Walking the tightrope: the new tax shelter disclosure regulations.
In February of this year, the Internal Revenue Service issued temporary and proposed regulations aimed at curbing what the Treasury Department perceives as the most serious compliance issue threatening the American tax system -- corporate participation in tax shelters.(1) Similarly, in May of this year, the Senate Finance Committee released a draft of proposed legislation that would also target corporate tax shelters.(2) The new regulations and draft legislation evidence increasing concern among government officials that billions of dollars a year are being lost to corporate tax-avoidance schemes.(3)The new tax shelter disclosure (TSD) regulations do not alter substantive tax rules, but rather attack the problem by requiring persons participating in corporate tax shelter transactions to create, maintain, and provide to the IRS certain information about the transactions and persons associated with the transactions.
The first of the TSD regulations, Temp. Reg. [sections] 1.6011-4T, outlines new reporting requirements for corporate taxpayers that engage in tax shelter transactions. The second set of the TSD regulations, Temp. Reg. [sections] 301.6111-2T, requires promoters and advisers to register corporate tax shelters. The third set, Temp. Reg. [sections] 301.6112-1T, requires promoters to collect and maintain information regarding investors who purchase interests in corporate tax shelters.
It is obvious that the Treasury Department hopes the TSD regulations will provide the IRS with more current and more complete information about tax-motivated transactions. The regulations require corporations to attach a special form to the first return upon which a tax motivated transaction affects the corporate tax liability.(4) Registration of tax shelters is required currently with the marketing of the product, and investor lists are to be made available for inspection without a summons within ten calendar days of a request.
If the tax shelter problem is as pernicious as perceived, these are laudable objectives. Unfortunately, the TSD regulations are overbroad in scope, may impose disproportionate burdens with respect to routine transactions, and create substantial uncertainty regarding their actual requirements.
CORPORATE REPORTING
Temp. Reg. [sections] 1.6011-4T(5) requires corporate taxpayers to file a statement with their tax return disclosing their participation in reportable transactions. As defined in the regulations, reportable transactions fall into two categories: (1) listed transactions, and (2) other reportable transactions.
Listed Transactions
A listed transaction is any transaction the IRS has identified through published guidance as a tax-avoidance transaction or a transaction that is substantially similar to a listed transaction. Along with the new regulations, the IRS also published Notice 2000-15,(6) detailing 10 listed transactions.
Other Reportable Transactions
The second category consists of other reportable transactions. A transaction will be an other reportable transaction if it possesses at least two of the following six characteristics:
1. The taxpayer has participated in the transaction under conditions of confidentiality.
2. The taxpayer has obtained contractual protection against the possibility that all or part of the intended tax benefits from the transaction will not be allowed.
3. The taxpayer's participation in the transaction was promoted, solicited, or recommended by one or more persons who are expected to receive fees or other consideration with an aggregate value in excess of $100,000.
4. The expected treatment of the transaction for federal tax purposes is expected to differ by more than $5 million from the treatment of the transaction for purposes of determining book income as taken into account on the schedule M-1 (or comparable schedule) on the taxpayer's federal tax return for the same period.
5. The transaction involves the participation of a person that the taxpayer has reason to know is in a federal income tax position that differs from that of the taxpayer (such as a tax-exempt entity or foreign person), and the participation of such person allows the taxpayer to receive more favorable federal tax treatment.
6. The expected characterization of any significant aspect of the transaction for federal tax purposes differs from the expected characterization of the same aspect of the transaction for purposes of taxation of any party to the transaction in a foreign country.
The characteristics and thresholds in the regulations present a number of problems. As a general matter, the two-of-six-factor test is excessively broad and sweeps in many ordinary transactions. Several of the six characteristics are often present in ordinary business transactions. For example, the $5 million of book/tax difference, the participation of a tax-exempt entity or foreign person, and incurring an aggregate of $100,000 in fees can occur with some frequency.
