TEI comments on Multistate Tax Commission draft model uniform statute: September 27, 2005.
On September 27, 2005, Tax Executives Institute submitted the following written comments and testified in respect of the Multistate Tax Commission Draft Model Statute on Reportable Transactions and Inconsistent Filing Positions. The Institute's comments were prepared under the aegis of its State and Local Tax Committee, whose chair is Janet M. Wilson.On June 16, 2005, the Executive Committee of the Multistate Tax Commission (MTC) approved for public hearing its Draft Model Statute on Reportable Transactions and Inconsistent Filing Positions. The public hearing is scheduled for September 27, 2005. Tax Executives Institute (TEI) appreciates the opportunity to submit written comments and testify in respect of the draft model uniform statute. The makeup of TEI's membership, as well as the Institute's experience in addressing these issues at the federal level, allows us to bring a unique and important perspective to this uniformity proposal.
Background
TEI was established in 1944 to serve the educational, networking, and advocacy needs of business tax professionals. Our more than 5,400 members are accountants, attorneys, and other professionals who work for 2,800 of the leading companies in North America, Europe, and Asia. The Institute is firmly dedicated to developing and implementing 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. The Institute is committed to maintaining a system that works--one that builds upon the principle of voluntary compliance and is consistent with sound tax policy, one that taxpayers can comply with, and one in which state taxing authorities can effectively administer their tax laws without unduly burdening taxpayers.
TEI members are responsible for conducting the tax affairs of their companies and ensuring their compliance with myriad federal, state, and local tax laws. We, along with federal, state, and local governments, have the most at stake in crafting a tax system that is administrable and efficient. Because TEI does not represent tax shelter promoters or their advisers, our comments relate, except for the definition of "material advisor," primarily to the draft model uniform statute provisions that require taxpayers to file statements with their returns disclosing "reportable transactions."
Because the Commission's draft model uniform statute draws heavily upon the federal statutes, regulations, and guidance in respect of reportable transactions, TEI's ongoing efforts to assist in identifying and curbing abusive tax avoidance transactions at the federal level merit review. TEI has consistently urged policymakers to focus on enhancing tax return disclosures. Thus, in a January 23, 2004 letter to the MTC, we stated,
... the key to stopping tax abuses lies not in demonizing taxpayers or draconian penalties, but in the effective administration of the tax law, including the ability of examiners to identify and analyze transactions, and, where necessary, to challenge them. To this end, TEI has urged both federal and state policymakers to focus on disclosure-based approaches to address tax shelters.
By identifying and targeting indicia of transactions that are characteristic of "tax shelters" and requiring enhanced disclosure of such transactions, tax officials can properly focus examination resources on questionable transactions Hence, TEI's 2000 and 2003 comments on the federal reportable transactions regulations commended the government for emphasizing objective criteria for the determination of reportable transactions. Our comments, however, cautioned the Department of Treasury and the Internal Revenue Service to refine the federal reportable transactions regime to make it more administrable.
Despite our concerns at the federal level, TEI believes that the best method for States wanting to adopt a disclosure regime is to conform with federal rules governing reportable transactions. Doing so would allow taxpayers to fulfill reporting requirements by attaching a copy of their federal Reportable Transaction Disclosure Statement to their state returns. (1) In doing so, however, States must be mindful of three overarching concerns: (1) substantially increasing compliance costs without a commensurate improvement in the quality of information supplied to tax officials, (2) increasing uncertainty for taxpayers, and (3) heightening the risk for penalties for foot faults and inadvertent failures to file disclosure statements for reportable transactions.
Defining Reportable Transactions
The draft model uniform statute is an amalgam of the federal statutes and regulations and some early state efforts in this area (notably California). Perhaps as a consequence, the definition of a reportable transaction is vague and unnecessarily broad. The uncertainty and misconceptions engendered by the draft model statute's definitional provisions will likely hamper compliance and undermine the Commission's express purpose of promoting "uniformity or compatibility in significant components of tax systems." (2)
The goal of uniformity is specifically endangered by the warrant granted to the head of a state tax agency to add to the list of "reportable transactions," especially through mere "informational bulletins." (3) With respect, the potential patchwork of reportability standards combined with the triple penalty scheme of Part II does not seem to "Facilitate taxpayer convenience and compliance in the filing of tax returns and in other phases of tax administration." (4)
TEI offers the following specific recommendations to refine and clarify the definition of "reportable transaction" in the draft model uniform statute:
1. In Section I.1, first sentence, the phrase "as determined under regulations" should simply read "under regulations."
2. In Section I.1, first sentence, the phrase "otherwise subject to the jurisdiction of this State" should be stricken. Because of the language that precedes it, it is unnecessary.
