a measure of
corporate income tax liability as well as a reference measure of corporate
profits. Two data sources are used in this analysis: (1) the National Income and
Product Accounts (NIPA) published by the U.S. Commerce Department; and (2) data
from audited financial statements of public companies filed with the Securities
and Exchange Commission (SEC) on Form 10K. Effective tax rate calculations based
on NIPA data are described in this section; calculations based on SEC data are
described in the following section.
One of the items used by BEA to
calculate GDP is "corporate profits before tax."10 This concept of profits
includes income earned in the United States (whether by U.S. or foreign
corporations) and excludes income earned outside the United States. For purposes
of calculating an effective tax rate, several adjustments are made to "corporate
profits before tax": (1) profits of the Federal Reserve Banks are subtracted;
(2) profits of subchapter S corporations are subtracted; (3) payments of State
and local income tax are subtracted; and (4) corporate capital gains are added.
These adjustments follow the methodology developed by CBO to estimate "taxable
corporate profits."11 BEA estimates that corporate profits before tax, as
adjusted, increased from $587 billion in calendar 1998 to $603 billion in 1999
(see Appendix 3).12 As a percent of GDP, pre-tax corporate profits are estimated
to have reached a post-1980 high of 7.0 percent in 1996, with a dip to 6.9
percent in 1997-1998, and a further dip to 6.8 percent in the first half of
calendar 1999 on an annualized basis.
Based on adjusted NIPA data, the
effective corporate tax rate, measured as federal corporate tax liability
divided by corporate profits before federal income tax, is projected to be 32.7
percent in 1999, higher than the 31.2 percent rate in 1998 and higher than the
32.6 percent average for the 19931999 period (see Appendix 3). Thus, based on
the National Income and Product Accounts, there is no evidence of a decline in
the effective rate of corporate income tax.
3. Effective Tax Rates: SEC Data
Corporate effective tax rates also can be estimated from the audited
financial statements that publicly traded companies are required to file with
the SEC. This method was used by the General Accounting Office in its 1992 study
of corporate effective tax rates. 13 Following the GAO methodology, the
effective corporate tax rate is measured by dividing the current provision for
federal income tax into reported U.S. operating income, reduced by the current
provision for State and local income tax. U.S. operating income is determined by
subtracting foreign operating income from total operating income net of
depreciation, based on geographic segment reporting.
Standard & Poors
publishes SEC 1 OK data in its Compustat database, which is updated monthly. 14
Based on the August 1999 Compustat data release, effective corporate tax rates
were calculated for the 1988- 1998 period using information from every
corporation in the database that supplied all of the necessary data items.
Recognizing that the results for 1998 might not be comparable to prior years due
to the limited sample size, the effective tax rates for 1996 and 1997 were
recomputed using information from the same companies as in the 1998 sample.
For purposes of this analysis we excluded publicly traded corporations and
partnerships that are not generally taxable at the corporate level (i.e., mutual
funds and real estate investment trusts). Separate calculations were made for
companies that reported foreign activity (multinationals) and for companies that
reported no foreign activity (domestics). A multinational's current provision
for U.S. tax may include U.S. tax on foreign
source income; consequently, measured relative to domestic
income, the effective tax rate of U.S. multinationals may be higher than for
comparable domestic firms. In theory, U.S. tax on
foreign source income should be removed from
the numerator of a domestic effective tax rate calculation; however, this
adjustment cannot accurately be made with financial statement data.
The
results of this analysis are shown in Appendix 4. For 1997, the most recent year
for which annual reporting is complete, companies included in the Compustat
sample report $78 billion of current federal income tax liability, accounting
for over 40 percent of federal corporate tax liability in the National Income
and Product Accounts. The Compustat sample of firms excludes private companies
and public companies that do not report all of the items necessary to calculate
the effective tax rate. While the average firm in Compustat is much larger than
the average corporate taxpayer, the main purpose of our analysis is to examine
the trend in effective corporate tax rates over time. We have no reason to
believe that there is a systematic difference in trend effective tax rates
between companies in Compustat and other corporate taxpayers. Indeed, if there
were a proliferation of corporate tax shelter activity, we might expect to see
indications of this first among the largest and most sophisticated corporations,
of the type included in the Compustat sample.
In general, we find that the
effective tax rates calculated from financial statement data are lower than
those calculated from the National Income and Product Accounts. One reason for
this is that the profit definition used for the NIPA calculations is based on
tax depreciation, while the profit definition used for the financial statement
calculations is based on book depreciation. Another reason is that the income
element of nonqualified stock options is deductible for tax purposes when the
option is excercised (and included in the employee's income), but is not treated
as an expense against income for financial statement purposes. We also find
that, on average, over the 1988-1998 period, effective federal tax rates are
higher for multinational corporation than for domestic corporations.
Based
on financial statement data, the corporate effective tax rate for all
corporations (domestic and multinational) was higher in 1997 (19.9 percent) than
the average over the ten-year period 1988-1997 (18.5) percent, and for the
sample of companies reporting financial results for 1998, the effective tax rate
increased between 1997 (19.4 percent) and 1998 (20.7 percent).
l5
In
summary, based on audited financial statements, there is no evidence for a
decline in the effective corporate tax rate. This is consistent with our
findings using National Income and Product Account data.
4. Corporate
capital gains
One category of corporate "tax shelter" that has received
recent attention is the use of transactions designed to avoid tax on capital
gains. Indeed, one commentator believes these transactions are so prevalent that
the tax on corporate capital gains has essentially been rendered "elective."16
If this assessment of the corporate income tax system were accurate, we would
expect to see a marked decline in corporate capital gain realizations in recent
years.
The IRS data, however, do not support the view that corporations
easily can avoid tax on capital gains. Excluding mutual funds, net corporate
gain on capital assets increased by 54 percent from $53 billion in 1992 to $82
billion in 1996 (the most recent year for which IRS data is available)---an
average annual increase of 11.5 percent per year (see Appendix 5). In short,
notices of the death of the corporate capital gains tax are premature.
5.
Conclusion
If unusually high levels of corporate tax shelter activity have
been occurring over the last few years, we would expect to see a drop in
corporate tax liability relative to normative measures of pre-tax corporate
income. To test this hypothesis, we measure corporate effective tax rates using
data from the National Income and Product Accounts and audited financial
statements. Neither measure shows a suspicious drop in tax liabilities relative
to corporate income; to the contrary, both measures show flat or rising
corporate effective tax rates over the last five years. Moreover, if corporate
capital gains tax was easily avoidable using tax shelter techniques, we would
expect to see little or no growth in net capital gains reported on corporate tax
returns. Again, the data disprove this hypothesis, showing instead a robust rate
of increase over the most recent four- year period for which data are available.