In comments to the IRS, Tax Executives Institute stressed that the Internal Revenue Code is replete with provisions creating book/tax accounting differences; thus, it is somewhat paradoxical that the more scrupulous a taxpayer is in complying with the tax law (i.e., reporting book/tax differences), the greater the likelihood of having to file additional disclosure. Large corporations generally disclose scores of Schedule M items on tax returns, and the book/tax differences for these items frequently exceed $5 million in a single tax year. Consequently, for a large corporation, the regulation's book/tax characteristic will almost invariably be present, and the two-of-six-factor test will in practice be more akin to a one-in-five-factor test.(7)
In addition, the Chicago Bar Association has pointed out that the sixth factor outlined in the regulations (i.e., transactions in which the expected characterization of a significant aspect of the transaction for federal income tax purposes differs from its characterization in a foreign country) will often be duplicative of the immediately preceding factor (i.e., participation of a person whose federal income tax position differs from that of the taxpayer).(8) By definition, a foreign person is a person whose federal tax position will usually be different from that of a U.S. taxpayer. Hence, the inclusion of both the fifth and sixth factors in the regulations may have the effect of automatically rendering every transaction that involves a foreign party a reportable transaction.(9)
Even if factors 5 and 6 are not identical, for multinational corporations, the presence of one of these two characteristics in many transactions is inevitable. Thus, many routine transactions will require disclosure because the book/tax differential will also be a characteristic of these transactions.
Projected Tax Effects
In addition to falling into either the listed or other reportable transaction category, a transaction must also satisfy a projected tax effects threshold before reporting is required. For listed transactions, the threshold is satisfied if the transaction reduces the corporation's tax liability by more than $1 million in any single tax year or by a total of more than $2 million for any combination of tax years. For other reportable transactions, the projected-tax-effects thresholds increase to $5 million for any single tax year and $10 million for any combination of tax years.
Unfortunately, the test for estimating the projected tax effect of a transaction and for determining whether it meets the monetary thresholds requiring disclosure is unclear in its application.(10) For example, how long must a taxpayer analyze a transaction in order to arrive at the $2 million and $10 million thresholds for a combination of tax years? Is it five years, ten years, or more?(11) This is a difficult estimate for corporations involved in complex non-tax motivated transactions that produce ancillary tax savings over a number of years. It seems that under the regulations, disclosure would be required of many transactions with small, but enduring tax savings.(12)
Exceptions
In an attempt to exclude nonaggressive tax transactions from the disclosure requirements, the TSD regulations include four exceptions for transactions that would otherwise fall into the other reportable transaction category. Regrettably, the exceptions do not provide meaningful relief for taxpayers swept in by the excessive scope of the two-of-six-factor test. The TSD regulations provide that a corporation does not have to disclose participation if any of the following conditions are satisfied:
1. The taxpayer participated in the transaction during the ordinary course of business, and the taxpayer reasonably determines that it would have participated in the transaction irrespective of the tax benefits.
2. The taxpayer participated in the transaction during the ordinary course of business, and the taxpayer reasonably determines there is a longstanding and generally accepted understanding that the expected tax benefits are allowable under the Code.
3. The taxpayer reasonably determines there is no reasonable basis under federal tax law for the denial of the tax benefits.
4. The transaction is identified in published guidance as excepted from disclosure.
The first exception requires that the taxpayer would have participated in the transaction during the ordinary course of business and on substantially the same terms irrespective of the expected tax benefits. This exception fails to recognize that taxes do in fact change the economics of a transaction.(13) In many transactions, tax benefits are an essential component of the price at which assets are exchanged, and the fact that terms would change absent tax benefits does not mean the transaction is a tax shelter.(14)
The second exception requires that the taxpayer participate in the transaction during the ordinary course of business and determine there is a long-standing and generally accepted understanding that the tax benefits are allowable. These terms create a great deal of uncertainty and raise many questions. How is such a provision measured? How long is long-standing? Whose understanding is the standard? Does the term prevent any novel tax planning idea from qualifying for the exception? Would a taxpayer be required to obtain an opinion to qualify for this exception? If so, what information would guide a professional in rendering the opinion?
Essentially, the exceptions introduce standards of assurance that are too vague to provide guidance to taxpayers and their advisers.(15) In particular, the third exception -- the no reasonable basis exception -- perplexes many tax professionals. Currently, there is no general consensus as to what exactly no reasonable basis means. Some argue the exception would not apply even in situations where the IRS consistently loses the issue in court but continues to challenge taxpayers.(16) For example, the IRS has lost cases in multiple courts regarding the deductibility of insurance premiums under captive insurance arrangements, yet the IRS continues to litigate the issue and assert its economic family position rejected by the courts.(17) Thus, although a taxpayer is likely to win in court, the taxpayer cannot claim there is no reasonable basis for the IRS to deny the benefits.(18)
If the IRS issues permanent regulations, the no reasonable basis exception should be replaced by a more meaningful and reliable standard. Comments submitted to the IRS have suggested two possible replacement standards, either of which would be more acceptable than the no reasonable basis exception.
