October 9, 2001

Mr. Kolan Davis                                       Mr. John Angell
Staff Director and Chief Counsel          Staff Director
Committee on Finance                           Committee on Finance
206 Dirkson Building                           219 Dirkson Building
United States Senate                             United States Senate
Washington , DC 20510                      Washington , DC   20510

Dear Kolan and John:

            The Tax Council is an association of senior tax advisers representing over one hundred of the largest corporations in the United States .  The Tax Council’s members include senior tax officers of companies involved in manufacturing, mining, energy, transportation, consumer products and services, retailing, telecommunications, insurance,  and financial services.
            

            The Tax Council is grateful for the opportunity to comment on the August 3, 2001 Tax Shelter Staff Discussion Draft.  Although this version of the discussion draft is an improvement over earlier versions of corporate tax shelter legislation, we respectfully disagree that it would be an improvement over current law.

Background

            The senior tax executive in a major company basically fulfills two roles.  First, he or she must assure senior management that the company is fulfilling its obligations to comply with the many tax laws governing its operations.  In addition to the U.S. Internal Revenue Code, most major companies are required to pay taxes to many foreign countries, several different states and local governments.  Second, the senior tax executive is a full partner in the financial and business planning of the company.  Companies’ business plans must be executed with a view to clear projection of their future tax liabilities. 

The senior tax executive, working with both company personnel and outside counsel, must be able to rely on objective conclusions regarding the prospective tax liability likely to be incurred from any transaction.  The duty of the tax executive is to advise management on a forward-looking basis of the company’s correct tax liability that may result from a planned acquisition, disposition, or other investment in plant and equipment. 

Since 1982, the Internal Revenue Code has been almost continuously amended with new penalties, disclosure requirements, lopsided interest rates, and a myriad of reporting rules.  Roughly seventy-five sections of tax laws enacted since 1982 directly address corporate tax compliance procedures and penalties.  Present law includes provisions directed at “abusive tax shelters.”  The Treasury Department has only recently issued temporary and proposed regulations that apply to all corporate taxpayers.  The Tax Council believes that these rules should be enforced for a reasonable period before any new tax shelter rules are enacted.

Even under current law there are several taxpayers whose IRS examinations of income tax returns have become bogged down over issues that are well-settled principles of the tax law.  The major corporate members of the Tax Council are subject to the IRS large case compliance rules.  Among other requirements, the “large case taxpayer” is subject to tax audits on an annual basis.

  The following example is typical of the type of misguided inquiry large case taxpayers face under current law.  IRS auditors challenge the treatment of an acquisition of an entity that carried with it several tax attributes that would reduce the liability of the acquiring company.  Despite the fact that the transaction followed all the legal requirements dictated by the business exigencies of the acquired entity, the IRS case manager opines that the transaction was a shelter subject to the disclosure rules because the taxpayer “could have” acquired the assets rather than the entity. In cases like these, involving taxpayers who are clearly correct in both the interpretation of current law and the decision not to disclose, a great deal of unnecessary time and effort is added to an already overly costly and complicated examination.  

At the time the current tax shelter reporting rules were passed, Congress was rightfully concerned with the proliferation of the aggressive marketing of questionable tax schemes.  The existing tax shelter rules already have discouraged both the prospective buyers and sellers of abusive tax shelters.  Although The Tax Council has not surveyed its member companies, there is a great deal of anecdotal evidence that the marketing of questionable tax schemes has abated.

Objective legal standards regarding the way a business is organized and operated are required.  Income tax compliance under the Internal Revenue Code is both complex and time-consuming.  No taxpayer is required to pay higher taxes, if there is a legitimate and authoritative way to pay a lesser amount correctly.  Any other approach to planning and compliance would be unfair to shareholders, employees and customers.  This is the context in which we review the tax shelter draft.

The August 3 Discussion Draft

We have reviewed the comments on the August 3 draft of the AICPA and the Tax Fairness Coalition.  Several members of The Tax Council are members of these two organizations.  The Tax Council agrees with the comments of those two groups.  The following are specific comments on several of the points they raised.

