The Clinton Administration's proposals relating to corporate tax shelters.

April 27, 1999

On April 27, 1999, Tax Executives Institute President Lester D. Ezrati presented the following testimony before the Senate Finance Committee regarding the Administration's proposals relating to corporate tax shelters.

Good morning. I am Lester D. Ezrati, General Tax Counsel for Hewlett-Packard Company in Palo Alto, California. I appear before you today as the president of Tax Executives Institute, the largest group of in-house tax professionals in North America. The Institute is pleased to provide the following comments on the corporate tax shelter provisions of the Clinton Administration's Fiscal Year 2000 Budget.(1)

Background

Tax Executives Institute is the preeminent association of corporate tax executives in North America. Our 5,000 members are accountants, attorneys, and other business professionals who work for the largest 2,800 companies in the United States and Canada; they are responsible for conducting the tax affairs of their companies and ensuring their compliance with the tax laws. Hence, TEI members deal with the tax code in all its complexity, as well as with the Internal Revenue Service, on almost a daily a basis. (Most of the companies represented by our members are part of the IRS's Coordinated Examination Program, pursuant to which they are audited on an ongoing basis.) TEI is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. Our background and experience enable us to bring a unique and, we believe, balanced perspective to the subject of corporate tax shelters.

Because of the importance of the Administration's proposals -- and their potential long-term effect on the fair and efficient administration of the tax system -- Tax Executives Institute has established a special task force to study the proposals and to develop alternatives that address the Administration's legitimate concerns without imperiling lawful tax minimization efforts. Although the task force's preliminary views are reflected in this testimony, its principal work awaits the issuance of the Department of the Treasury's forthcoming "white paper" on corporate tax shelters. It is our understanding that the Treasury paper will elaborate on the Administration's still inchoate proposals. Our hope is that, in doing so, the Treasury will allay the concerns that TEI and other commentators have identified with the proposals.(2) Because the Administration's proposals themselves remain a "work in progress," TEI stands ready to supplement this testimony at the appropriate time.

Overview of the Administration's Proposals

The Administration's Fiscal Year 2000 Budget contains 16 provisions related to so-called corporate tax shelters. In this testimony, TEI does not address each of these proposals, but rather sets forth its general reactions to and questions about the proposals. In particular, we seek to explain our concerns about the proposals' lack of clarity (e.g., in defining the term "corporate tax shelter"), their overall lack of proportionality, their possible interference with normal business transactions, and their potentially detrimental effect on tax administration. We also comment on our disappointment that the Administration has proposed a series of new provisions without having fully utilized the tools currently at its disposal. Finally, we set forth our preliminary suggestions on how the Administration's proposals can be refined to address our concerns.

Under the general corporate tax shelter proposals in the Administration's budget, a corporate tax shelter would be any entity, plan, or arrangement in which a direct or indirect corporate participant attempts to obtain a tax benefit in a tax avoidance transaction. A tax benefit would include any reduction, avoidance, or deferral of tax, but would not include any tax benefit clearly contemplated by Congress; a tax avoidance transaction would be any transaction in which the reasonably expected pretax profit of the transaction is insignificant relative to the reasonably expected net tax benefits of the transaction. In addition, a tax avoidance transaction would include certain transactions involving the improper elimination or significant reduction of tax on economic income.

If a corporation received an improper tax benefit from a corporate tax shelter, it would suffer a number of adverse consequences. First, the corporation would be subject to a 40-percent penalty, even if it acted with reasonable cause and in good faith. (The penalty would be reduced to 20 percent if the transaction were adequately disclosed.) Second, the taxpayer could not deduct any fees paid for advice concerning the corporate tax shelter. Third, a 25-percent excise tax would be imposed on investment banking and other fees relating to the shelter. Fourth, if the seller of the corporate tax shelter agreed to rebate any fees paid if the shelter were not successfully implemented, a 25-percent excise tax would be imposed on such "unwind" payments. Fifth, the income received by tax-indifferent parties (including tax-exempt organizations, foreign entities, Native American tribes, and taxpayers having expiring loss or credit carry-forwards) from the corporate tax shelter would be subject to tax. In addition, taxpayers would be prohibited from taking tax positions inconsistent with the form of their transactions, and the IRS would be given broader authority to deny tax benefits under section 269 of the Internal Revenue Code in respect of tax avoidance transactions.

The Nature of the Problem

Tax Executives Institute's perspective differs from that of other organizations that have commented on the Administration's proposals. TEI does not represent the so-called tax shelter promoters and developers who either sell or facilitate the transactions (including investment bankers). The Institute does not represent the professional advisers (be they attorneys or accountants) who opine on the legitimacy of the arrangements. Rather, TEI's...