The first replacement standard, suggested by TEI(19) and the Chicago Bar Association,(20) is a substantial authority test similar to the one employed by the current rules governing disclosure required to avoid substantial understatement penalties under section 6662. This test is commonly interpreted to mean a 40-percent chance of prevailing on the merits. The exception would apply if the taxpayer determines the IRS would not have substantial authority to deny the tax benefits. In other words, when a taxpayer concludes the IRS would have less than a 40-percent chance of prevailing against the taxpayer, the exception would apply. Stated positively, the taxpayer must conclude they have better than a 60-percent chance of prevailing on the merits.
The second replacement standard -- proposed by the AICPA(21) and the Coalition for Fair Taxation of Business Transactions(22) -- is a realistic possibility of success standard. This standard is similar to the one used under section 6694 as the basis for imposing penalties on persons who prepare tax returns, and regulations under section 6694 provide a clear interpretation of the standard. Treas. Reg. [sections] 1.6694-2(b) states that a position is considered to have a realistic possibility of being sustained on its merits if a reasonable and well-informed analysis by a person knowledgeable in the tax law would lead such a person to conclude that the position has approximately a one in three, or greater, likelihood of being sustained on the merits.(23) This test would provide an exception from disclosure when the taxpayer determines there is less than a one-in-three chance that an IRS challenge would be sustained on the merits. The test is slightly more demanding than the substantial authority test, requiring the taxpayer to conclude they have better than a 66-2/3rd percent chance of prevailing over the IRS.
Because the TSD regulations are excessively broad and it is not clear what transactions the Treasury means to except from disclosure, conservative taxpayers will likely disclose more than they need to just to be safe. If this occurs, not only will taxpayers face an unnecessary burden, but disclosure-by-the-moving-van will defeat the intended objective of the disclosure. There will be so much disclosure that the IRS will not be able to review the disclosure it receives. The sought-after tax shelter information will be the proverbial needle in the haystack.
Record Retention
Along with the reporting requirements, the regulations also require the taxpayer to retain all documents related to a transaction subject to disclosure. This provision requires corporations to maintain volumes of documents until the expiration of the statute of limitations. Such documents include, but are not limited to, the following: all marketing materials related to the transaction; all written analyses used in decision making related to the transaction; all correspondence and agreements between the taxpayer and any promoter, adviser, lender, or other party to the reportable transaction; all documents discussing, referring to, or demonstrating the tax benefits arising from the transaction; and all documents, if any, referring to the business purposes for the transaction.
This provision imposes an immediate burden on corporate taxpayers. Documents related to corporate transactions inevitably go through several drafts before they accurately reflect the transaction in which the taxpayer ultimately participates. In addition, routine, non-substantive editing of text produces multiple versions of documents. The regulations appear to require taxpayers to retain not just final drafts but all drafts of documents related to a transaction. To comply with the regulations, corporations with stated document destruction policies apparently must now alter those policies and make room to store volume upon volume of documents that are of dubious benefit to the IRS (should it ever choose to inspect them) and of no value to the taxpayer. There is also the ever-recurrent problem of electronic message retention. Do the new TSD regulations require corporations to institute new e-mail retention policies?
Penalties
A separate penalty provision is conspicuously absent from the corporate reporting regulations. Nonetheless, in the preamble to the temporary regulations, the IRS noted that a taxpayer's failure to satisfy the disclosure requirements of the TSD regulations could be a factor in determining exposure to penalties under sections 6662 and 6663. Section 6664(c)(1) provides a defense to the penalties imposed by sections 6662 and 6663 if the taxpayer relies in good faith on a professional tax adviser. The preamble notes, however, if a taxpayer has an underpayment attributable to its participation in a reportable transaction that has not been properly disclosed on its return, the nondisclosure could indicate that the taxpayer has not acted in good faith with respect to the underpayment. Although the logic of this position is convoluted, the threat is clear and, given the hostility in some quarters to aggressive tax planning, cannot be ignored.
