Non-Cooperative Compliance in the Corporate Tax Audit

• Author: Bret N. Bogenschneider
• Position: PhD, JD, LLM; Assistant Prof. of Accounting & Taxation, Indiana University, East
• Pages: 67-117

NON-COOPERATIVE COMPLIANCE IN THE CORPORATE TAX AUDIT BRET N. BOGENSCHNEIDER * I. I NTRODUCTION A substantial academic literature exists on the theory of the tax audit under the methodological framework of “cooperative compliance.” 1 This term refers to a type of responsive tax audit originating in sociological theory, 2 and as now implemented by many taxing authorities around the world, including in the United States, Australia, the United Kingdom, Sweden, and the Netherlands. 3 Such programs can be thought of as a type * Bret N. Bogenschneider, PhD, JD, LLM; Assistant Prof. of Accounting & Taxation, Indiana University, East; bnbogens@iu.edu. Thank you to Benjamin Walker for helpful comments. Any errors are those of the author. 1 See OECD, Co-operative Compliance: A Framework: From Enhanced Relationship to Co-operative Compliance 3 (2013), https://read.oecd-ilibrary.org/taxation/co-operative-compliance-a-framework_9789264200852-en#page1. [https://perma.cc/4CRX-K9H3]. 2 Valerie Braithwaite, Responsive Regulation and Taxation: Introduction , 29 L. & POL’Y 3, 9 (2007); John Braithwaite, The Essence of Responsive Regulation , 44 U.B.C. L. REV. 475, 475–76 (2011); see also Sjoerd Goslinga, Maarten Siglé & Robbert Veldhuizen, Cooperative Compliance, Tax Control Frameworks and Perceived Certainty About the Tax Position in Large Organisations , 5 J. TAX ADMIN. 41, 42–43 (2019) (citing Valerie Braithwaite, A New Approach to Tax Compliance, in TAXING DEMOCRACY: UNDERSTANDING TAX AVOIDANCE AND TAX EVASION 1, 1–11 (Valerie Braithwaite ed., 2003), http://regnet.anu.edu.au/ sites/default/files/publications/attachments/2015-05/BraithwaiteV_TaxDem-Ch1_0.pdf [https://perma.cc/JE6H-D46Q]); Valerie Braithwaite, Kristina Murphy & Monika Reinhart, Taxation Threat, Motivational Postures and Responsive Regulation , 29 L. & POL’Y 137 (2007); Eric Kirchler, Christoph Kogler & Stephan Muehlbacher, Cooperative Tax Compliance: From Deterrence to Deference , 23 CURR. DIR. PSYCH. SCIENCE 87 (2014); Dennis J. Ventry, Jr., Cooperative Tax Regulation , 41:2 CONN. L. REV. 433 (2008)) (“Cooperative compliance programmes also fit in with the broader literature on tax compliance, in which it is recognized that the relationship between tax authority and taxpayer is not adversarial per se, and that trust and cooperation can increase voluntary compliance.”). 3 Judith Freedman, Responsive Regulation, Risk, and Rules: Applying the Theory to Practice , 44 U.B.C. L. REV. 627, 640–41 (2011), https://pdfs.semanticscholar.org/ cd18/c6d00c4f33d87b0b1b5eeb0e305068f1ea4f.pdf [https://perma.cc/UP3F-PHQT] (“The [OECD] framework was informed by the experiences of jurisdictions which have already established such cooperative relationships such as Ireland, the Netherlands, and the 352 CAPITAL UNIVERSITY LAW REVIEW [48:351 of “tax incentive” 4 made available exclusively to large corporate taxpayers providing limits on how the corporate tax audit will, or more aptly, will not , be conducted. 5 Perhaps the most conspicuous examples of these types of collaborative tax enforcement programs are here in the United States and include the (i) IRS’s CAP Program, 6 and (ii) IRS’s FIN 48 “Policy of Restraint” initiative. 7 Since an extensive literature already exists on the topic of cooperative compliance, this article will focus on recent evidence, the U.S. . . . [T]he Dutch horizontal monitoring system does require that the tax authority is satisfied with the company´s tax control framework and that the audit committee of the company is obliged to review the company’s strategy for tax planning.”); Lotta Björklund Larsen, What Tax Morale? A Moral Anthropological Stance on A Failed Cooperative Compliance Initiative , 5 J. TAX ADMIN. 26, 26(2019) (discussing the failure of the cooperative compliance initiative in Sweden); L. van der Hel-van & T. Poolen, Horizontal Monitoring in the Netherlands: At the Crossroads . 67 BULL. INT’L TAX. 673, 674 (2013). 4 Alicja Majdanska & Jonathan Leigh Pemberton, Different Treatment, Same Outcome: Reconciling Cooperative Compliance with the Principle of Legal Equality , 5 J. TAX ADMIN. 111, 114 (2019), https://pdfs.semanticscholar.org/ec7d/41ff63382fcd9ec0387d12b4aec ebc54bcce.pdf [https://perma.cc/3CZ5-HGFN] (“[Cooperative compliance] is not based on deterrence but aims instead to encourage voluntary compliance. It can be thought of as a form of tax incentive, under which taxpayers obtain some benefits in exchange for greater transparency.”). 5 Id. (“The essence of the co-operative compliance model is an exchange of transparency for certainty. The taxpayer is expected to offer full disclosure in respect of its tax position, while the tax administration should provide the taxpayer with certainty about its tax treatment, ideally in advance and certainly earlier than might otherwise be the case.”). 