B. Efficacy of Current-Law Tools
Proponents of extensive new legislation
to address "corporate tax shelters" overlook the formidable array of tools
currently available to the government to deter and attack transactions
considered as abusive. In our view, the tools described below are more than
sufficient to achieve compliance with the corporate income tax. That is, these
tools enable the IRS and courts to ensure that corporations pay the corporate
income tax liability that results from application of the Internal Revenue Code.
1. Threat of penalties
As an initial matter, the tax Code includes
significant disincentives to engage in potentially abusive behavior. Present law
imposes 20- percent accuracy-related penalties under section 6662 in the case of
negligence, substantial understatements of tax liability, and certain other
cases. In considering a proposed transaction that may turn on a debatable
reading of the tax law, a corporate tax executive must weigh the potential for
imposition of these penalties, which could have a negative impact on shareholder
value and on the corporation.
Furthermore, it should be noted that Congress,
in the 1997 Taxpayer Relief Act, strengthened the substantial understatement
penalty as it applies to "tax shelters." Under this change, which was supported
and encouraged by the Treasury Department, an entity, plan, or arrangement is
treated as a tax shelter if it has tax avoidance or evasion as just one of its
significant purposes. ! 7 The Congress believed that this change, coupled with
new reporting requirements that Treasury has failed to activate, would "improve
compliance by discouraging taxpayers from entering into questionable
transactions."18 Although this change is effective for current transactions, the
IRS and Treasury have not yet issued regulations providing guidance on the term
"significant purpose."
The 1997 Act changes have made it even more important
for chief tax executives to weigh carefully the risks of penalties and even more
difficult to determine which transactions might trigger penalties. At this time,
there is no demonstrated justification for making these penalties even harsher.
2. Anti-abuse rules
The Code includes numerous provisions that arm
Treasury and the IRS with broad authority to prevent tax avoidance, to
reallocate income and deductions, to deny tax benefits, and to ensure taxpayers
clearly report income.
These rules long have provided powerful ammunition
for challenging tax avoidance transactions. For example, section 482 authorizes
the IRS to reallocate income, deductions, credits, or allowances between
controlled taxpayers to prevent evasion of taxes or to clearly reflect income.
While much attention has been focused in recent years on the application of
section 482 in the international context, section 482 also applies broadly in
purely domestic situations. Further, the IRS also has the authority to disregard
a taxpayer's method of accounting if it does not clearly reflect income under
section 446(b).
In the partnership context, the IRS has issued regulations
under subchapter K aimed at arrangements the IRS considers as abusive. 19 The
IRS states that these rules authorize it to disregard the existence of a
partnership, to adjust a partnership's methods of accounting, to reallocate
items of income, gain, loss, deduction, or credit, or otherwise to adjust a
partnership's or partner's tax treatment in situations where a transaction meets
the literal requirements of a statutory or regulatory provision, but where the
IRS believes the results are inconsistent with the intent of the Code's
partnership tax rules.
The IRS also has issued a series of far-reaching
anti-abuse rules under its legislative grant of regulatory authority in the
consolidated return area. For example, under Treas. Reg. Sec. 1.1502- 20, a
parent corporation is severely limited in its ability to deduct any loss on the
sale of a consolidated subsidiary's stock. The consolidated return investment
basis adjustment rules also contain an antiavoidance rule.20 The rule provides
that the IRS may make adjustments "as necessary" if a person acts with "a
principal purpose" of avoiding the requirements of the consolidated return
rules. The consolidated return rules feature several other anti-abuse rules as
well.21
3. Common-law doctrines
Pursuant to several "common-law" tax
doctrines, Treasury and the IRS can challenge a taxpayer's treatment of a
transaction if they believe the treatment is inconsistent with statutory rules
and the underlying Congressional intent. For example, these doctrines may be
invoked where the IRS believes that (1) the taxpayer has sought to circumvent
statutory requirements by casting the transaction in a form designed to disguise
its substance, (2) the taxpayer has divided the transaction into separate steps
that have little or no independent life or rationale, (3) the taxpayer has
engaged in "trafficking" in tax attributes, or (4) the taxpayer improperly has
accelerated deductions or deferred income recognition.
These broadly
applicable doctrines - known as the business purpose doctrine, the substance
over form doctrine, the step transaction doctrine, and the sham transaction and
economic substance doctrine give the IRS considerable leeway to recast
transactions based on economic substance, to treat apparently separate steps as
one transaction, and to disregard transactions that lack business purpose or
economic substance. Recent applications of those doctrines have demonstrated
their effectiveness and cast doubt on Treasury's asserted need for additional
tools.
The recent decisions in ACM v. Commissioner/22 and ASA Investerings
v. Commissioner/23 illustrate the continuing force of these long-standing
judicial doctrines. In ACM, the Third Circuit, affirming the Tax Court, relied
on the sham transaction and economic substance doctrines to disallow losses
generated by a partnership's purchase and resale of notes. The Tax Court
similarly invoked those doctrines in ASA Investerings to disallow losses on the
purchase and resale of private placement notes. Both cases involved complex,
highly sophisticated transactions, yet the IRS successfully used common-law
principles to prevent the taxpayers from realizing tax benefits from the
transactions.
More recent examples of use of common-law doctrines by
the IRS are the Tax Court's decisions in United Parcel Service v.
Commissioner/24 (8/9/99), Compaq Computer Corp. v. Commissioner/25 (9/21/99),
and Winn-Dixie v. Commissioner/26 (10/19/99). In United Parcel Service, the
court agreed with the IRS's position that the arrangement at issue - involving
the taxpayer, a third-party U.S. insurance company acting as an intermediary,
and an offshore company acting as a reinsurer - lacked business purpose and
economic substance. In Compaq, the court agreed with the IRS's contention that
the taxpayer's purchase and resale of certain financial instruments lacked
economic substance and imposed accuracy-related penalties under section 6662(a).
In Winn- Dixie, the court held that an employer's leveraged corporate-owned life
insurance program lacked business purpose and economic substance.
This
recent line of cases and the IRS's increasingly successful use of common-law
doctrines in these cases argue against any need for expanding the IRS's tools at
this time or, as the Treasury Department has suggested, codifying such
doctrines.