REGISTRATION REQUIREMENTS
Temp. Reg. [sections] 301.6111-2T(24) requires tax shelter promoters to register with the Secretary transactions (1) that have been structured for a significant purpose of tax avoidance or evasion, (2) that are offered to corporate participants under conditions of confidentiality, and (3) for which the tax shelter promoters may receive fees in excess of $100,000. In addition, any person who sells an interest in a registered tax shelter must furnish the tax shelter identification number to the purchaser, and any person claiming a deduction, credit or other tax benefit derived from the registered shelter must include the identification number on the return in which the benefit is claimed.
Significant Purpose of Tax Avoidance or Evasion
The regulations outline three categories of transactions that will satisfy the first prong of the three-prong test (the significant purpose test). These include (1) listed transactions, (2) transactions that lack economic substance, and (3) other tax-structured transactions.
Listed Transactions
Similar to the listed transactions under Temp. Reg. [sections] 1.6011-4T,(25) a transaction will satisfy the significant purpose test if the transaction is a transaction the IRS has determined to be a tax avoidance transaction and identified in published guidance as a listed transaction for purposes of section 6111 or is substantially similar to such a transaction.
Economic Substance
Additionally, the transaction will satisfy the significant purpose test if the structure lacks economic substance. Under the regulations, a transaction lacks economic substance if the present value of the participants expected pre-tax profit from the transaction is insignificant when compared to the participant's tax savings from the transaction.
Many practitioners have labeled this provision an attempt to codify the judicially created economic substance doctrine. After identifying the doctrine's origins in the seminal case of Gregory v. Helvering,(26) the courts have elaborated and expanded on the doctrine most recently in high-profile cases including ACM,(27) Compaq(28) and Winn-Dixie Stores.(29) The doctrine is the court's attempt to strike a balance between the taxpayer's right to decrease his taxes by any legal means and the government's right to require that a transaction be related to a useful non-tax purpose.(30)
Striking such a balance in numerous cases with vastly different facts and circumstances under review, requires a standard that is versatile and adaptable. Judge David Laro of the United States Tax Court has noted that the economic substance doctrine must be a standard flexible enough to assist the court in its evaluation of the most sophisticated transactions as well as the most simple business dealings.(31) Moreover, the standard must allow the court to evaluate and examine all proper evidence in a transaction, including subjective notions such as the intent of the taxpayer.(32)
The Treasury's attempt to capture such a multifaceted concept within the regulations is both unsuccessful and unnecessary. The TSD regulations would treat a transaction as lacking economic substance if the reasonably expected pre-tax profits (determined on a present value basis) of the transaction are insignificant relative to the reasonably expected tax benefits. Pre-tax profit is only one of the many factors corporations evaluate and consider as they attempt to assess the economic substance of a transaction, yet this is the only factor contemplated by the regulations. The regulations provide no guidance on what discount rate is appropriate for calculating the present value of pre-tax profit and tax benefits. Nor do the TSD regulations provide guidance on the required profit/tax benefit ratio. How much profit is insignificant? In addition, no consideration is given to routine transactions that are not intended to produce a profit.
Inasmuch as the economic substance test is already an established judicial doctrine, one can legitimately question whether it is necessary to try to embed the doctrine in administrative regulations. If such an attempt is to be made, however, the least that can be expected is that taxpayers not be required to guess at the standard the administrator will apply.
Other Tax-Structured Transactions
The third way in which a transaction can satisfy the significant purpose test is if it is an other tax-structured transaction. The regulations provide that a transaction will be included in this category if it has been structured to produce tax benefits that constitute an important part of the transaction and the promoter expects to present the structure to more than one participant. However, a transaction does not come within this third category if the potential participant is expected to participate in the transaction in the ordinary course of business and the promoter reasonably determines there is a longstanding and generally accepted understanding that the tax benefits are allowable.
The regulations are unclear about what type of transactions fall into this category. In particular, the regulations do not specify what constitutes an important part of a transaction. Because tax rates approach 40 percent for many corporations, tax savings will inevitably be an important part of the intended results of a transaction.
