Corporate tax shelter regulations: disclosure of reportable transactions.

• Position: Tax Executives Institute

June 5, 2000

On June 5, 2000, Tax Executives Institute submitted the following comments to the Internal Revenue Services on proposed regulations relating to the disclosure of certain "reportable transactions" under section 6011 of the Internal Revenue Code. The regulations, which were the subject of a public hearing on June 20, 2000, were issued as part of the IRS's efforts to address so- called corporate tax shelters. TEI's comments were prepared under the aegis of the Institute's Corporate Tax Shelter Task Force, whose chair is Philip G. Cohen of the New York Chapter. Mr. Cohen, who is also 1999-2000 chair of TEI's Federal Tax Committee, also represented TEI at the June 20 public hearing, as did TEI Tax Counsel Jeffery P. Rasmussen.

On February 28, 2000, the Treasury Department and Internal Revenue Service issued a plethora of guidance aimed at identifying and curbing tax-motivated transactions. Specifically, the government issued temporary and proposed rules (T.D. 8876, REG-110311-98) requiring the registration of "confidential corporate tax shelters," temporary and proposed rules (T.D. 8877, REG-103735-00) requiring taxpayers to report their participation in certain "reportable transactions," and temporary and proposed rules (T.D. 8875, REG-103736-00) requiring tax shelter promoters to maintain lists of investors in "potentially abusive shelters."(1) The rules were published in the FEDERAL REGISTER (65 Fed. Reg. 11205) and in the Internal Revenue Bulletin (2000-11 I.R.B. 747). A hearing on the temporary and proposed rules will be held on June 20, 2000. In addition to the temporary and proposed rules, the government released Rev. Rul. 2000-12 (curbing certain transactions in debt straddle instruments), Notice 2000-15 (identifying 10 categories of "listed" transactions for purposes of Temp. Reg. [sections] 1.6011-4T(b)(2) and Temp. Reg. [sections] 301.6111-2T(b)(2)), and Announcement 2000-12 (announcing the formation of the IRS Office of Tax Shelter Analysis and describing the government's overall anti-tax-shelter strategy).

Background

Tax Executives Institute is the preeminent association of business tax executives in North America. Our more than 5,000 members represent 2,800 of the leading corporations in the United States, Canada, and Europe. TEI represents a cross-section of the business community, and 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. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the package of rules released by the government to address tax-motivated transactions. TEI members know all too well that the inherent complexity and nebulous provisions of the Internal Revenue Code make drawing the line between sound tax reduction strategies, on the one hand, and tax shelters, on the other, difficult.(2) Since TEI does not represent tax shelter promoters or their advisers, our comments relate primarily to the temporary regulations under section 6011(a), relating to the requirement that corporate taxpayers file statements with their returns disclosing "reportable transactions." Thus, our comments on the registration regulations (T.D. 8876, REG-110311-98) and the investor list regulations (T.D. 8875, REG-103736-00) are limited in scope.

Overview

Under Temp. Reg. [sections] 1.6011-4T(a), every taxpayer that files a corporate tax return that has participated directly or indirectly in a reportable transaction as defined in Temp. Reg. [sections] 1.6011-4T(b) is required to attach a disclosure statement to its return for each taxable year affected by its participation in the transaction. In addition, a copy of the disclosure statement for the first taxable year for which disclosure is required must be filed with the National Office of the IRS. Under Temp. Reg. [sections] 1.6011-4T(b)(1), a reportable transaction is any transaction described in either paragraph (b)(2) or (b)(3) that meets one of the projected tax effect tests of paragraph (b)(4). The regulations define two categories of reportable transactions. The first category set forth in paragraph (b)(2) ("listed" transactions) includes transactions identified by the Treasury and IRS as "tax avoidance" transactions. The second category in paragraph (b)(3) ("other reportable transactions") includes transactions warranting scrutiny because they possess at least two of six characteristics or factors deemed common in corporate tax shelters.