6 See Dennis de Widt et al., The US Compliance Assurance Process: A Relational Signalling Perspective , 5 J. TAX ADMIN. 145, 151–55 (2019). 7 Memorandum for LB&I Employees, Uncertain Tax Positions - Modified Policy of Restraint , I.R.S. (March 23, 2011), https://www.irs.gov/businesses/corporations/uncertain-tax-positions-modified-policy-of-restraint [https://perma.cc/V4B5-XN8T]. See also Internal Revenue Service, Announcement 2010-76 , Requests for Documents Provided to Independent Auditors, Policy of Restraint and Uncertain Tax Positions , www.irs.gov/pub/irs-drop/a-10-76.pdf [https://perma.cc/6SK8-4QPB] (citing Financial Accounting Standards Board (FASB) ASC 740-10) (“The Internal Revenue Service is expanding its policy of restraint in connection with its decision to require certain corporations to file Schedule UTP [Uncertain Tax Positions], Uncertain Tax Position Statement, and will forgo seeking particular documents that relate to uncertain tax positions and the workpapers that document the completion of Schedule UTP.”); see also Bret Wells, Voluntary Compliance: This Return Might Be Correct but Probably Isn’t , 29 VA. TAX REV. 645, 656 (2010). 2020] NON-COOPERATIVE COMPLIANCE 353 respective policy effects of such programs, and propose an alternative realist model of the corporate tax audit. 8 By way of background, many large corporations have applied for and been granted access to the CAP Program, including Wal-Mart Stores, Inc. (hereafter “Wal-Mart”) resulting in tax avoidance benefits that are alleged by an insider to exceed $2.6 billion to that company. 9 Notably, that figure is attributable solely to that one corporate taxpayer from just one overseas affiliate. 10 Yet, this affiliate represents merely one of perhaps hundreds within the corporate structure of Wal-Mart many of which might also have been similarly designed to achieve hidden tax avoidance benefits. Such a high degree of tax avoidance should be expected more widely in respect of the other approximately 180 corporate participants in the CAP program, 11 meaning that high-dollar figures of tax avoided may be considered typical for program participants. 12 An estimate of the amount of aggregate tax 8 The realist model discussed here is based on: Russell J. Leng , Influence Techniques in Militarized Crises: Realpolitik versus Reciprocity, in RECONSTRUCTING REALPOLITIK 125, 126 (Frank W. Wayman & Paul F. Diehl eds., 1994). (“Classical realism assumes that political action is the manifestation of an ongoing struggle for power, a struggle that has its roots in human nature. Politics consists of the pursuit of interests defined as power. At the international level, the realist views states as unitary actors who base their actions on a calculation of national interest in terms of their relative power.”). 9 Max de Haldevang Quartz, Walmart Dodged up to $2.6 Billion in US Tax Through a “Fictitious” Chinese Entity, Former Executive Says , YAHOO! FINANCE (Sep. 5, 2019), https://finance.yahoo.com/news/walmart-dodged-2-6-billion-151531554.html . [https://perma.cc/6GCL-X9D4]. 10 Id. Wal-Mart defended the position on the grounds that it was enrolled in the CAP Program. Id. (“Walmart rejected that assessment. ‘These issues were raised years ago, independently and thoroughly investigated at the time and the tax year covering the matter has been closed by the IRS,’ a company spokesman said in an emailed statement. ‘The IRS also has an on-site office at Walmart full-time, year-round. Through our participation in the IRS Compliance Assurance Process [CAP] program, we have open and transparent discussions, proactively share information about corporate structures as they occur, including this matter, and provide other materials the IRS requests.’ Walmart has been in the voluntary CAP program since 2005.”). 11 de Widt et al., supra note 6, at 151 (“As of August 2016, there were 181 taxpayers participating in the permanent CAP programme . . . .”). 12 See generally Wells, supra note 7, at 659–60. (“Thus, the environment today is that companies are required to document on an issue-by-issue basis their uncertain tax positions, to provide this self-assessment analysis to their external auditors, and then to disclose the 354 CAPITAL UNIVERSITY LAW REVIEW [48:351 avoidance resulting from the lack of comprehensive audits due to participation in the CAP program should therefore be measurable in the many billions of dollars. The magnitude of tax avoidance resulting from the CAP program likely represents many multiples of the total enforcement budget of the IRS of $11.7 billion per annum. 13 Accordingly, the recent evidence from the Wal-Mart affiliate indicates that the proffered tax enforcement windfall that cooperative compliance programs supposedly offer—that is, better tax enforcement with an allocation of less enforcement resources 14 —is not remotely plausible because the lost revenue from just one affiliate of one corporate taxpayer exceeds one-sixth of the entire operating budget of the IRS in respect of all taxpayers. One purpose of this article is to suggest that the failure of cooperative compliance in...