4. Treasury action
Treasury on numerous occasions has issued
IRS Notices stating an intention to publish regulations that would preclude
favorable tax treatment for certain transactions. Thus, a Notice allows the
government (assuming that the particular action is within Treasury's rulemaking
authority) to move quickly, without having to await development of the
regulations themselves - often a time-consuming process - that provide more
detailed rules concerning a particular transaction.
Recent examples of the
use of this authority include Notice 97-21, in which the IRS addressed
multiple-party financing transactions that used a special type of preferred
stock; Notice 95-53, in which the IRS addressed the tax consequences of "lease
strip" or "stripping transactions" separating income from deductions; and
Notices 94-46 and 94-93, addressing so-called "corporate inversion" transactions
viewed as avoiding the 1986 Act's repeal of the General Utilities doctrine. 27
Moreover, section 7805(b) of the Code expressly gives the IRS authority to
issue regulations that have retroactive effect "to prevent abuse." Although many
Notices have set the date of Notice issuance as the effective date for
forthcoming regulations,28 Treasury has used its authority to announce
regulations that would be effective for periods prior to the date the Notice was
issued.29 Alternatively, Treasury in Notices has announced that it will rely on
existing law to challenge abusive transactions that already have occurred.30
5. Targeted legislation
To the extent that Treasury and the IRS may lack
rulemaking or administrative authority to challenge a particular type of
transaction, one other highly effective avenue remains open - that is, enactment
of legislation. In this regard, over the past 30 years dozens upon dozens of
changes to the tax code have been enacted to address perceived abuses. For
example, earlier this year Congress enacted legislation (H.R. 435) addressing
"basis-shifting" transactions involving transfers of assets subject to
liabilities under section 357(c).
These targeted legislative changes often
have immediate, or even retroactive, application. The section 357(c) provision,
for example, was made effective for transfers on or after October 19, 1998 the
date House Ways and Means Committee Chairman Bill Archer introduced the proposal
in the form of legislation. Chairman Archer took this action, in part, to stop
these transactions earlier than would have been accomplished under the effective
date originally proposed by Treasury (the date of enactment).
C. Adverse
Impact of Proposals
The Treasury, JCT staff, and similar proposals
addressing "corporate tax shelters" would impose additional uncertainty and
burdens on corporate tax executives. As discussed below, each turns on a vague
and subjective definition of "corporate tax shelter" that would threaten to
sweep in legitimate transactions undertaken in the ordinary course of business,
such as financing transactions, capital restructuring transactions, corporate
reorganizations, and other transactions. Businesses already are confronted by a
complicated, ever-changing, and in many instances, arcane and outdated tax
system comprised of an intricate jumble of statutes, case law, regulations,
rulings, and administrative procedural requirements. Rather than providing
clearer and more precise rules defining transactions viewed as abusive, the
proposals would add new layers of complexity and uncertainty.31
Some
commentators have suggested that the broad sweep of the "corporate tax shelter"
proposals can be justified as representing a balance between "objective" rules
and "flexible" concepts to ensure appropriate behavior by corporations. We
disagree, believing that the vast majority of corporations abide by rules of
appropriate planning and that the extremely broad and vague concepts introduced
by the proposals severely would hamper legitimate business planning. Faced with
the regime of draconian sanctions proposed by Treasury and the JCT staff,
taxpayers would find it difficult to make business decisions with any certainty
as to the tax consequences. This would be particularly true since classification
as a "tax shelter" could result not from taking an incorrect position under the
tax code, but merely because "significant" tax benefits resulted from certain
vaguely defined types of arrangements.
Like individual taxpayers,/32
corporations have the right legitimately to seek minimization of tax
liabilities, i.e., to pay no more in taxes than the tax law demands. Indeed,
corporate executives have a fiduciary duty to preserve and increase the value of
a corporation for its shareholders. Some commentators decry this responsibility,
termed "profit center activity'? in current management parlance, as wrong. We
disagree. Responsible minimization of taxes in conjunction with the business
activity of a corporation is one important function of corporate executives
seeking to enhance profitability, and one that long has been viewed as
consistent with sound policy objectives.33
In a broad sense, the proposals
overlook the significant responsibilities shouldered by corporate tax executives
in collecting and remitting corporate income taxes, withholding taxes, and an
array of excise taxes.34 In addition to these duties as a significant private
administrator of the U.S. tax code, a chief corporate tax executive must
understand management's business decisions and planning objectives, and provide
reasoned advice to management on the tax consequences of various possible
business decisions and on appropriate ways to minimize tax liabilities. Once
these business decisions are made, the tax executive must implement them by
supervising the formation of applicable entities, creating systems for capturing
tax- related information as it is generated from the business, and implementing
procedures for the calculation and remittance of taxes, information returns, and
additional documentation necessary for compliance. The collective effect of the
Treasury and JCT staff "shelter" proposals would be to penalize these
responsible tax executives by adding to their burden and increasing complexity
and uncertainty in determining the tax consequences of business decisions.
Ironically, the proposed "corporate tax shelter" definitions strongly
resemble a test included in the new U.S.-Italy Income Tax Treaty and the new
U.S.-Slovenia Income Tax Treaty that drew strong criticism from the JCT staff.
"Main purpose" tests in the proposed treaties would have denied treaty benefits
(e.g., reduced withholding rates on dividends) if the main purpose of a
taxpayer's transaction is to take advantage of treaty benefits. The JCT staff
correctly raised policy objections to this proposed test:
The new main
purpose tests in the proposed treaty present several issues. The tests are
subjective, vague and add uncertainty to the treaty. It is unclear how the
provisions are to be applied .... This uncertainty can create planning
difficulties for legitimate business transactions, and can hinder a taxpayer's
ability to rely on the treaty .... This is a subjective standard, dependent on
the intent of the taxpayer, that is difficult to evaluate .... It is also
unclear how the rule would be administered .... In any event, it may be
difficult for a U.S. company to evaluate whether its transaction may be subject
to Italian main purpose standards.
35
The Senate approved these
treaties on November 5. In light of concerns raised by the JCT staff and the
Senate Foreign Relations Committee, the Senate approved the treaties subject to
a "reservation" that has the effect of eliminating the "main purpose" test.
These very same objections - "vague," "subjective," "difficulties for
legitimate business transactions" - have been raised by businesses with respect
to the Treasury's and the JCT staff's "corporate tax shelter" proposals. Any
distinction between the "main purpose" test and the "corporate tax shelter"
tests is extremely fine. Like the "main purpose" test, these proposals would
give tax administrators broad authority to disregard the application of written
rules where they believe they see tax considerations playing too important a
role in structuring transactions.