In addition to the ordinary course of business exception discussed previously, the regulations provide that, except for listed transactions, the transaction will not satisfy the significant purpose test if the tax shelter promoter determines there is no reasonable basis under federal tax law for the denial of the tax benefits. These exceptions are the same as the ordinary course and reasonable basis exceptions previously discussed and are plagued by the same problems.
Conditions of Confidentiality
The second prong of the confidential corporate tax shelter test is the confidentiality test. Under the regulations, confidentiality will exist if an offeree's disclosure of the structure is limited in any way by an express or implied agreement with the promoter. An offer will also meet the confidentiality test if any promoter has reason to know the transaction is protected from disclosure in any other manner (e.g., the transaction is claimed to be proprietary by the promoter or another party other than the offeree).
Unless facts and circumstances indicate otherwise, an offer is not considered made under conditions of confidentiality if the promoter enters into a written agreement with each person who participates or discusses participation in the transaction, and the agreement expressly authorizes such persons to disclose every aspect of the transaction to any and all persons, without limitation.
There is wide expectation that this part of the TSD regulations will be negated by the simple elimination of confidentiality requirements in the marketplace. As a practical matter, few ideas remain confidential for very long -- the tax community is a garrulous one. Even before the publication of the TSD regulations, many corporations simply would not enter such agreements. Now the impetus to do so is significantly reduced.
Another significant and unanswered question concerns proprietary software. Is a licensee of a product subject to a copyright for which a royalty is paid operating under a condition of confidentiality?
Fees
The third prong of the confidential corporate tax shelter test is that the tax shelter promoters, whether or not related, may receive fees of more than $100,000 in the aggregate. All consideration that may be received by the tax shelter promoter is taken into account, including contingent fees, fees in the form of equity interests, and fees the promoter may receive for other transactions as consideration for promoting the tax shelter.
Who Registers?
A confidential corporate tax shelter must be registered by the tax shelter's promoter. The regulations provide that the term tax shelter promoter includes a tax shelter organizer under section 6111(e)(1) and any other person who participates in the organization, management or sale of a tax shelter or any person related (within the meaning of section 267 or 707) to such person. Thus, under the regulations the brothers, sisters, spouse, ancestors, and children of a person who organizes, manages, or sells a shelter could potentially be subject to the registration requirements. It is unclear how such provisions would operate, but some highly irrational results are conceivable.
In addition, if all promoters of a confidential corporate tax shelter are foreign persons, the regulations impose the obligation to register on any person who discusses participation in the transaction. The person must register the shelter within 90 days of beginning the discussions unless (1) the person does not participate in the shelter and notifies the promoter in writing, within the 90-day period, that the person will not participate; or (2) within the 90-day period, the person obtains and reasonably relies on both a written statement from the promoter that the shelter is registered and a copy of the registration.
This provision raises First Amendment concerns that are more than trivial.(33) The provision could potentially impose penalties upon a person who never participates in a shelter but simply talks about it with a promoter or someone who conveys the promoter's proposal. Because the government is capable of penalizing those who actually do participate in the shelter, and no harm to the Treasury results unless there is someone who participates, such overreaching seems both imprudent and unnecessary.(34)
In addition, the regulations will treat a person as having discussed participation if the person participates either directly or indirectly in the transaction. This presents special problems for persons with investments in foreign entities. In some situations, the regulations will treat a person as having indirectly participated in the transaction if they own more than 10 percent of a foreign entity that participates. Accordingly, in many situations, 10-percent stakeholders could be responsible to register transactions entered into by a foreign corporation they cannot control.
The regulations provide that the person registering a shelter must provide a detailed description of the structure and the tax benefits. Also, the promoter must submit with the registration form any written materials presented in connection with an offer to participate in the shelter.
Privilege
If the person required to register is an attorney or a federally authorized tax practitioner and believes information required to be disclosed is protected by the attorney-client privilege or the confidentiality privilege of section 7525, the TSD regulations provide a procedure for claiming protection for the privileged information. The claim for privilege is made by attaching a separate statement to the disclosure form. The statement must be signed under penalty of perjury, identify by document or category the information for which the claim is made, represent that the information was a protected communication, and represent that the person required to register has not waived the privilege by disclosing the information to persons whose receipt thereof would not be privileged. (In this context, it would appear that the only claim for protection available under section 7525 would be for oral communications since, by its express terms, section 7525's protection does not extend to any written communication. ... in connection with ... the direct or indirect participation ... in any [corporate] tax shelter.... Information unrelated to the promotion of participation in a corporate tax shelter would presumably be irrelevant to the registration, require no disclosure, and hence not require a claim of privilege.