3. In Section I.1, second sentence, beginning at "inclusive, where such transaction or arrangement is of a type which the U.S. Secretary of [the] Treasury determines as having a potential for tax avoidance or evasion, a listed transaction as defined under Section I.2, a non-economic substance transaction as defined under Section I.4, and a tax shelter as defined in Section I.5" should be stricken. The word "inclusive" is superfluous, and the remainder of the sentence appears to be drawn from the federal regulation's definition of a listed transaction, which is covered in Section I.2 (except for references to Section I.4 and I.5, which we recommend be eliminated). In short, this part of the sentence is unnecessary and unhelpfully conflates Section I.1 with Section I.2.
4. In Section I.2, because of the amorphous nature of the phrase "substantially similar to," we recommend it be avoided entirely, even acknowledging its use in the federal provisions. Indeed, full conformity with the federal provisions would ameliorate difficulties in applying this phrase at the state level in so far as federal authorities bring its scope into sharper focus.
5. In Section I.2, first sentence, the word "reportable" should be stricken; it does not belong and commingles Section I.2 with Section I.1 in a way that blurs the distinctiveness of a listed transaction vis-a-vis a reportable transaction.
6. In Section I.2, first sentence, we recommend that "Informational Bulletins or other published Department guidance" be changed to read "notice, regulation, or other form of official Department guidance." Even better would be eliminating this discretion entirely in favor of fully conforming to the federal provisions.
7. In Section I.2, second sentence, the phrase "any reportable transaction that is the same as, or substantially similar to, a transaction or arrangement specifically identified by the U.S. Secretary of [the] Treasury as a tax avoidance transaction for purposes of Internal Revenue Code Section 6011," should be replaced with the phrase "one of the types of transactions that the Internal Revenue Service (IRS) has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction." TEI's suggested change is drawn directly from the current version of Treas. Reg. [section] 1-6011.4(b)(2) defining listed transactions for federal purposes.
8. We urge the elimination of Section I.4, Non-Economic Substance Transaction. Almost all governments--and the federal government in particular--have refrained from codifying a judicial doctrine heavily reliant on the facts and circumstances established in a court proceeding. The draft model uniform statute seemingly includes Section I.4 as a mere place holder, referring only to "state or federal law." While non-economic substance transactions are thus engulfed within the draconian reportable transactions penalty scheme, this provision does not further the purpose of the draft model uniform statute. The economic substance doctrine has not been codified at the federal level at least in part because of concern that no codified provision could properly address the issue without both hindering valid business transactions and possibly constraining the courts' ability to apply the doctrine to situations not covered by the statute. (5) Thus, what has proven to be an effective judicial backstop becomes an inadequate deterrent though codification, at the same time adding significantly uncertainty and complexity to tax systems. It has been deliberated and eschewed at the federal level; we recommend the Commission avoid it also.
9. We also urge the elimination of Section I.5, Tax Shelter. The federal reportable transaction regime is a disclosure-based approach based on objective criteria to curb abusive tax avoidance transactions. Indeed, the federal tax authorities developed the reportable transaction regulations to replace the old subjective test for an ill-defined "tax shelter." Because the provisions related to reportable and listed transactions provide objective guidance to taxpayers and revenue agents, the regime is more administrable. Eliminating the definition of "tax shelter" from Part I will similarly enhance the workability of the draft model uniform statute in respect of reportable transactions. (6)
Notably absent from the draft model uniform statute is any exception to the disclosure requirements. The federal regulations include a provision allowing the Commissioner of Internal Revenue to make a determination that a transaction is not subject to the reporting requirements. Absent fully conforming to the federal rules, an analogous provision allowing the head of a state tax agency to make such a determination should be added to the draft model uniform statute. TEI also advocates including exceptions for transactions in the ordinary course of business and for transactions comporting with the intent of state tax laws, which will foster better allocation of audit resources and minimize over disclosure by cautious taxpayers. Further, it will substantially reduce the administrative burdens associated with a reportable transaction regime.
Extraordinary Penalties
The draft model uniform statute sets up a series of penalties related to reportable transactions: (1) a penalty for failure to disclose a reportable transaction (doubled for listed transactions); (2) a 20-percent penalty for understatement of tax related to a reportable transaction, based on increase in taxable income times highest tax rate (30-percent if the transaction was not disclosed); and (3) a 50-percent of the interest assessed on an amended return, presumably for understatement of tax related to a reportable transaction (100-percent if the taxpayer is contacted by the IRS or state tax authorities regarding a reportable transaction, presumably if the taxpayer has not previously filed an amended return).
The non-delegable authority to abate these penalties resides solely with the head of the state's tax agency. TEI submits that adopting the three penalties of the draft model uniform statute, without any correlative grant of administrative discretion, would thwart due process and constitutes overkill. TEI believes that consistency and certainty in the application of penalties play a larger role in deterring noncompliance than increasing the amount of them.
We are also concerned because a disproportionate penalty could well exacerbate taxpayer-auditor relations, prolong and disrupt the audit process, and even prove counterproductive to the provision's goals. Because administrative review is essential to ensuring the fairness of any penalty regime, TEI believes substantially limiting administrative discretion is unwarranted. More fundamentally, we submit that prohibiting any administrative or judicial review of a waiver determination by the head of a tax agency is unconscionable. While judicial review is denied in the federal provisions, administrative review is not. Why should the draft model uniform statute preclude administrative review at an appropriate level?