D. Worldwide Experience with
Anti-Avoidance Rules
Recent experiments with "anti-avoidance" tax
legislation undertaken by other major industrialized countries provide useful
case histories for U.S. policymakers contemplating the Treasury and JCT staff
proposals.
Sweden
Sweden repealed its "general anti-avoidance rule"
(GAAR) in 1993 following "some dissatisfaction with its performance."36
Canada
Canada in 1988 adopted a GAAR disregarding transactions resulting
in reductions of tax unless the transaction is carried out primarily for non-tax
purposes. Regarding the practical impact of the Canadian GAAR, one commentator
has noted that "very few transactions that would have been carried out before
the introduction of the rule have not been carried out since its
introduction."37 While withholding final judgment on the GAAR, the commentator
has noted that "the courts could make the rule into an overly broad weapon that
discourages legitimate commercial activity."38 This commentator also notes that
the Canadian GAAR was enacted after the Canadian Supreme Court had rejected
judicial approaches to fighting tax-avoidance - this absence of judicial
activism is hardly the case in the United States, as the recent ACM, United
Parcel Service, and Winn-Dixie decisions clearly show. As one observer has
noted, in the United States, "robust judicial doctrines have served in the place
of a GAAR."39
Australia
Australia reinstituted a GAAR in 1981, following
the failure of earlier GAAR provision. The new GAAR continued to draw criticism.
As one commentator has noted, "If we are concerned about the philosophical
questions as to the rule of law in a complex society and not just about revenue
collection, we should as a result have concerns about the present GAAR operative
in Australia."40
United Kingdom
The United Kingdom's recent experience
with a GAAR is particularly noteworthy. In the 1997 Labor Party budget
submission, U.K. Chancellor of the Exchequer Gordon Brown proposed creation of a
GAAR to counter perceived tax avoidance in the corporate sector. The U.K. Inland
Revenue was directed to review this area and consider how such a GAAR might be
framed.
A "consultative document"41 published by Inland Revenue in October
1998 provided a rough draft for a GAAR. Inland Revenue would be given authority
to ignore "tax-driven transactions" or to substitute the tax results that would
have been produced by a "normal" commercial transaction. A "tax-driven
transaction" would be defined as a transaction one of whose main purposes is
"tax avoidance." "Tax avoidance" would defined as:42
(a) not paying tax,
paying less tax, or paying later than would otherwise be the case,
(b)
obtaining repayment or increased repayment of tax, or obtaining repayment
earlier than would otherwise be the case, or
(c) obtaining payment or
increased payment by way of tax credit, or obtaining such payment earlier than
would otherwise be the case.
The draft plan also discussed a safe harbor for
"acceptable tax planning," which Inland Revenue sketchily defined as "arranging
one's affairs so as to avoid tax in a way that does not conflict with or defeat
the purpose of the legislation."
Businesses responded that the proposal,
with its lack of any objective test, would raise significant uncertainties over
the tax treatment of transactions undertaken in the normal course of business.
The draft plan itself envisioned that taxpayers would need some sort of quick
"clearance," before undertaking a transaction, that Inland Revenue would not
seek to apply the GAAR to the transaction. However, following issuance of the
draft, concerns mounted at Inland Revenue that the agency might lack the
resources to process clearance applications on a timely basis. In light of
problems that had been identified calling into question whether a GAAR could
work in practice, Chancellor Brown in March 1999 announced that the U.K.
government would not be proceeding with plans to implement the GAAR.
The
U.K. experience with the GAAR proposal parallels the current U.S. "corporate tax
shelter" proposals. Both initiatives would rely on subjective terminology and
would give broad discretion to the taxing authorities, raising concerns from the
business sector that legitimate transactions would be affected. For U.S.
policymakers, the U.K. experience with the GAAR presents a clear picture of the
dangers and difficulties associated with overly broad anti-avoidance rules. As
with the U.K. experience, the IRS would not be able to provide effective and
timely advance approval of a multitude of transactions submitted for clearance;
also taxpayers would incur substantial costs in applying for approval.
We
respectfully urge Congress to reach the same conclusion regarding Treasury's and
the JCT staff proposals that prudent decisionmakers in the United Kingdom
ultimately reached in rejecting the GAAR proposal.
III. ANALYSIS OF
"CORPORATE TAX SHELTER" PROPOSALS
A. Treasury Department Proposals
The
Treasury Department's "corporate tax shelter" proposals were advanced in the
Administration's FY 2000 budget and revised in a "White Paper" published July 1,
1999.43 The following are brief summaries of the Treasury proposals as revised,
followed by our comments:44
1. Disallowance of tax benefits
Summary
The proposal would disallow deductions, credits, exclusions, or other
allowances obtained in a "tax avoidance transaction." This would be defined
generally as any transaction in which the reasonably expected pre-tax profit of
the transaction is insignificant relative to the reasonably expected net tax
benefits of such transaction. The proposal also would deny tax benefits
associated with financing transactions where the benefits are in excess of the
economic return of the counterparty to the transaction.
Comment
The
proposal would expand the current-law section 269 rules to deny deductions or
other tax allowances flowing from a "tax avoidance transaction," an entirely new
and vague concept. While the first prong of Treasury's definition of this term
is styled as an objective test, the inclusion of subjective or unexplained
concepts in the equation precludes such a characterization. The proposal raises
significant questions of policy and practicality. As an initial matter, what
constitutes the "transaction" for purposes of this test? Next, what are the
parameters for "reasonable expectation" in terms of both pre- tax economic
profit and tax benefits? Further, where is the line drawn regarding the
significance of the reasonably expected pre-tax economic profit relative to the
reasonably expected net tax benefits?
Under this ill-defined proposal, even
though a taxpayer's transaction may have economic substance and legitimate
business purpose, the tax savings could be denied to the taxpayer if another
route of achieving the same end result would have resulted in the remittance of
more tax. The proposed expansion of section 269 would create uncertainty for
corporate taxpayers that engage in prudent tax planning to implement business
objectives.
2. Substantial understatement penalty
Summary
The substantial understatement penalty imposed on corporate tax shelter
items generally would be increased to 40 percent (reduced to 20 percent if the
taxpayer satisfies certain disclosure requirements). The reasonable cause
exception would be retained, but narrowed with respect to transactions deemed to
constitute a corporate tax shelter - for these transactions, taxpayers would
have to have a "strong" probability of success on the merits and to meet
disclosure requirements. A "corporate tax shelter" would be defined as any
arrangement (to be determined based on all the facts and circumstances) in which
a direct or indirect corporate participant attempts to obtain a tax benefit in a
tax avoidance transaction.