Penalties
Failure to comply with the registration regulations may result in the imposition of penalties under section 6707. Thus, the penalty for failing to timely register a shelter is the greater of $10,000 or 50 percent of the fees paid to all promoters of the shelter. In the event of an intentional failure to register or the submission of false or incomplete information, the penalty is increased to the greater of $10,000 or 75 percent of fees. No penalty is imposed if the failure to register is due to reasonable cause.
LIST MAINTENANCE
Temp. Reg. [sections] 301.6112-1T,(35) requires a promoter of a potentially abusive tax shelter to maintain a list identifying each person who was sold an interest in the shelter. A potentially abusive tax shelter includes any transaction that has been structured for a significant purpose of tax avoidance or evasion (as defined under section 6111(d)). Any person required to maintain the list of investors must retain the list for seven years, and make the list available to the Secretary for inspection upon request. No summons is required.
The universe of transactions to which the list maintenance requirements apply is substantially broader than the universe of transactions for which registration is required. The conditions of confidentiality restrictions do not apply, and there is no minimum promoter fee threshold. Moreover, rather than applying only to corporate taxpayers, the listing rules may also apply to individual taxpayers. If the potentially abusive tax shelter was sold to both corporate and individual participants, the regulations require the listing of the individual participants as well as the corporate taxpayer.(36) If the transaction is marketed to only individual taxpayers, the program is not subject to the listing requirements.
Each list must include the following: (1) a detailed description of the tax shelter describing both the structure and the intended tax benefits for the participants; (2) the amount of money invested by each person who is required to be on the list; (3) a summary or schedule of the tax benefits each participant expects to gain from participation in the structure; and (4) copies of any additional written materials, including tax analyses and opinions, relating to the shelter that have been given to participants by the promoter.
As in the registration regulations, here the definition of promoter is too expansive. The TSD regulations can be interpreted to require the spouses and children of some tax advisers to maintain lists. In addition, because the listing requirements apply to transactions without any minimum thresholds on tax savings or fees, a great deal of ordinary tax planning that is of little interest to the IRS will be subject to list maintenance. To limit the effect of the list requirements on smaller practitioners, the AICPA suggests three de minimis exceptions to the list requirements. First, the AICPA recommends a $1 million fee threshold to except smaller transactions from the listing rules. Although it may be argued there are not many small transactions that generate fees in excess of $1 million, some kind of fee threshold would help lessen the unnecessary burden the regulations place on small practitioners. The AICPA also suggests tax-savings thresholds similar to the ones in force under Temp. Reg. [sections] 1.6011-4T, as well as a threshold on the number of hours of professional services an organizer devotes to a transaction before listing would be required.(37)
Privilege
The same procedures are available for protecting attorney-client communications and confidential communications with federally authorized tax practitioners as are provided under the TSD regulations on registration.
Penalties
Penalties under the listing rules are limited to $50 for each investor omitted from the list, with a maximum penalty of $100,000. In the context of multimillion dollar transactions marketed selectively to perhaps only a score of investors, these penalties seem trivial and unlikely to have any real effect on compliance.
CONCLUSION
Corporate taxpayers and their advisers will be affected by the temporary and proposed regulations, especially the corporate reporting regulations. With respect to the effect on advisers, they may be asked to render new types of tax opinions. For example, an adviser may be asked to render an opinion whether disclosure of a specific transaction is required, or whether the regulations can be reasonably construed not to require disclosure.
Alternatively, in order for a taxpayer to come within the no reasonable basis exception to other reportable transactions (until the exception is replaced by a different standard, such as the previously discussed substantial authority or realistic possibility of success standards), the adviser may be asked to opine that the IRS has no reasonable basis to deny the expected tax benefits of a transaction. Given the number of vague, undefined terms in the regulations and the relatively low standard for the IRS to have a reasonable basis to deny benefits, it will be difficult for advisers to provide such opinions. This will be particularly true if Circular 230 is revised to increase adviser sanctions.
