Congress To Investigate Enron's Tax Practices

by Mike Godfrey, Tax-News.com, New York

20 February 2002

Senate Finance Committee Chairman Max Baucus (D., Mont.) reportedly will next month begin sittings of a Congressional committee to review the strategies which enabled fallen energy giant Enron to avoid massive amounts of US tax.

"Our investigation needs to find out whether Enron's actions were legal, somewhat questionable, highly questionable, or even illegal," said Sen. Charles Grassley of Iowa, the panel's ranking Republican. "In the end, what's legal for any company could be the most shocking of all."

It's well known that big business can rely on a host of strategies to reduce taxes, from incorporation in Bermuda to the use of quasi-legal tax shelters. Congress has made many, usually unsuccessful attempts to ban many such strategies, and it isn't surprising that the Enron affair would offer an ideal opportunity to have another go at the murky world of tax minimisation.

Enron itself has given permission for investigators to examine its tax files. Enron said its consent is intended to help the panel determine "whether there are, in the events that gave rise to Enron's bankruptcy, significant tax-policy issues of relevance beyond Enron's particular circumstances such that they may need to be addressed through changes to the federal tax laws," according to a letter to the committee from company attorney Fred T. Goldberg Jr., a former IRS commissioner.

Enron is known to have had multiple offshore subsidiaries and related companies, but also used domestic tax shelters. The Houston energy trader, for example, was one of the first issuers of so-called "trust preferred" securities, a now-widespread practice that allows a parent company to issue debt through a subsidiary and claim the interest deduction on the parent's tax return, yet avoid characterizing the obligation as debt on its books.

Another, somewhat similar transaction that was first employed by Enron allowed two of the company's big finance subsidiaries - Marlin Water Trust and Osprey - to borrow billions of dollars from outsiders while flattering the parent company's balance sheet. Among other things, the transactions allowed Enron to pay off debtholders, if necessary, through issuance of stock rather than cash. Such "hybrid securities" are well understood by Wall Street investment bankers, and are now widely employed by businesses.

Like many other companies, Enron also benefited substantially from tax and accounting rules that allow companies to deduct the cost of many stock options for tax purposes, but avoid accounting for them on their books. Legislation has already been introduced in the Senate to clamp down on this practice.

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