Comment
This proposal is overbroad,
unnecessary, and inconsistent with the goals of rationalizing penalty
administration and reducing taxpayer burdens. Here again, the penalty would
introduce the vague concept of "tax avoidance transaction."
Second, sharp
restrictions on the reasonable cause exception would result in situations where
a revenue agent may feel compelled to impose a punitive 40-percent penalty even
though the agent determines that (1) there is substantial authority supporting
the return position taken by the taxpayer, and (2) the taxpayer reasonably
believed (based, for example, on the opinion or advice of a qualified tax
professional) that its tax treatment of the item was more likely than not the
proper treatment. It is doubtful that agents would accept a taxpayer's argument
against application of the penalty based on having had a "strong probability of
success," an undefined term setting an unrealistically high threshold.
Rather than serving as a deterrent to undertaking questionable transactions,
the virtually automatic proposed penalty would penalize - at a harsh 40-percent
rate - taxpayers for entering into arrangements that they reasonably believed to
be proper and supported by substantial authority. 3. Disclosure
Summary
The Treasury proposal would require disclosure of transactions that have a
combination of"some" of the following characteristics: a book/tax difference in
excess of a certain amount; a rescission clause, an unwind provision, or
insurance or similar arrangement for the anticipated tax benefits; involvement
with a tax-indifferent party; advisor fees in excess of a certain amount or
contingent fees; a confidentiality arrangement; and the offering of the
transaction to multiple corporations.
Disclosure would be required of
corporations and promoters. Corporations entering into transactions having these
characteristics would be required to file a disclosure form with the IRS
National Office by the due date of the tax return for the taxable year for which
the transaction is entered into. The corporation also would have to attach the
form to all tax returns to which the transaction applies. Promoters would be
required to file the disclosure form within 30 days of offering the
transaction.The form would require information regarding the transaction
characteristics discussed above and the nature and business or economic
objective of the transaction. For corporations, it would have to be signed by a
corporate officer who has knowledge of the factual underpinnings of the
transaction for which disclosure is required; the officer would be "personally
liable" for misstatements on the form. The corporation would not be required to
file the form if it had specific knowledge that the promoter had disclosed the
transaction. A "significant" monetary penalty would apply for failure to
disclose.
Taxpayers also would be required to disclose on the return
transactions reported differently from their form if the tax benefits exceed a
certain threshold amount.
Comment
This proposal represents another
example of Treasury overreaction aimed at perceived "shelter" transactions,
imposing further burdens on corporate taxpayers. The existing tax shelter
registration rules - which Treasury has yet to implement - and the existing
penalties provide Treasury with ample tools to address situations of perceived
abuse.
This proposal would create considerable uncertainties for taxpayers
determining whether disclosure is required. Consider, for example, the
requirement to disclose transactions that are reported differently from their
form. Does "form" refer to the label given to the transaction or instrument, or
does it refer to the rights and liabilities set forth in the documentation? For
example, if an instrument is labeled debt, but has features in the documentation
typically associated with an equity interest, is the form debt or equity? What
if the taxpayer reasonably believed that it was reporting the transaction in
accordance with its "form," but later interpretations of "form" suggested that
it had not so reported the transaction?
It appears that the proposal would
require disclosure for a number of other common and legitimate corporate
business transactions. For example, the requirement to disclose transactions and
arrangements with a significant book/tax difference would sweep in a wide range
of non-abusive transactions. (See also our comments, below, on the JCT staffs
disclosure requirements.)
4. Promoters
Summary
The proposal would
impose a 25-percent excise tax on fees received in connection with promoting or
rendering tax advice related to corporate tax shelters. Treasury also notes that
an alternative might be to amend current-law penalties applicable to promoters
and advisors under sections 6700, 6701, and 6703.
Comment
The imprecise
definition of a corporate tax shelter transaction contained in this and related
Treasury proposals would make it difficult for professional tax advisers to
determine the circumstances under which this provision would apply. The
substantive burdens of interpreting and complying with the statute and the
administrative problems that taxpayers and the IRS would face cannot be
overstated. The creation of the new excise tax would subject tax advisers to an
entirely new and burdensome tax regime that again shifts the focus away from the
substantive tax aspects of the transaction to unrelated definitional issues.
5. "Tax-indifferent" parties
Summary
Treasury would retain its
proposal to tax income allocable to a "tax- indifferent" party with respect to a
corporate tax shelter, but notes that certain modifications would be necessary
to narrow the scope of its proposal.
Comment
Treasury itself now
concedes that its proposal "may be difficult to administer and may only
represent an additional penalty on the corporate participant (because the
tax-indifferent party is not subject to U.S. taxing jurisdiction) .... "45
This overreaching Treasury proposal cannot be justified on any tax policy
grounds. The proposal ignores the fact that many businesses operating in the
global economy are not U.S. taxpayers, and that in the global economy it is
increasingly necessary and common for U.S. companies to enter into transactions
with such entities. The fact that a tax-exempt person earns income that would be
taxable if instead it had been earned by a taxable entity surely cannot in and
of itself be viewed as objectionable.
Moreover, as it applies to foreign
persons in particular, the proposal is overbroad in two significant respects.
First, treating foreign persons as tax-indifferent ignores the fact that
in many circumstances they may be subject to significant U.S. tax, either
because they are subject to the withholding tax rules, because they are engaged
in a U.S. trade or business, or because their income is taxable currently to
their U.S. shareholders. Second, limiting the collection of the tax to parties
other than treaty- protected foreign persons does not hide the fact that the
tax- indifferent party tax would constitute a significant treaty override.
B. Joint Committee on Taxation Staff Recommendations
JCT staff proposals
on "corporate tax shelters" were included in a 300-page study reviewing the
interest and penalty provisions of the Code.46 The following are brief summaries
of the JCT staff proposals, followed by our comments:
1. Definition of
"corporate tax shelter"
Summary
The JCT staff recommends "clarifying"
the definition of a corporate tax shelter for purposes of the understatement
penalty with the addition of several "tax shelter indicators." A partnership or
other entity, a plan, or an arrangement would be considered (with respect to a
corporate participant) to have a significant purpose of avoidance or evasion of
federal income tax if it is described by at least one of the following
indicators:
The reasonably expected pre-tax profit from the arrangement is
insignificant relative to the reasonably expected net tax benefits.
