Tax reform, changing business roles are focus of TEI's 60th annual conference.

More than 650 tax professionals made San Diego their port of call from October 23-26 to participate in the Institute's 60th Annual Conference. With the increasing importance of non-tax issues, numerous sessions during the three-day program focused on the Many Masters of the Tax Department, including the financial statement overseers from the FASB, SEC, and PCAOB, as well as the more traditional tax (and task) masters from Congress, the IRS, CRA, and the OECD.

The conference included timely sessions on the Sarbanes-Oxley Act, the FASB exposure draft on uncertain tax positions, tax shelter developments, efiling, and the attorney-client privilege as well as updates on Canadian developments, state and local taxes, and a host of other tax planning topics. The conference was held at the Manchester Grand Hyatt on the waterfront of San Diego harbor.

Tax Policy and Reform

The shifting winds of U.S. tax policy was the first topic of the conference, with Michael Graetz of Yale Law School and former Deputy Assistant Treasury Secretary for Tax Policy, previewing the soon-to-be-released recommendations for tax reform from the President's Advisory Panel on Federal Tax Reform.

Professor Graetz described the demographic, budget, and revenue trends confronting U.S. policymakers and outlined the principal features of the two proposals from the Advisory Panel. The first proposal--a modified income tax approach--would exempt active foreign earnings from U.S. tax and put intense pressure on the allocation of expenses to exempt and non-exempt income. In addition, certain foreign royalties would likely remain taxable.

The second proposal, he explained, would essentially be a subtractive method value added tax. Probably the sole business deduction permitted under this proposal would be wages. With the denial of deductions for interest expense, the proposal would make the taxation of financial institutions problematic. The consumption tax proposal would also require renegotiation of many international tax treaties.

Lamenting the dearth of real-world input to the Advisory Panel from tax practitioners and businesses, Mr. Graetz urged conference participants to become involved in the pending tax reform debate.

"This is a moment for the business community to intervene and to describe the tax system you would like to live with, and to explain the real-world impact of these proposals," he said. "There are great risks and great opportunities, so I hope you seize the moment."

Prospects for Reform

In the subsequent session on legislative developments, two former congressional aides echoed the call for greater business involvement in the tax reform debate.

With pressure building on Congress to balance the need for hurricane relief, current social programs, and the military's efforts in Iraq, Ed McClellan and Jeff McMillen agreed that there is a substantial risk that more of the tax burden will shift to corporations. Mr. McClellan (who formerly worked for the Senate Finance Committee) predicted that the Treasury Department will prepare legislative proposals to be announced in President Bush's 2006 State of the Union message. He added that the looming expiration of several tax cuts in 2010 will provide an impetus for congressional action, likely in 2007.

During his Tuesday luncheon remarks, former IRS Commissioner Charles Rossotti, a member of the President's Advisory Panel, urged registrants to seriously consider the simplified income tax proposal as an antidote to the complexity of Internal Revenue Code and the enormous costs of compliance. Fundamental reform and simplification of the tax system, he said, will also serve as an alternative to the enhanced enforcement efforts that Congress currently expects from the IRS to close the budget shortfalls.

Mr. Rossotti said that the timing of any action on the Panel's reform proposals was up to the President, but that action will likely come in 2006, if at all. He added that now is the time for the corporate community to let its voice be heard in the reform process.

"The simplified tax is better for your businesses and better for the country," Mr. Rossotti said. "Now, even if you lose a little bit, think about what we gain in the long run."

The Changing Tax Environment

During Monday's luncheon address, former IRS Commissioner Lawrence Gibbs sounded a cautionary note about the increased scrutiny member companies face in a changing--and challenging--regulatory environment.

Congress, he said, expects the IRS to do more to close a $45 trillion dollar fiscal imbalance between spending and revenues by stepping up enforcement efforts. With limited increases anticipated for IRS budget resources, he added, the agency may borrow enforcement ideas from other government agencies such as the SEC and expand the use of compliance programs that rely on disclosure and self regulation.

For now, Mr. Gibbs explained, the IRS is relying on its more traditional "carrot-and-stick" approach to enforcement, but with a twist: Taxpayers are treated differently depending on whether they are viewed as compliant or noncompliant. Chief among the carrots the IRS has developed is access to programs--such as the Compliance Assurance Process, the Limited Issue Focused Examination program, and pre-filing agreements--that accelerate the currency of taxpayers' audits. The sticks include seeking taxpayers' tax accrual workpapers, increasing the assertion of penalties, and tightening Circular 230's requirements for tax practitioners.

The upshot of the efforts is that the IRS will "reward" taxpayers who comply and punish noncompliance more harshly than ever before, he stated.

Mr. Gibbs observed that taxpayers have adapted to the new environment by shunning tax strategies that depend on developing a business purpose around a prepackaged transaction. Today, he said, taxpayers are structuring the best possible tax package for real business transactions. He urged registrants to consider refocusing their audit strategies as well. Full disclosure and a straightforward presentation of the facts and tax law supporting a company's tax positions will preclude many issues from being raised by the audit teams in the first instance and will likely lead to the resolution of more issues in the field.

