U.S. Treasury Forces Companies To Disclosure Tax Shelters

Mike Godfrey, Tax-news.com, Washington

01 March 2000

In a speech to the Federal Bar Association in Washington this week, Treasury Secretary Lawrence H Summers announced sweeping new rules to prevent and punish the use of what are termed 'abusive' corporate tax shelters; both companies themselves and their advisers are targeted by the new rules.

Summers began his speech by confirming his acceptance of legitimate tax avoidance:

'We well remember the words of Learned Hand: "There is nothing sinister in arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; for nobody owes any public duty to pay more than the law demands; to demand more in the name of morals is mere cant." We must, however, draw the line at the pursuit of engineered transactions that are devoid of economic substance. These transactions have no goal other than to reduce a corporation's tax liabilities. In doing so, they undermine the integrity of the tax system.'

Citing a list of the negative aspects of tax shelters, the Treasury Secretary quoted a former tax official, now a leading member of a well-known law firm: "You can't underestimate how many of America's greatest minds are being devoted to what economists would all say is totally useless economic activity."

Saying that since 1990 the gap between book income and taxable income has more than doubled, in real terms, to more than $90bn, Summers said that the IRS was hampered by having to learn about tax shelters by inspecting sets of accounts, through tip-offs and in other ad hoc ways. The new rules would ensure that tax shelters were disclosed when created, so that the IRS could strike them down immediately rather than having to pursue them through the Courts one at a time, years afterwards.

Among tax shelter practices which had already been banned or are now coming under attack were the LILO (Lease-in Lease-out), the BOSS (artificial tax loss), the liquidating REIT transaction, and the 'debt straddle' involving the manipulation of two separate debt instruments.

The new regulations are effective immediately, and include three new requirements:

First, taxpayers will be required to attach a statement to their return providing information on any transactions with multiple characteristics common to tax shelters. These include situations where there is a significant difference between book and tax income; where there are fees of more than $100,000 to a promoter; where there is use of a tax indifferent party to provide tax benefits; and where there is insurance against benefits that do not materialize;
Second, promoters must disclose any transaction that has a "significant purpose" of tax avoidance or evasion, that is offered under conditions of confidentiality, and that has promoter fees above $100,000;
Third, in order to facilitate cross-checking of tax reporting by investors in promoted products promoters of tax shelters are required to maintain lists of investors and other relevant information that must be supplied on request to the IRS.
Summers announced various changes to structure and practice at the IRS to strengthen its performance in tracking tax shelters, and also addressed the issue of how to improve clarity in tax legislation both inside and outside the IRS, partly by trying to limit what he sees as the mis-directed ingenuity of tax practitioners. He said: 'The dilemmas of this area have been exemplified by the recent remark of a tax practitioner, that "writing tax opinions is a choice between eating and sleeping. I like to eat." We would prefer that he get some rest.' There would be consultation on how to improve 'professionalism' among tax advisers.

Summers expected that the new regulations will be tracked by parallel legislation in Congress, and he announced new penalties which would be included in any new law:

'A penalty of $100,000 for each failure to disclose a transaction with features common to tax shelters. Raising the penalty for substantial understatement from 20 to 40 percent where a taxpayer's statement does not disclose a corporate tax shelter.
Also, we would reduce the dollar thresholds on the understatement penalty for large corporations.'
He said that sanctions should also apply to related parties such as foreign companies and entities that profit indirectly from shelters; new measures would include:

'A 25 percent excise tax on fees received in connection with the promotion and implementation of corporate tax shelters.
The imposition of tax consequences on otherwise tax indifferent entities that enable shelter deals to go ahead by absorbing otherwise taxable income in exchange for a fee.'
Finally, the Treasury Secretary said that legislation would be brought forward to codify the principle that a transaction whose tax consequences are substantially greater than its economic benefit should be unlawful.

Such generalised anti-avoidance statutes already exist in other countries, for instance the UK, and tend to be gradually strengthened over the years.

One major question that arises from the Treasury secretary's speech is how IOFCs figure in the IRS's bestiary. We know from the President's recent budget speech that they are to be subject to a more generalised attack than previously, and Lawrence Summers' speech is presumably not completely unrelated to that. Offshore jurisdictions figure in many tax minimisation schemes, but that doesn't necessarily bring them within the scope of anti-avoidance legislation. On one view, IOFCs might even benefit from an attack on domestic US shelters, since they offer established and apparently legitimate tax bolt-holes which are, perhaps reluctantly, accepted by the IRS.

It is nicely ironic that the Treasury Secretary's fulminations against tax avoidance take place in the same week when the IRS and Government legal experts are desperately trying to redraft the Tax Reform Act 1984 to preserve Foreign Sales Corporations from the WTO!

Related article:
y DAVID CAY JOHNSTON, New York Times
http://www.nytimes.com/library/financial/fed/022900tax-shelters.html

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