- The
arrangement involves a "tax-indifferent party," and the arrangement (1) results
in taxable income materially in excess of economic income to the taxindifferent
participant, (2) permits a corporate participant to characterize items of
income, gain, loss, deductions, or credits in a more favorable manner than it
otherwise could without the involvement of the tax-indifferent participant, or
(3) results in a noneconomic increase, creation, multiplication, or shifting of
basis for the benefit of the corporate participant, and results in the
recognition of income or gain that is not subject to federal income tax because
the tax consequences are borne by the tax- indifferent party. - The reasonably
expected net tax benefits are significant, and the arrangement involves a tax
indemnity or similar agreement for the benefit of the corporate participant
other than a customary indemnity agreement in an acquisition or other business
transaction entered into with a principal in the transaction.
- The
reasonably expected net tax benefits are significant, and the arrangement is
reasonably expected to create a "permanent difference" under GAAP.
- The
reasonably expected net tax benefits from the arrangement are significant, and
the arrangement is designed so that the corporate participant incurs little (if
any) additional economic risk as a result of entering into the arrangement.
Under the JCT staff proposal, an entity, plan, or arrangement still could be
treated as a tax shelter even if it does not display any of the tax shelter
indicators, provided that a significant purpose is the avoidance or evasion of
federal income tax.
Comment
Rather than "clarify" the existing
definition of a corporate tax shelter for purposes of the penalty, the JCT staff
recommendation would layer on top of that already vague definition a test based
on the existence of any one of five so-called "indicators"- each of which itself
would introduce new, subjective tests. The first indicator, for example, would
require the taxpayer (and the IRS) to analyze whether the "reasonably expected"
pre-tax profit from a transaction is "insignificant" relative to the "reasonably
expected" net tax benefits - and these determinations, in turn, must be based on
"reasonable assumptions and determinations."
A multitude of common,
legitimate corporate business transactions that do not have a significant
purpose of tax avoidance nevertheless would be treated as corporate tax shelters
if deemed to exhibit just one of the five "indicators." Conversely, even if an
arrangement has no indicator of shelter status, it still could be treated as a
shelter under the existing "significant purpose" definition. The five indicators
raise a number of concerns and questions:
- The "profit vs. benefit"
indicator, which uses such vague terms as "reasonably expected," "arrangement,"
and "insignificant," could taint as tax shelters many types of inherently risky
corporate ventures, such as wildcat oil-drilling, basic research partnerships
where profit projections necessarily are uncertain, and some real estate
investments by REITs,as well as investments encouraged by the tax law that do
not produce profits, such as cleanups of brownfield sites.
- The
"tax-indifferent party" indicator ignores the fact that to compete in a global
economy, U.S. businesses must engage in arrangements with foreign entities.
Subjecting these transactions to an economic profit test would further
complicate U.S. tax-law treatment of cross-border transactions.
- The
"indemnity agreement" indicator would punish a corporation that prudently
engages a tax practitioner to analyze a planned transaction where the
practitioner is confident enough to stand behind the opinion with an indemnity
or similar agreement.
- The "permanent difference" indicator could call into
question transactions that the Code explicitly seeks to encourage, e.g., through
augmented charitable deductions for certain contributions of inventory property,
on the ground that there would be a permanent difference under GAAP.
- The
"economic risk" indicator seems to taint ordinary business decisions as to
operating structures as "shelter" activities merely because the business
decision results in lower ultimate tax liability than alternative choices. These
types of decisions, such as choosing a form of business or organizing tiers of
subsidiaries, may not involve economic risk.
As a result of these layers of
complexity, businesses and their tax advisors would be unable to determine with
any confidence whether transactions entered into for strategic business reasons
could trigger harsh penalties if later viewed as having either just one
"indicator" of shelter status or a "significant" tax avoidance purpose. This
problem would be aggravated by the JCT staff recommendation to eliminate the
reasonable cause exception to the understatement penalty.
2. Substantial
understatement penalty
Summary
The understatement penalty rate would be
increased from 20 percent to 40 percent for any understatement that is
attributable to a corporate tax shelter. The 40-percent penalty would be reduced
to 20 percent if certain required disclosures are made, provided the taxpayer
had substantial authority in support of its position. The JCT staff proposal
also would eliminate the present-law reasonable cause exception and prohibit the
IRS from waiving the penalty.
The 40-percent penalty could be abated
completely if (1) the taxpayer establishes that it was at least 75 percent sure
that its tax treatment would be sustained on the merits and (2) the taxpayer
discloses certain information (discussed further below) that is certified by the
chief financial officer or another senior corporate officer with knowledge of
the facts.
A corporate participant that must pay an understatement penalty
of at least $1 million in connection with a corporate tax shelter would be
required to disclose the penalty payment to its shareholders, including the
facts causing imposition of the penalty. Comment
The stunning complexity of
the JCT staff penalty recommendations can be seen in the JCT staffs own chart
(attached hereto as Appendix 6) seeking to explain the various permutations and
combinations of factors that can result in penalty rates of zero, 20 percent,
and 40 percent.
The JCT staff recommendations include eliminating the
present-law reasonable cause exception.
Treasury itself already has
backed away from its original proposal to eliminate the exception. The narrow
abatement procedure proposed by JCT staff would be available only where a
business could establish that it had been "highly confident" (75 percent) of
prevailing in its position that any reliance on a third-party opinion was
"reasonable," that no "unreasonable" assumptions were made in the opinion, and
that the transaction had a "material" nontax business purpose. Thus, the new
40-percent penalty rate could apply (absent satisfying the proposed disclosure
requirements) even if a taxpayer established that it had substantial authority
for its position, that it had a greater than 50 percent (but not at least 75
percent) likelihood of prevailing, and that it had reasonable cause. It is
unclear how a taxpayer would be able to support a 75-percent degree of
confidence with respect to a transaction successfully challenged by the IRS. The
JCT staff proposals are inconsistent with the acknowledged purpose of tax code
penalties, namely, to encourage voluntary compliance by taxpayers rather than to
serve as a punitive weapon wielded by the IRS.
The JCT staff recommendation
that companies must disclose to shareholders payment of shelter penalties of $1
million or more - given the factors mentioned above - would be a highly
inappropriate use of the tax statute. It is noteworthy that the proposal would
require disclosure of a payment even if the company is challenging the penalty
assessment in court.
3. Disclosure
Summary
For arrangements that are
described by one of the "tax shelter indicators" and in which the expected net
tax benefits are at least $1 million, corporations would have to satisfy certain
disclosure requirements within 30 days of entering into the arrangement. This
disclosure would have to include a summary of the relevant facts and
assumptions, the expected net tax benefits, the applicability of any tax shelter
indicator, the arrangement's analysis and legal rationale, the business purpose,
and the existence of any contingent fee arrangements. The CFO or another senior
corporate off.leer with knowledge of the facts would be required to certify,
under penalties of perjury, that the disclosure statements are true, accurate,
and complete. Disclosure of tax shelter arrangements also would be required on
the company's tax return, regardless of the amount of net tax benefits.