Tax Executives Institute has consistently said that the proper approach to addressing corporate tax shelter transactions is to enhance tax return disclosures. By identifying and targeting the indicia of transactions that are characteristic of "confidential corporate tax shelters" and requiring enhanced disclosure of such transactions, the IRS can properly focus its examination resources on questionable transactions. Hence, we commend the government for taking the steps necessary to effectuate the tax shelter registration rules of section 6111 that Congress authorized in the Taxpayer Relief Act of 1997. In addition, we commend the Treasury and IRS for their creative use of section 6011, the general rules governing the filing of returns and statements, to craft new disclosure rules compelling taxpayers to highlight transactions that the government may wish to scrutinize. Moreover, we commend the government for largely eschewing pejorative labels in setting forth the new disclosure requirements. References to "listed" and "reportable" transactions are less likely to taint the examination process than references to "confidential tax shelters" or "potentially abusive tax shelters."(3)

Notwithstanding TEI's support in principle for administrative rules to assist taxpayers in disclosing transactions that the IRS may wish to examine, we believe the temporary rules depend in too many cases on vague and nebulous terms. Moreover, even without the added uncertainty of vague terminology, the regulations are overbroad. Specifically, whereas the scope of "listed transactions" that must be disclosed under Temp. Reg. [sections] 1.6011-4T(b)(2), as supplemented by Notice 2000-15, is reasonably concise, the definition of "other reportable transactions"-- i.e., those meeting the two-of-six factor test of Temp. Reg. [sections] 1.6011-4T(b)(3) -- is excessively broad. Moreover, the exceptions to disclosure under the regulations are too narrow to provide meaningful relief for taxpayers and guard against over-disclosure. Hence, we believe the disclosure rules may well sweep in many ordinary transactions, compelling disclosure of more transactions than the IRS's Office of Tax Shelter Analysis can timely review, analyze, and provide beneficial guidance for.

More specific comments elaborating about the overbroad triggers for the required disclosures, and the attendant uncertainty thereby engendered for compliant taxpayers, follow. TEI's overarching concern with these regulations is the potential they pose for paralyzing the day-to-day administration and resolution of cases. Where a taxpayer discloses one or more transactions under these rules, examining agents may likely feel compelled to examine every aspect of the transactions and emboldened to challenge them. Notwithstanding the helpful statement in Temp. Reg. [sections] 1.6011- 4T(a) that filing a disclosure statement for a reportable transaction does not affect the legal determination whether the benefits claimed are allowable, the visceral reaction of revenue agents may regrettably be to set up a high-profile issue and let someone "higher up" decide whether the benefits are allowable. Moreover, it is unclear who -- case managers, territory managers, Directors of Field Operations, officials in the Office of Tax Shelter Analysis, Appeals, Counsel, et al. -- will judge the legitimacy of the disclosed transactions. If each is to play a role in the decision-making process, the questions become how quickly and how judiciously the IRS, or the Treasury Department, will respond. In our view, it is unclear whether the OTSA (or the Large & Mid-Size Business Division) will have the resources or expertise to routinely inject itself into all large-case examinations involving disclosures under these regulations. The high-profile and sensitive nature of the issues, however, may necessitate an active, hands-on response. If that is the case, it is imperative that the regulations be revised to circumscribe the number of required disclosures -- especially if the government intends to enact legislation revising the penalty standards for nondisclosure of reportable transactions.

Definition of Reportable Transaction

Under Temp. Reg. [sections] 1.6011-4T(b)(1), the term "transaction" "includes all of the factual elements necessary to support the tax benefits that are expected to be claimed with respect to any entity, plan, or arrangement, and includes any series of related steps carried out as part of a prearranged plan and any series of substantially similar transactions entered into in the same taxable year." With the exception of the italicized language in the foregoing quotation, the definition of "transaction" in Temp. Reg. [sections] 1.6011-4T(b)(1) is identical to the definition of "transaction" in Temp. Reg. [sections] 301.6111-2T(a)(3) for purposes of defining a "confidential corporate tax shelter" transaction...