In addition, increasing the already stern 20-percent penalty in the case of an understatement of tax related to undisclosed transactions may effectively compel prudent taxpayers to disclose myriad legitimate business transactions that are otherwise unremarkable to avoid being penalized, undermining the goal of highlighting troublesome transaction and complicating tax administration.
As a matter of equitable tax administration, TEI urges the Commission to abandon the 50-percent and 100-percent interest penalty. Potentially, a taxpayer that fails to disclose a reportable transaction (which results in a reportable transaction understatement) and subsequently is contacted by tax officials before filing an amended return, is subject to three penalties: (1) an essentially strict liability penalty for failure to disclose the transaction, (2) an essentially strict liability 20-percent penalty computed by applying the highest rate of tax to the reportable transaction understatement, and (3) an essentially strict liability, 100-percent interest penalty (which would also be included in the base amount of the reportable transaction understatement for purposes of the 20-percent penalty). This "piling on" of penalties runs counter to prevailing theories of good tax administration. Hardly necessary to compel participation in any voluntary compliance program, the interest penalty provision is beyond the pale of equitable tax administration. Indeed, under the draft model uniform statute, a state is not even required to have a voluntary compliance program to make use of this penalty.
Inconsistent Filing Positions
Section III of the draft model uniform statute establishes a requirement for disclosing an "inconsistent filing position" on a return. That term is defined in Section I.3 and includes three circumstances identified in Section III.1.A.ii, along with a "catch-all" provision allowing the head of the State's tax agency to further identify "inconsistent filing positions." Associated record-keeping requirements, penalties (complete with a non-delegable, non-reviewable waiver provision), and extension of the statute of limitations are also included in Section III.
These provisions seem predicated on the misconception that: (1) state tax systems are substantially alike in the treatment of items on a return, or (2) dissimilar treatment of items on returns connotes unscrupulous tax behavior that will be deterred by requiring disclosure. Neither of these is accurate to a degree that would support subjecting compliant taxpayers to administratively burdensome, subjective requirements fraught with the peril of being penalized. The irony of the inconsistent filing positions provisions of the draft model uniform statute is that taxpayers that strive to comply in all states in which they are required to file are at risk of penalty where the inconsistent positions on the returns are a result of following the tax laws in each state.
TEI submits that the state tax policy objective of these provisions can more easily be achieved through efficient use of information sharing among the states rather than burdening compliant taxpayers. At a minimum, inconsistent filing positions in respect of transactions (rather than return items) could be included within the definition of reportable transactions along with adding an exception for positions that are the result of complying with a state's tax laws.
For these reasons, this entire section should be eliminated.
Definition Of Material Advisor
TEI recommends that Section I.10, Material Advisor, be revised to exclude from the definition of "material advisor" all officers, directors, or employees of a taxpayer who provide advice to their employer in respect of their employer's reportable transactions. Such a distinction would recognize that the relationship between in-house advisers and their client, i.e., their employer, is different from that of promoters and promoters' advisors. In addition, TEI recommends that the scope of the definition of material advisor be narrowed to exclude external advisors who are unconnected to a promoter. For example, material advisors should not include those (1) who are selected solely by the taxpayer and not a promoter and (2) whose fees for legal opinions are based on usual, customary, and reasonable hourly rates.
Conclusion
Tax Executives Institute appreciates this opportunity to present its views on the Commission's Draft Model Uniform Statute on Reportable Transactions and Inconsistent Filing Positions. In sum, TEI submits that the least burdensome, most administrable method for States wanting to adopt a disclosure regime in respect of reportable transactions is to conform with the federal rules. A model uniform statute thus crafted also advances the uniformity goals of the Commission.
The Institute's comments were prepared under the aegis of its State and Local Tax Committee, whose chair is Janet M. Wilson. If you have any questions, please contact Ms. Wilson at 713.839.4838 or janet.wilson@halliburton.com or Gregory S. Matson of the Institute's legal staff at 202.638.5601 or gmatson@tei.org.
(1) IRS Form 8886.
(2) Multistate Tax Compact Article I 2.
(3) The interplay of Section I.1, Reportable Transaction, and Section I.2, Listed Transaction, leaves us uncertain (1) whether a transaction is determined to be reportable through regulations, (2) regulations will address the process by which the head of a state's tax agency makes such determination, or (3) whether this can be done through "Informational Bulletins or other published Department guidance."
(4) Multistate Tax Compact Article I 3.
(5) Cf. JCX-78-02, pp. 6-8.
(6) Section I.5 is also superfluous to Part V, Tax Shelters, which contains its own definitional criteria.
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| Title Annotation: | Tax Executives Institute |
|---|---|
| Publication: | Tax Executive |
| Date: | Nov 1, 2005 |
| Words: | 2851 |
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