Comment
The recommended double disclosure requirements (at the time of
the transaction and in the taxpayer's return) would be onerous and unnecessary.
This flood of documents under the 30-day requirement would defeat the cited
"early warning" purpose, since under the vague definitions of the proposal the
IRS would receive so many documents it would have great difficulty processing
and identifying those transactions it might want to examine. The proposed
exceptions for certain arrangements already reported on specific forms would
apply only after regulations are issued - given that Treasury has yet to publish
regulations under the 1997 tax shelter registration provision, the exceptions
might never be triggered.
The breadth of the JCT staff's shelter
recommendations can be seen by its statement that a mere purchase or sale of one
asset, in and of itself, does not constitute an "arrangement." This statement is
indicative of the overwhelming volume of guidance that would be necessary to
implement and administer this proposal. These determinations would plunge
businesses and their tax advisers deeper into an abyss of unfathomable
terminology and complexity.
4. "Promoter" provisions
Summary
The JCT
staff document includes a number of recommendations affecting other parties
involved in "corporate tax shelters," including an expansion of the aiding and
abetting penalty.
Comment
Having proposed a 75-percent
likelihood-of-success threshold for avoiding the 40-percent penalty rate in
certain situations - thereby virtually forcing businesses to obtain outside tax
advice as to the proper treatment of transactions - the JCT staff recommendation
next proposes imposing an "aiding and abetting" penalty on the practitioner
giving the opinion if an understatement results and a so-called "reasonable
practitioner" would have rendered a different opinion. No definition of a
"reasonable practitioner" is provided.
The JCT staff proposal would allow
the practitioner being penalized a "meaningful opportunity" to present evidence
on his or her behalf. Should this evidence not sway the IRS, the practitioner
would be penalized in an amount equal to the greater of $100,000 or one-half his
or her fees, the practitioner's name would be published by the IRS, and the IRS
would forward the practitioner's name to State licensing authorities "for
possible disciplinary sanctions." These harsh provisions seem aimed at thwarting
companies from seeking tax opinions as to the appropriate treatment of business
transactions and arrangements, while also penalizing them if they do not.
5.
Tax shelter registration requirements
Summary
The JCT staff recommends
modifying the present-law rules regarding the registration of corporate tax
shelters by (1) deleting the confidentiality requirement, (2) increasing the fee
threshold from $100,000 to $1 million (in this respect, loosening the
present-law requirement), and (3) expanding the scope of the registration
requirement to cover any corporate tax shelter that is reasonably expected to be
presented to more than one participant. Additional information reporting would
be required with respect to arrangements covered by a tax shelter indicator.
Comment
The JCT staff recommendations would modify a legislative
provision requiring registration that was enacted in 1997, but that has not
become effective because Treasury has not issued implementing regulations.
Before recommending further changes to the law relating to registration issues,
Treasury should issue guidance on the existing registration requirements, which
were enacted in 1997.
C. "Abusive Tax Shelter Shutdown Act of 1999"
Rep.
Lloyd Doggett (D-TX) introduced on June 17, 1999, the "Abusive Tax Shelter
Shutdown Act of 1999" (H.R. 2255), which includes several proposals that
essentially follow Treasury's initial recommendations to disallow tax benefits
for "corporate tax shelters" and to increase the substantial understatement
penalty.
Our comments above on Treasury's proposals apply with equal force
to H.R. 2255. If anything, the H.R. 2255 proposal disallowing "noneconomic tax
attributes" would introduce even greater uncertainty by using terms such as
"meaningful changes," "economic position," and "substantial value." This
proposal would create tremendous uncertainty for companies following prudent tax
planning in implementing business strategies in a global marketplace. Similarly,
the H.R. 2255 penalty proposals (like those of Treasury) are overbroad,
unnecessary, and punitive.
IV. CONCLUSION
It is respectfully submitted
that Congress should reject the broad legislative proposals regarding "corporate
tax shelters" that have been advanced by the Treasury Department, the JCT staff,
and others.
The revenue and economic data indicate no need for these radical
changes. Further, the proposals are completely unnecessary in light of the array
of legislative, regulatory, administrative, and judicial tools available to
curtail perceived abuses. Finally, these proposals would create an unacceptably
high level of uncertainty and burdens for corporate tax officials while
potentially imposing penalties on legitimate transactions undertaken in the
ordinary course of business. Proponents of this type of sweeping legislation
have not demonstrated that these proposals are necessary or advisable in our
corporate tax system.
FOOTNOTES:
1 The Problem of Corporate Tax
Shelters, Department of the Treasury, July 1999; General Explanations of the
Administration's Revenue Proposals, Department of the Treasury, February 1999.
2 Study of Present-Law Penalty and Interest Provisions as Required by
Section 3801 of the Internal Revenue Service Restructuring and Reform Act of
1998 (Including Provisions Relating to Corporate Tax Shelters), Staff of the
Joint Committee on Taxation, July 22, 1999 (JCS-3-99) (hereinafter JCT study).
3 http://www.law.nyu.edu/bankmanj/federalincometax
4 See, Martin A
Sullivan, "Despite September Surge, Corporate Tax Receipts Fall Short," 85 Tax
Notes 565 (Nov. 1, 1999).
5 See, New York Times, September 21, 1999, "When
an Expense is Not an Expense." This article points to rising compensation paid
in the form of stock options as a possible explanation. An increase in employee
compensation increases personal income tax (at the employee level) at the
expense of corporate income tax, because employee compensation generally is
deductible in computing corporate income tax and includable in computing
personal income tax.
6 Congressional Budget Office, The Economic and Budget
Outlook: An Update, July 1, 1999.
7 The Administration's FY 2000 budget
projected that corporate income revenues would total $182.2 billion in FY 1999,
or $2.5 billion less than actual.
8 U.S. Dept. of the Treasury, Monthly
Treasury Statement of Receipts and Outlays of the United States Government.
9 See, IRS, Statistics of lncome Bulletin, Winter 1998/1999.
10 BEA
makes two adjustments to this measure of corporate profits in determining GDP:
(1) BEA uses an "economic" measure of depreciation rather than tax depreciation
(i.e., the "capital consumption adjustment"); and (2) BEA removes inventory
profits attributable to changes in price (i.e., the "inventory valuation
adjustment").