Corporate taxpayers will likewise be affected by the regulations. Tax directors will be faced with the decision which and how many transactions to disclose. The (1) broad nature of the corporate reporting regulations and narrow exceptions, and (2) admonition in the preamble that a taxpayer's failure to disclose may affect its exposure to the accuracy-related penalty under section 6662 and the fraud penalty under section 6663 tend to create a bias toward over disclosure. This could lead to, as described by one group of commentators, compliance by the truckload.(38) The number of disclosure statements filed with the IRS remains to be seen, as the first post-regulation federal income tax return filing season is currently under way.
In their present state, the TSD regulations are unlikely to achieve their obvious objective: providing the IRS with timely and useful information with respect to abusive transactions. Instead, the presence of overbroad definitions and undefined (or indefinable) standards is more likely to lead to confusion, controversy, and contempt. The information gathered, more likely than not, will be too voluminous for analysis. The IRS will have no reasonable basis upon which it can discern which transactions need immediate attention.
Both the private sector and the Treasury Department need to work together constructively to refine the TSD standards. The "no reasonable basis" standard should be jettisoned. The "economic substance" rules, if not abandoned, need objective criteria in the way of discount rates and profit/tax benefit ratios. Accounting for transactions where economic profit is not relevant must be covered, perhaps by example. Raising the fee threshold and the tax-effect threshold deserves serious consideration, but the private sector should not think that comments suggesting thresholds that will effectively eliminate reporting and registration will or should be taken seriously.
The task, like the judicial task of deciding when tax planning crosses the line from permissible creativity to abuse, will not be easy; but it is not impossible. And only if both sides are willing to devote the energy and resources required will the task be accomplished.
IRS MODIFIES TAX SHELTER DISCLOSURE REGULATIONS
Just prior to publication of this article, the IRS issued additional temporary and proposed regulations (T.D. 8896), modifying the previously issued temporary and proposed regulations in six important aspects:
1. Coverage of companies required to disclose. The new regulations clarify that both insurance companies and mutual savings banks conducting life insurance business are subject to the disclosure requirements.
2. Record retention. Taxpayers are not required to keep all documents. The documents required to be retained are those that are material to (1) an understanding of the facts of a reportable transaction, (2) the reportable transaction's expected tax treatment, or (3) the corporation's decision to participate in the reportable transaction.
3. Confidentiality. An exclusivity agreement constitutes a condition of confidentiality. Limitations on disclosure required by Federal or state securities laws are not conditions of confidentiality.
4. Definition of promoters. The definition of a promoter is narrowed to clarify that a person is a promoter only if the person participates in the organization, management or sale of a tax shelter under the rules in code section 6111(e)(1) and Temp. Reg. [sections] 301.6111-1T (Q&A 26 through Q&A 33) or is related to such person under section 267 or 707(b).
5. Investor list maintenance. The list maintenance requirements are amended to provide that a transaction may be subject to the list maintenance requirements whether or not the transaction is offered to corporate investors. The list maintenance requirements are also amended to include fee and tax reduction thresholds.
6. Fee and tax reduction thresholds for investor list maintenance. For a potentially abusive tax shelter that is not required to be registered, is not a listed transaction, and is not a projected income investment, an organizer or seller is not required to list an investor if the total consideration paid to all organizers and sellers with respect to the investor's acquisition is less the $25,000 or if the organizer believes the investor's acquisition will not result in a reduction of Federal corporate income tax liability of $1 million in a single year or $2 million in a combination of years. For noncorporate investors, the tax reduction thresholds are $250,000 for a single year and $500,000 for a combination of years.
(1) Remarks of Treasury Secretary Lawrence H. Summers to Federal Bar Association on February 28, 2000, reprinted in HIGHLIGHTS & DOCUMENTS, February 29, 2000, at 2945.
(2) On May 24, 2000, the Senate Finance Committee released draft proposed legislation addressing "corporate tax shelters," defined as any arrangement where a significant purpose is the avoidance or evasion of federal income tax and a large corporation (gross receipts greater than $10 million) participates directly or indirectly in the arrangement. The bill would increase the substantial understatement penalty to 40 percent for corporate tax shelters of large corporations. If certain requirements are met, the penalty could either be reduced to 20 percent or eliminated entirely. A detailed discussion of the Finance Committee proposal is beyond the scope of this article.
