Draft IRS report on International Enforcement Program - Key Performance Indicators.

On August 9, 1993, Tax Executives Institute filed the following comments with the Internal Revenue Service on the IRS's June 1993 draft report on the International Enforcement Program's Key Performance Indicators. The comments took the form of a letter from TEI President Bob Periman to Marc Greenfield, IRS Regional CEP Manager for the Mid-Atlantic Region, who is heading a task force on IRS measurement systems. The letter supplements the Institute's March 15, 1993, comments on the measurement of a successful international audit, as well as several meetings between the IRS and TEI over the past six months. The comments were prepared under the aegis of its International Tax Committee. whose chair is Lisa Norton of Ingersoll-Rand Company. Robert L. Ashby of Northern Telecom Inc. and Alan Getz of Mitsui & Co. (USA) Inc. contributed materially to the development of the Institute's position.

On behalf of Tax Executives Institute, I am pleased to submit the following comments on the IRS's June 1993 Draft Report on the International Enforcement Program's Key Performance Indicators. The comments supplement the Institute's March 15, 1993, comments on the measurement of a successful international audit, as well as our discussions with members of your task force on December 22, 1992, February 22, 1993, and July 15, 1993.

General Comments

Although TEI supports the IRS's efforts to improve the quality of the examination process for multinational taxpayers, we must reiterate our basic concern with the project's thesis. As we stated at the outset, the Institute questions whether measurements for international audits should be divorced from the standards applied to domestic audits. The draft report states that "a separate management measurement system is necessary" for international audits because the IRS's "customers and regulators have required separate and unique accountability [in respect of international operations]." We respectfully disagree.

TEI recognizes that certain aspects of an international audit--particularly the information-gathering challenges--may be different from those of a domestic audit. These differences, however, do not by themselves require "separate and unique accountability." While the techniques for auditing multinational corporations may vary, the institutional standards for judging the success of that audit should not. We believe that differences between international and domestic audits can be properly analogized to differences among various industries. Certain industries may similarly require different knowledge, skills, and audit techniques, but these differences do not by themselves dictate the need for a separate measurement system. Thus, although the Industry Specialization Program recognizes, and indeed owes itself to, cross-industry differences, the success or failure of the ISP program is not--so far as we are aware--judged in accordance with a different set of standards. Rather, the core measurement system applies across the board.

Moreover, we suggest that the efficacy of "separate and unique accountability'' in respect of international audits should be independently justified before it drives the creation of a "separate and unique" measurement system. In other words, if it is decided that the basic measurement system should be applied across the board (which is what TEI believes), then perhaps that means "separate and unique accountability" should be abandoned, and the same standards of accountability should also apply to domestic and international examiners alike.

Our concern is more than academic in nature. If separate standards are created to measure international audits, artificial barriers may be raised between the international and domestic audit teams. If the international examiners are rated under different standards from those applicable to domestic examiners, the Case Manager's ability to supervise the audit may be inhibited. We have long believed that one means of expediting audits is to insist that Case Managers exercise their authority to resolve issues, including those within the purview of the international examiners and specialists. Case Managers should be empowered to resolve most issues and held accountable for not doing so. In addition, the entire audit team--including the international examiner or specialist--must be accountable to the Case Manager. Rating an international examiner under different criteria may reduce that accountability and impair the Case Manager's ability to manage the audit in an efficient and timely manner. Thus, a separate measurement system could undermine one of the goals of the International Enforcement Program: to reduce taxpayer burden by resolving issues at the lowest possible level.

Although it is impossible for Case Managers to be technically proficient in all areas that may arise in a CEP audit, they must be sufficiently well versed to grasp issues that may arise and to decide which resources should be used. We recognize that vivifying the Case Manager's control in respect of the international examiner may require additional training in international tax law, but suggest that such an approach will lead to smoother, more efficient audits.

CSF No. 1: Reduce Taxpayer Burden

a. Standard 1: Resolve Issues at the Lowest Level. TEI agrees that "[r]esolving issues at the examination level contributes greatly to relieving taxpayer burden." In this regard, the IRS proposes to track and measure the "percentage of closed international feature cases in which the Accelerated Issue Resolution procedure was used in international issues."

TEI is particularly pleased to have participated in the development of the draft procedure on Accelerated Issue Resolution (AIR). Utilizing the procedure as a performance measurement will encourage its use. What will encourage it even more, however, is the issuance of the final revenue procedure. Our members report that Case Managers and Branch Chiefs in some districts have declined to use the draft procedure. They view (perhaps understandably so) the failure to issue a final revenue procedure as a negative signal from the National Office. To overcome field resistance, we strongly recommend that the IRS issue the final AIR procedure as soon as possible.

b. Standard 3: Improve Examination Timeliness. The draft report defines examination timeliness as the lapsed time between significant actions within the examination cycle. TEI believes that a critically important feature of examination timeliness is the coordination of issues between the international and domestic auditors. The Case Manager should control the audit, including the involvement and scheduling of the international examiners.

CSF No. 2: Maximize Quality Driven Productivity

a. Standard 2: Issues Raised Will Be Factually Well-Developed and Technically Correct. The draft report measures this standard based on agreement rates and Appeals sustention rates of proposed adjustments and penalties. TEI agrees that agreement and sustention rates are a proper measure of a successful audit.

