Corporate tax shelters and corporate tax management.

AuthorKleinbard, Edward D.

Introduction

  1. Overview

    This article expands on some of the themes presented to Tax Executives Institute's Midyear Conference this past March, where I was privileged to have been asked to speak on the topic of "Evaluating Corporate Tax Shelters." The first half of that presentation urged companies to adopt formal and rigorous internal protocols for reviewing tax-advantaged strategies. The heart of these protocols should be what I termed a "treaty" between a company's Tax Department and its Chief Financial Officer, in which the Tax Department would undertake to work creatively to implement the Chief Financial Officer's agenda (or at least fairly to quantify the attendant rights), and the Chief Financial Officer in turn would undertake to respect the integrity of the tax analytical process.

    The second half of the presentation was directed to a critique of the President's corporate tax shelter proposals, as unveiled in February of this year.(1)(*) In making its case for its corporate tax shelter proposals, the Administration repeatedly has stressed that it is responding, in part, to cries for help from corporate tax executives.(2) Tax executives are described as hounded by tax shelter sales-people at every turn, and as pressured to accept those tax shelter transactions by senior management, who look only to the existence of an opinion from a brand-name tax advisor (supplied by the promoter) to validate the tax analysis. I have no doubt that this phenomenon is real, but I suggest that a company's best long-term solution lies in the development of precisely those internal protocols -- an internal treaty -- of the type I outlined in the March presentation.

    Nonetheless, advocates of corporate tax shelter reform argue that, in the absence of some form of governmental prodding, many companies are unlikely to overhaul their internal decision-making process. This article therefore focuses on the second of the two themes presented in March--the Administration's corporate tax shelter proposals. The article then offers alternative suggestions for improving our corporate tax collection system, some of which, while possibly as unpopular as those advanced by the Administration, are intended to be more consistent with the underlying principles of our corporate tax system.

  2. Summary

    In my view, the Administration's corporate tax shelter proposals miss the mark. Many have pointed out that the proposals are too vague to be amenable to practical application. More fundamentally, the proposals are flawed in that they confuse the corporate tax shelter phenomenon with the contemporary corporate tax collection problem.

    What the Administration views as a corporate tax shelter problem is better portrayed as a natural outgrowth of an improvement in the efficiency of corporate management, as a result of which corporate income tax liabilities are treated, along with other business liabilities, as costs that respond to modern management techniques. Corporate tax shelters, I believe, are a demand-driven phenomenon, not a supply-side problem. Moreover, this trend is irreversible and will only intensify as corporate managerial arts become more sophisticated.

    What, then, is to be done about the problem? Rather than attempting to moralize this issue and shame corporate participants in tax shelters, I think what is needed are practical rules that encourage the collection of the right amount of corporate income tax in the first instance. More substantively, the Treasury Department's recent emphasis on overarching "standards" that would supplement our system of operative tax "rules" is ill advised. There is no natural law of corporate income taxation. In such circumstances, an emphasis on standards would significantly undermine our rule-based system by interjecting an unacceptably high degree of arbitrariness into the process, which would ultimately corrode the most important aspect of our corporate tax system -- the sense of its underlying fairness.

    Having made these points, I offer the following suggestions for improving the system:

    * The quality of disclosure on corporate tax returns should be improved, to enable the Internal Revenue Service to understand and analyze the complex issues that are embedded beneath the surface of every number on a corporate tax return. In addition, an "early warning system" should be developed for "tax shelter" items, under which contemporaneous disclosure would be required shortly after a transaction is consummated, to give tax policymakers the necessary data with which to respond to anomalies in the system. (This is the only use I would make of an expanded definition of "corporate tax shelter.") The Treasury would need to respond promptly to this disclosure by issuing guidance (which might be retroactive, in some situations) dealing with the discrete issues posed by the particular transaction disclosed.