Improvements in the draft include stepping back from a strict liability approach and using incentives for better disclosure.  The single-tier penalty regime is an improvement over the two-tier regime set forth in the earlier draft.

The most fundamental concern about this legislative proposal is the definition of the term “tax shelter.”  A transaction that has “a significant purpose” of tax avoidance in all likelihood will sweep in legitimate transactions and planning techniques.  As a practical matter this is a problem with current law, also.  As noted above, IRS audit teams on large cases are having enough trouble administering the current rules.  While The Tax Council shares the concern that abusive tax shelters erode confidence in the income tax system, we believe that the system will be harmed by sweeping into the tax shelter net issues that are properly part of a routine IRS inquiry on a large case audit.

            While The Tax Council does not endorse any particular definition of tax shelter, we believe that the legislation should be more specific and should be moved to the “principal purpose” approach with clear guidelines as to what an “abusive” shelter is.  Clarity is required so that advice from outside counsel and advice to management regarding proposed planning will be reliable. 

           The vagueness of the significant purpose standard coupled with the severe penalty restrictions would likely cause the IRS to be flooded with disclosures that do not help them resolve the abusive shelter problems.  Moreover, there would be a greater potential for misguided IRS examination teams to hold up audits that would be better settled on the facts and issues presented, and not the threat of a potentially huge penalty. 

            The proposed 40 percent penalty should be substantially reduced and applied with greater certainty.  The standard for disclosure should be based on the standards in the regulations under section 6011.  This would give the Treasury and IRS the authority and flexibility necessary to focus on the truly abusive tax shelters.

The de minimis rule is a welcome change.  However, in the context of a large case taxpayer, $50,000 is far too low. 

Under the draft, taxpayers would be permitted to avoid the 40 percent penalty if there is “substantial authority” for the position taken.  The substantial authority test should be clarified so that taxpayers may rely on a well-reasoned and thorough opinion, even if there is no specific guidance from the IRS through regulations or rulings.  Commercial transactions are often necessarily complex.  As business relationships across the economy evolve, planning decisions must be made more quickly than has often been the case in the past.  A good faith effort to comply with the law through a well-reasoned and thorough opinion should not become the equivalent of an “abusive” tax shelter.

As the draft is further refined, The Tax Council encourages the staff to consider improvements to the rules that require disclosure of transactions.  Any new rules should put the penalty provisions in the proper context.  Taxpayers should be permitted to challenge the IRS assertion that a given transaction is a “reportable” transaction.  Taxpayers should not suffer a penalty for failure to disclose in a case in which it is finally determined that the correct tax had been paid.  Cascading penalties do not permit the constructive and efficient administration of the Internal Revenue Code and should be avoided.

Conclusion

            The Tax Council believes that the goal of shutting down the proliferation of truly abusive corporate tax shelters is a worthy pursuit.  However, this goal should not be pursued at the expense of sound and efficient business planning and tax administration.  Over the past several years the IRS has implemented several constructive changes to the rules governing the income tax return process.  Many of these administrative changes have given taxpayers more certainty.  Others provide for streamlined procedures to resolve differences that arise during the examination of returns.  By adopting overly aggressive definitions of reportable transaction and disclosure requirements the legislation runs a real risk of reversing this positive trend.

            The Tax Council recommends that the current law and regulations on corporate tax shelters be given sufficient time to work before additional new changes are considered.  Based on the common experiences of many large case taxpayers, IRS should focus on better training of field agents under current law.  Adding yet another layer of rules to the heavy load of IRS agents who serve as examiners of returns could create a nightmare for IRS training efforts. 

Senior tax executives are required to give advice as to the taxation of income from investments, acquisitions, and business reorganizations before they are consummated.  The IRS sees the result of this business planning after the fact, as the income tax returns are filed and the audit team prepares to examine a new cycle of corporate tax returns.  Any further changes to the tax shelter regime in the Internal Revenue Code should neither hamper the ability of tax executives to give forward looking advice to management, nor increase the costs and time expended in compliance.

            We trust that our comments will be helpful to you, and we appreciate your taking them into consideration.

                                    Sincerely,   

                                    Roger J. LeMaster
                                    Executive Director