11 See, Congressional Budget Office, The Shortfall in
Corporate Tax Receipts Since the Tax Reform Act of 1986, CBO Papers, May 1992.
The first adjustment reflects the fact that the Federal Reserve system is not
subject to corporate income tax; the second adjustment is made because S
corporations generally do not pay corporate level tax (rather the income is
flowed through to the shareholders); the third adjustment is made because state
and local income taxes are deductible in computing federal income tax; and the
fourth adjustment is necessary because corporations are taxed on capital gains
while GDP excludes capital gains.
12 1999 data are annualized based on the
first six months of the year, seasonally adjusted.
13 See, General
Accounting Office, "1988 and 1989 Company Effective Tax Rates Higher Than in
Prior Years," GAO/GGD-92-11, August 1992.
14 Financial statements for
companies with fiscal years ending after May of 1998, and before June of 1999,
are classified as 1998 statements in Compustat. Because there is a lag between
the end of a company's fiscal year and the time it files Form 10K, and another
lag between the time the form is filed and the time it is processed by Standard
& Poors, information for Compustat's 1998 year was incomplete as of August
1999.
15 These results also generally hold up when effective tax rates are
measured relative to U.S. assets or U.S. revenues. Among domestic-only firms,
however, income has grown more slowly than either assets or revenues since 1995,
with the result that the ratio of tax liability to either assets or revenues has
declined slightly for companies without foreign operations.
16 Michael
Schler, as quoted in the September 1, 1999, Wall Street Journal "Tax Report,"
A1.
17 Section 6662(d)(2)(C)(iii). Prior law defined tax shelter activity as
an entity, plan, or arrangement only if it had tax avoidance or evasion as the
principal purpose.
18 General Explanation of Tax Legislation Enacted in
1997, Staff of the Joint Committee on Taxation, December 17, 1997 (JCS 23-97).
19 Treas. Reg. Section 1.701-2.
20 Treas. Reg. Section 1.1502-32(e).
21 E.g., Treas. Reg. Section 1.1502-130a) (anti-avoidance rules with respect
to the intercompany transaction provisions) and Treas. Reg. Section 1.1502-17(c)
(anti-avoidance rules with respect to the consolidated return accounting
methods). 22 157 F.3d 231 (3d Cir. 1998). See also Saba Partnership, T.C.M.
1999-359 (10/27/99).
23 T.C.M. 1998-305.
24 T.C.M. 1999-268.
25 113.
T.C. No. 17.
26 113. T.C. No. 21.
27 The General Utilities doctrine
generally provided for nonrecognition of gain or loss on a corporation's
distribution of property to its shareholders with respect to their stock. See,
General Utils. & Operating Co. v. Helvering., 296 U.S. 200 (1935). The
General Utilities doctrine was repealed in 1986 out of concern that the doctrine
tended to undermine the application of the corporate-level income tax. H.R. Pep.
No. 426, 99th Cong., Ist Sess. 282 (1985).
28 See, e.g., Notice 95-53,
1995-2 CB 334, and Notice 89-37, 1989-1 CB 679.
29 See, e.g., Notice 97-21,
1997-1 CB 407.
30 Notice 96-39, I.R.B. 1996-32.
31 Treasury Department
Acting Assistant Secretary (Tax Policy) Jonathan Talisman, in an October 4
letter to Pep. Lloyd Doggett (D-TX) states that the Administration's proposals
would not "unduly" interfere with legitimate business transactions.
32
Individual taxpayers often undertake actions to obtain favorable tax treatment,
but this alone is not considered a reason simply to disallow the benefits. For
example, an individual holding an appreciated security may decide to hold it for
sale until a particular date solely to obtain long-term capital gain treatment.
Also, an individual may take out a home-equity loan to pay off credit-card debt
because interest on the home loan can be tax deductible. As another example, an
individual renting a home may decide to purchase it, viewing the tax benefits as
a principal purpose for entering into the transaction. In such cases, Congress
has not been concerned that the taxpayer acted out of tax motivations; the tax
benefits still are allowed.
33 Judge Learned Hand wrote: "Over and over
again courts have said that there is nothing sinister in so arranging one's
affairs as to keep taxes as low as possible. Everybody does so, rich or poor;
and all do right, for nobody owes any public duty to pay more than the law
demands: taxes are enforced extractions, not voluntary contributions." Comm'r v.
Newman, 159 F.2d 848, 850-851 (2d Cir. 1946) (dissenting opinion).
34 Of the
$1.7 trillion in tax revenue collected by the federal government in FY 1998,
corporations either remitted directly or withheld and remitted more than 50
percent, vastly reducing the compliance burden on the IRS and individuals.
35 "Explanation of Proposed Income Tax Treaty and Proposed Protocol between
the United States and the Italian Republic," October 8, 1999 (JCS-9-99); see
also, "Testimony of the Staff of the Joint Committee on Taxation before the
Senate Committee on Foreign Relations Hearing on Tax Treaties and Protocols with
Eight Countries," October 27, 1999 (JCX-76-99).
36 Graeme S. Cooper, Tax
Avoidance and the Rule of Law, IBFD Publications BV, 1997, p. 10.
37 Brian
Arnold, "The Canadian General Anti-Avoidance Rule," Tax Avoidance and the Rule
of Law, ed. Graeme S. Cooper, IBFD Publications BV, 1997, p. 241.
38 Ibid.
p. 244.
39 Cooper, supra p. 10.
40 Jeffrey Waincymer, "The Australian
Tax Avoidance Experience and Responses: A Critical Review," Tax Avoidance and
the Rule of Law, ed. Graeme S. Cooper, IBFD Publications BV, 1997, p. 306.
41 "A General Anti-Avoidance Rule for Direct Taxes: Consultative Document,"
U.K. Inland Revenue, October 1998. 42 ld., at 6.5.2.
43 Treasury dropped
proposals to eliminate completely the reasonable cause exception in the case of
"corporate tax shelters," to disallow deductions for fees paid to tax shelter
promoters and advisors, and to impose a 25-percent excise tax on tax benefits
subject to rescission or insurance provisions.
44 These comments supplement
analysis provided in testimony presented by PricewaterhouseCoopers in
conjunction with the House Ways and Means Committee's March 10, 1999, hearing on
the revenue proposals in the Administration's FY 2000 budget.
45 The Problem
of Corporate Tax Shelters, supra n.l, at 114. 46 JCT study, supra, n.2.
END
LOAD-DATE: November 11, 1999