    * A corporate taxpayer should not be allowed to rely on a tax adviser's opinion to sustain a "reasonable cause" defense to the imposition of penalties, unless (a) the opinion is not rendered by a promoter (or adviser to a promoter) of the tax-advantaged product, (b) the opinion sets out all relevant facts of the transaction which a corporate officer certifies is accurate and (c) the tax adviser is not compensated on a basis of the percentage of the tax savings purportedly derived from the transaction.

    * The present system contains inadequate incentives for corporate taxpayers, in response to uncertain tax rules, to overpay tax and subsequently claim a refund of tax with interest (thereby fully airing the underlying issue with the IRS). The interest charged on corporate underpayments of tax and the interest paid on corporate overpayments of tax therefore should be the same (or nearly so). In addition, the current rule for individual taxpayers should be applied to corporations, so that interest charged on corporate underpayments of tax generally would not be deductible for federal income tax purposes, while interest income received on overpayments would remain taxable.

    The purpose of this rule would be to encourage corporate taxpayers to resolve difficult issues conservatively and to file for refunds. By forcing more issues to the surface for explicit resolution between the IRS and the taxpayer, the proposal is intended to help reverse current law's perverse incentive for corporate taxpayers systematically to adopt aggressive interpretations of the rules. This agenda can succeed, however, only if the IRS and the Treasury have adequate resources to take on the additional burden. Hence, Congress should couple this proposal for reforming the rules for interest paid or received on tax overpayments/underpayments with the additional funding necessary to ensure that the system can handle the increase in explicit negotiations that the proposal is designed to promote.

  3. The Administration's Proposals

    The Administration's corporate tax shelter proposals have been the subject of extensive commentary, and no point would be served by producing another summary at this late date.(3) It may be helpful, however, to restate the principal themes underlying the Administration's statutory proposals.

    The Administration's general corporate tax shelter proposals consist of (i) the Administration's so-called super-section 269 proposal, which would turn section 269.(4) into a general anti-abuse provision, by giving the IRS the authority to disallow any losses, deductions, credits, or other tax benefits that arise from participating in a "corporate tax shelter," and (ii) five other operative rules designed to discourage promoters of or participants in "corporate tax shelters" by imposing various strict liability penalties and excise taxes.(5) These last five rules arguably would be largely redundant in a world of super-section 269, because it is difficult to imagine a corporate taxpayer knowingly entering into a transaction where all the favorable tax attributes flowing therefrom could simply be taken away by a determination that the transaction constituted a "corporate tax shelter."

    The heart of the Administration's corporate tax shelter initiative, of course, is the proposed definition of "corporate tax shelter," because that definition is shared by all the operative rules, and because that definition by itself determines the scope of super-section 269. The proposed definition looks to whether a corporation has "attempt[ed] to obtain a tax benefit in a tax avoidance transaction." A "tax benefit" is any reduction, exclusion, avoidance or deferral in tax, unless that benefit is "clearly contemplated by the applicable [Code] provision." A "tax avoidance transaction" is any transaction (i) "in which reasonably anticipated pre-tax profit ... is insignificant relative to the reasonably expected net tax benefits," or (ii) "that inappropriately eliminates or significantly reduces tax on economic income."

    This definition properly has been criticized as too vague to work evenhandedly in practical application.(6) Moreover, the operative rules are clearly duplicative, and would, if actually all enacted, produce aggregate costs and penalties orders of magnitude greater than that imposed in civil fraud cases.(7)

    For purposes of this article, however, we need to concede that vagueness is a feature, not a bug, in the Administration's proposals. The Administration's avowed goal is to articulate a set of general principles of tax law that override any particular result inconsistent with them. As Assistant Secretary Donald C. Lubick has repeatedly stressed, the Administration views this debate as between "rules and standards,"(8) by which I believe he means a debate between clear operative rules, on the one hand, and grand overarching principles to which all rules (even clear ones) ought to be subservient, on the other. Almost by definition, therefore, if these principles are going to apply to the whole range of economic activity reached by our...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT