Testimony on Interest and Penalty Provisions of the Internal Revenue Code, Including Those Relating to Corporate Tax Shelters Before the Senate Committee on Finance.

March 9, 2000

On March 9, 2000, Tax Executives Institute President Charles W. Shewbridge, III testified before the Senate Committee on Finance on the interest and penalty provisions of the Internal Revenue Code and issues related to corporate tax shelters. The testimony was prepared under the aegis of the Institute's IRS Administrative Affairs Committee, whose chair is Robert J. McDonough, and Corporate Tax Shelter Task Force, whose chair is Philip G. Cohen.

Good morning. I am Charles W. Shewbridge, III, Chief Tax Executive for BellSouth Corporation in Atlanta, Georgia. I appear before you today as the President of Tax Executives Institute, the preeminent group of corporate tax professionals in North America. The Institute is pleased to present testimony on two related, but independent, issues -- (1) reforming the Internal Revenue Code's general interest and penalty provisions (including the standards to which taxpayers and practitioners are held), and (2) addressing the critically important issue of corporate tax shelters, by ensuring that taxpayers, practitioners, and promoters have sufficient incentive to comply with the law without unduly interfering with legitimate business transactions.

After providing an overview of developments since this Committee held an April 1999 hearing on the corporate tax shelter provisions of the President's Fiscal Year 2000 budget and briefly summarizing TEI's conclusions and recommendations, this statement separately provides detailed comments on the two subjects of today's hearing. First, we focus on the recommendations made last year by the staff of the Joint Committee on Taxation and the Department of the Treasury relating to the Internal Revenue Code's interest and penalty provisions generally (other than those relating to corporate tax shelters). Next, we turn to the various proposals, including those in the Administration's Fiscal Year 2001 budget, that have been made in respect of corporate tax shelters.

Background

Tax Executives Institute was established in 1944 to serve the professional needs of in-house tax practitioners. Today, the Institute has 52 chapters in the United States, Canada, and Europe. Our more than 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. TEI members deal with the tax code in all its complexity, as well as with the Internal Revenue Service, on almost a daily 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 interest and penalty provisions of the Internal Revenue Code in general and the subject of corporate tax shelters in particular.

The Evolving Landscape

Last April, my predecessor as President of Tax Executives Institute (Lester D. Ezrati of Hewlett-Packard Company) presented testimony to this Committee on the corporate tax shelter provisions of President Clinton's Fiscal Year 2000 budget. Although acknowledging that the Administration had identified a significant issue requiring action, TEI's testimony last spring urged Congress to move cautiously before enacting legislation.

TEI's plea for caution was prompted not only by our conclusion that the IRS had already taken several effective steps toward stanching abusive transactions, but also by our concern that the cumulative effect of the Administration's proposals could well be to impede legitimate business transactions and to undermine the effective administration of the tax law by impairing the audit process. Quite candidly, we were also concerned that, inasmuch as the Treasury Department and IRS had not undertaken to quantify the scope of the so-called corporate tax shelter program or even to define what was meant by the term "corporate tax shelter," the Administration might legitimately be criticized as engaging in a "ready, fire, aim" exercise. Before rushing to judgment, TEI recommended, Congress should ensure that it had a complete picture of the facts -- the extent of the problem, the reasons for the problems, the tools at the Treasury Department's and IRS's disposal to deal with the problem, and the consequences (both intended and unintended) that might flow from the potpourri of proposals put forth by advocates of change.

Several things have occurred since that April hearing that are worthy of note. First, as already noted, both the Treasury Department and the staff of the Joint Committee on Taxation completed comprehensive studies on corporate tax shelters (as well as on the interest and penalty provisions of the Code generally).(1) Second, the IRS continued to challenge over-aggressive tax-reduction schemes and the courts sustained those efforts, thereby vivifying the economic substance and business purpose tests of the common law. Third, the Administration did not rigidly hew to its original proposals but instead responded positively to the comments and suggestions made by TEI and others. Although certain aspects of the Treasury's revised legislative proposals (as reflected in the President's Fiscal Year 2001 budget) remain problematic, they have clearly been improved. Fourth, the IRS established an Office of Tax Shelter Analysis to collect and analyze information on the depth and breadth of questionable transactions. And finally, just last week, the Treasury Department moved decisively to support the IRS's enforcement efforts by issuing comprehensive proposed and temporary regulations to enhance disclosure requirements by both promoters and taxpayers and by promising to revise the standards of conduct to which lawyers, accountants, and other tax advisers are held.

Tax Executives Institute believes that these developments, in the aggregate, are quite positive. In our view, they confirm the soundness of the call last year that Congress proceed prudently and base its actions not on isolated cases and narrow (albeit disturbing) anecdotes, not on rhetoric, but on reality. TEI views this hearing as the next step in the process.

Summary of TEI Recommendations

1. Penalty and Interest Provisions

   Mr. Chairman, based on media reports, "corporate tax shelters" are the flavor of the week, attracting attention and in some instances triggering overreaction in terms of the size and significance of the problem. Although TEI agrees that the subject of corporate tax shelters is important, we believe it is extremely important not to give short shrift to the other subject on the agenda today: the important work done by the Treasury Department and the staff of the Joint Committee on Taxation on the penalty and interest provisions of the Code. TEI's recommendations and conclusions can be summarized, as follows:

   * The interest-rate differential should be repealed in its entirety and the interest charged on under- and overpayments should be equalized.

   * The rate of interest on under- and overpayments should equal the applicable federal rate plus no more than two or three percentage points.

   * The estimated tax penalty should be converted to an interest charge and a safe harbor should be created for all taxpayers, corporations and individuals.

   * The Internal Revenue Service's ability to abate interest should be expanded.

   * A dispute reserve account to suspend the running of interest while an issue is disputed by the taxpayer and the IRS should be established. TEI believes the proposal has great promise, not only because it would advance the principle that interest should be paid for the use or forbearance of money but because it would encourage the early payment of amounts in dispute.

   * The Code's penalty regime should encourage disclosure by taxpayers. The standards for imposing penalties should be harmonized and consistently applied. Further, there should be a realization that certainty and fairness of application play a more prominent role in encouraging compliance than reflexively increasing penalty rates.

   * The pension-related penalties should be consolidated for enforcement purposes under a single government agency.

2. Corporate Tax Shelter Proposals

   From the outset, TEI has acknowledged that over-aggressive tax-advantaged products are being marketed and agreed that this poses a challenge to the efficacy of the tax system. The Institute firmly believes that the key to stopping such abuses is the effective administration of the tax law. To be sure, the law should be changed if the law needs to be changed, but a plethora of new penalty provisions -- or the codification of the economic substance doctrine -- is no substitute for strong, but fair, enforcement of the laws that are already on the books. In other words, TEI believes that the IRS must do more to challenge and curtail questionable transactions, including raising practitioner standards, and where appropriate, asserting penalties more frequently. For this reason, the Institute applauds the announcement that the IRS has created an Office of Tax Shelter Analysis to identify, quantify, and develop comprehensive approaches to dealing with tax shelters (including the issuance of needed guidance). Without the IRS's focused involvement in the process -- without its input on defining the nature and scope of the problem and the administrative steps that it can and should take under current law -- TEI regrets that legislative proposals to stanch tax shelter activity ex ante will miss the target and impede legitimate transactions.(2)

   In...