Note: Mr. Gibbs's remarks are printed in this issue of The Tax Executive.

The Role of the SEC

During her Tuesday morning plenary address, Susan Markel, Chief Accountant of the SEC's Enforcement Division, reinforced Mr. Gibbs's themes of a changing regulatory environment and the most appropriate practitioner response to that environment.

The agency handles between 450 and 700 enforcement cases each year, she said, with Fortune 500 companies making up a growing percentage of the cases. Only 5 percent of the agency's actions involved Fortune 500 companies in 1998, Ms. Merkel noted, but that figure jumped to 17 percent in 2003 and 23 percent in 2004. Criminal prosecutions are also rising, she warned, with 131 indictments in 2003 and 159 indictments in 2004. Major fraud cases, such as those against Enron and WorldCom, she said, have changed the agency's views on the efficacy of criminal prosecutions as a tool to deter misreporting.

To discover financial fraud, investigators generally look for characteristics such as premature revenue recognition, the use of excess reserves to smooth earnings, and improper capitalization. Ms. Merkel added that the use of excess tax reserves with the intent to manage earnings will raise a red flag with the SEC. Other areas that may prompt investigations include related-party transactions, undisclosed compensation, and the use of financial products to manage earnings in structured financial transactions. In fashioning its enforcement approach, the SEC will take into account the efforts companies make to disclose their own failures and address problems as they are discovered.

"Cooperation is extremely important and it can affect how the individual is treated at the end of the day," Ms. Markel concluded.

International Tax Developments

Mary Bennett, Head of the Tax Treaty and Transfer Pricing Division at the OECD's Centre for Tax Policy and Administration, provided registrants with an update on the OECD's activities, explaining that there will be a significant focus on permanent establishment (PE) issues in both the business restructuring and the attribution of profits projects currently underway.

The OECD is considering how the attribution of profits affects whether a taxpayer has a permanent establishment in a particular jurisdiction. The business restructuring project, she added, will raise both PE and transfer pricing issues. Although, the business restructuring and attribution of profits projects are separate, there is likely to be a significant overlap in the discussions and the ultimate determination of how to address each issue, she said.

In her comments on the attribution-of-profits project, Ms. Bennett said that the OECD is studying the comments on the draft commentary and seeking the best approach to implement the reports. New guidance on cross-border, related-party financial dealings will also be "picking up steam," and several initiatives are under way in the area of dispute resolution, including the use of mandatory arbitration.

IRS Associate Chief Counsel (International) Hal Hicks and LMSB International Programs Director Robert Green provided registrants with an update on the proposed cost-sharing regulations as well as IRS efforts to resolve outstanding disputes.

Mr. Green reported that the IRS will use an Appeals settlement guideline approach to "allow taxpayers to do one-stop shopping" in complex cases. Under the process envisioned by IRS, Appeals will be the principal "owner" of the process, retaining its independence when resolving cost-sharing issues. Mr. Green added that "buy-in" cases represent the bulk of the cost-sharing cases and said that the IRS is attempting to identify common threads among the cases in order to develop settlement guidelines. He also announced that he will return to the private sector in January 2006; Steven Musher, current IRS Deputy Associate Chief Counsel (International), will continue work on the project.

Mr. Hicks defended the investor model set forth in the proposed cost-sharing regulations. Under that model, he said, each cost-sharing participant is viewed as making an aggregate investment, attributable to both cost contributions and pre-existing intangibles brought to the arrangement. This is intended to achieve a return appropriate to the risks over the term of the development and exploitation of the intangibles resulting from the arrangement.

In response to a question from panelist John Peterson of Baker & McKenzie concerning whether the proposed regulations adhere to arm's-length principles, Mr. Hicks said the proposed rules are true to that principle but shift more of the value to buy-in transactions that reflect contributions expected to develop cost-shared intangibles.

Presentation of Awards

At the Tuesday evening banquet, the Institute conferred Honorary Membership on James R. Murray of the Portland Chapter. Mr. Murray held a variety of positions and served the Institute at the chapter and national levels during his 31 years of membership, including serving as Portland Chapter president and 1996-1997 Institute president. During Mr. Murray's term as President TEI was actively involved in efforts to improve the efficiency of the IRS and Canada Revenue Agency.

In accepting the award, Mr. Murray said that a high point of his term was testifying before the National Commission on Restructuring the IRS. He noted that, during his term on the IRS Advisory Council, he was able to help the IRS's design groups implement proposals to address TEI's concerns about the restructuring.

Mr. Murray concluded his remarks by encouraging members to become active in TEI.

"Take advantage" of the opportunities that participation in TEI affords, he urged. "Participate in chapter meetings. Be active at the regional and Institute levels by participating in technical matters and the leadership of the organization. Your employers will benefit and so will you."

Gerald Goldberg, recently retired as Executive Officer of the California Franchise Tax Board, received the Institute's Distinguished Service Award during the Tuesday luncheon. During his remarks to the conference, he emphasized the need for tax professionals to work constructively with government officials to improve tax administration, and he thanked TEI for its cooperation during his 25 years with the Franchise Tax Board.

Photographic highlights of the 60th Annual Conference begin on page 564.