We recommend that the concept of materiality should be an additional criterion in evaluating the international examiner's performance. Thus, even if a particular approach or position is legally sustainable, it may impose inordinate costs on the taxpayer (and the IRS) that, when viewed from either a policy or revenue perspective, should reflect negatively on the examiner's conduct of the audit. For example, an agent may require a taxpayer to produce all of its receipts for foreign taxes paid--without regard to the amount or the taxpayer's long history of compliance. The standard should ask, Is the proposed adjustment material in relation to the taxpayer's overall tax liability or to the burden imposed on taxpayers and the IRS?

b. Standard 3: Maximize the Productivity and Return on Investment on International Feature returns. The draft report measures this standard based on the return on investment (ROI) on CEP international feature returns by market segments. TEI remains wary of any use of ROI methodology because it may incorrectly emphasize raising tax revenue as the principal focus of an audit rather than the determination whether a taxpayer complies with the tax laws. Many taxpayers believe that ROI-- because it is easier to gauge than other measures--means simply that revenue, not quality, will drive the CEP process. The IRS should take steps to assuage taxpayers' concerns.

CSF No. 3: Meet Customer Needs

a. Standard 1: Effective Working Relationships with Taxpayers, Taxpayer Representatives, and professional Organizations. The draft report states that "[t]rust is critical to healthy customer relationships." It proposes to build that trust through regular, recurring, and candid communications. TEI agrees that effective working relationships may be fostered by maintaining open lines of communication with taxpayers, representatives, and professional organizations. To further this standard, we suggest that a fourth measure be added that focuses on efforts to involve taxpayers in IRS training initiatives.

CSF No. 4: Improve Voluntary Compliance

a. Standard 1: Promote Taxpayer Initiatives to Ascertain Substantially Correct Tax Liability. The draft report measures this standard by focusing on a number of programs that permit taxpayers to voluntarily come forward to ensure their international activities and income are properly reported, including the Advance Pricing Agreement procedure, section 6038A agreements, and pre-filing determinations. We suggest that the Accelerated Issue Resolution procedure should also be included in this list.

b. Standard 2: Taxes Voluntarily Paid with the Return by International Taxpayers Will Be the Substantially Correct Amount. The draft report measures this standard by focusing on the percentage of tax paid on filed returns compared with the total tax paid after examination. We suggest that a more appropriate measurement would be the percentage of tax paid on filed returns compared to the total tax paid at the conclusion of the audit process, including any Appeals or court settlement. Any other standard would encourage examiners to raise tenuous issues. In addition, the "percentage of tax paid on filed returns" should include any amount voluntarily paid by the taxpayer before the commencement of the examination (e.g., with an amended return or pursuant to Rev. Proc. 8526).

c. Standard 3: Taxpayer Disclosure of Improper Previous Reporting. The draft report measures this standard by reviewing the use of Rev. Proc. 85-26, the filing of amended returns, and the number of voluntary elections under section 482.

The word "improper" in this standard implies that taxpayers are deliberately misreporting their income and then later correcting items. The implication is pernicious and, indeed, improper. There are many valid reasons that taxpayers may file an amended return or avail themselves of Rev. Proc. 85-26. For example, a foreign tax credit carryback, a redetermination of foreign tax, or a correction to transfer pricing when new data becomes available may result in an amendment to the taxpayer's original return. Such voluntary compliance should be encouraged. Or there may be a court decision or regulations issued after the return is filed that affects the calculation of the tax. The use of the pejorative term sends the wrong signal to international examiners and should be eliminated. We suggest that a more appropriate standard is, Taxpayer Disclosure of Changes in Previous Reporting.

Moreover, we find the reference to "voluntary elections under section 482" confusing. What elections are being referred to? We fail to see how a taxpayer election to use the interestrate safe harbor for intercompany loans or to use a certain method, for example, measures a taxpayer's voluntary compliance with the tax law. We suggest that this measurement be clarified or deleted.

d. Standard 4: Taxpayer Agreements with Service Proposals. The draft report measures this standard by reviewing the dollars of proposed international adjustments at the examination and Appeals levels, and submitted to Competent Authority. The draft fails to delineate, however, what the adjustments will be compared with. We suggest that an appropriate measure would be to compare the figures to the total dollars adjusted.

Tax Executives Institute appreciates this opportunity to present our views on the criteria for measuring a successful international audit. If you have any questions, please do not hesitate to call Lisa Norton, chair of TEI's International Tax Committee, at [phone], or Mary L. Fahey of the Institute's professional staff at [phone].

TEI Publishes Results of Tax Department Survey

Tax Executives Institute has published the results of its recent membership survey on the organization and structure of corporate tax departments. Described by TEI President Ralph Weiland as "a breakthrough in corporate tax department research," The Structure and Size of the Corporate Tax Department: An Empirical Analysis explores the relationship between tax department size and a variety of factors, including revenues, the number of federal, state/provincial, and local returns filed, the size of the corporate group, the amount of audit activity, and the number of countries in which the group operates. The 300-plus pages of tables also address the use of outside consultants and of computer software packages or service bureaus, the reporting structure within the corporate group, and the changes in staff size from 1989-1991. Finally, the book provides an industry-by-industry breakdown of the data.

Copies of TEI's Corporate Tax Department book have been mailed to all TEI members, and additional copies may be purchased at $75 a copy. For additional information, contact Dawn-Lynn Bardwell at TEI Headquarters (202/638-5602).