(3) Id. According to some estimates, corporate tax shelters cost the government more than $10 billion a year.
(4) In addition, a separate copy of the disclosure form must be sent to the IRS's Office of Tax Shelter Analysis in Washington, D.C.
(5) Temp. Reg. [sections] 1.6011-4T (2000).
(6) I.R.S. Notice 2000-15, 2000-12 I.R.B. 826. See also Rev. Rul. 2000-12, 2000-11 I.R.B. 744, which provides a death notice for debt-straddle transactions.
(7) Comments on Temporary and Proposed Regulations, Tax Executives Institute, Inc, to Internal Revenue Service (June 5, 2000) (on file with IRS Reading Room).
(8) Comments on Temporary and Proposed Regulations, The Chicago Bar Association to Internal Revenue Service (May 17, 2000) (on file with IRS Reading Room).
(9) Id.
(10) Comments on Temporary and Proposed Regulations, The Coalition for the Fair Taxation of Business Transactions to Internal Revenue Service (May 26, 2000) (on file with IRS Reading Room).
(11) Id.
(12) Id.
(13) Id.
(14) Id.
(15) Comments on Temporary and Proposed Regulations, Deloitte & Touche to Internal Revenue Service (June 2, 2000) (on file with IRS Reading Room).
(16) Comments of the Coalition for the Fair Taxation of Business Transactions, supra note 10.
(17) Id. See Americo Inc. v. Commissioner, 70 AFTR2d 92-6051 (9th Cir. 1992); Sears, Roebuck & Co. v. Commissioner, 70 AFTR2d 92-5540 (7th Cir. 1992).
(18) Id.
(19) Comments of Tax Executives Institute, supra note 7.
(20) Comments of the Chicago Bar Association, supra note 8.
(21) Comments on Temporary and Proposed Regulations, American Institute of Certified Public Accountants to Internal Revenue Service (May 31, 2000) (on file with IRS Reading Room).
(22) Comments of the Coalition for Fair Taxation of Business Transactions, supra note 10.
(23) Treas. Reg. [sections] 1.6694-2(b).
(24) Temp. Reg. [sections] 301.6111-2T (2000).
(25) Supra note 5.
(26) Gregory v. Helvering, 293 U.S. 465 (1935).
(27) ACM Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998).
(28) Compaq Computer Corp. v. Commissioner, 113 T.C. 214 (1999).
(29) Winn-Dixie Stores v. Commissioner, 113 T.C. No. 21 (1999).
(30) Hon. David Laro, Economic Substance: A View From the Tax Court, THE TAX EXECUTIVE, Jan.-Feb. 2000, at 44, 46.
(31) Id. at 46.
(32) Id.
(33) Kenneth W. Gideon & Christopher P. Bowers, The New Tax Shelter Disclosure Rules: Registration, List Maintenance, and Reporting, JOURNAL OF TAXATION, May 2000, at 261, 266.
(34) Id.
(35) Temp. Reg. [sections] 301.6112-1T (2000).
(36) HIGHLIGHTS & DOCUMENTS, April 7, 2000, at 243.
(37) Comments of AICPA, supra note 16.
(38) Kenneth W. Gideon & Christopher P. Bowers, supra note 33.
McGEE GRIGSBY is a partner in the Washington office of Latham & Watkins and chairs the firm's tax controversy practice. He has participated in numerous TEI meetings at both the Institute and local level, and is a regular contributor to The Tax Executive. JACK F. HARRISON is Director--Tax Planning and Tax Counsel for Household International, Inc. and currently serves as co-chair of the Chicago Chapter's International Tax Committee. The authors wish to express their appreciation to Brandon Tidwell, a summer associate at Latham & Watkins, for his invaluable assistance in preparing this article.
 Printer friendly
 Cite/link
 Email
 Feedback
| |
| Title Annotation: | Tax Executives Institute |
|---|---|
| Author: | Harrison, Jack F. |
| Publication: | Tax Executive |
| Geographic Code: | 1USA |
| Date: | Jul 1, 2000 |
| Words: | 6579 |
| Previous Article: | Drop shipments, destination sales, and the multi-factor apportionment statute: a critical review of Stryker Corporation v. Director, Division of... |
| Next Article: | Corporate tax shelter regulations: disclosure of reportable transactions. |
| Topics: | |