AICPA comments on administration's corporate tax shelter proposals.
The President's budget contains sixteen proposals addressing "corporate tax shelters." The first six of these address the topic generically by imposing new penalties and sanctions and by establishing new tax rules to govern transactions generally. This section provides our comments on the six generic proposals. We expect to comment on some of the specific transaction rules separately in subsequent submissions after our technical committees have completed their reviews of the proposals.
We begin by recognizing that tax laws are usually followed, but that they can also be abused. Where there are abuses, we hold no brief for them--whether they fall under the pejorative rubric of "tax shelters" or any other part of our tax system. Thus, we sympathize with and support efforts to restrict improper tax activities through appropriate sanctions. Specifically, we favor the Administration's recommendation regarding exploitation of the tax system by the use of tax-indifferent parties.
However, we also support and defend the right of taxpayers to arrange their affairs to minimize the taxes they must fairly pay and, with that in mind, we have some serious concerns about where the President's proposals draw the distinction between legitimate tax planning and improper tax activities. We see them as an overbroad grant of power to the Internal Revenue Service to impose extremely severe sanctions on corporate taxpayers by applying standards that are far from clear and that could give examining revenue agents a virtual hunting license to go after corporate taxpayers (which, by the way, include huge numbers of small and medium-sized businesses, not just Fortune 100 companies). This would seem to be inconsistent with the taxpayer rights thrust of last year's IRS restructuring legislation. In our view, the debate concerning the sanctions for improper corporate tax behavior must begin with a clear understanding of the standards that distinguish abusive transactions from legitimate tax planning. What standards justify the imposition of extraordinary punishment on a corporation (or tax adviser) whose tax treatment of a transaction is successfully challenged by the IRS?
Our primary concern with the Treasury proposals is the absence of a clear standard defining what is and what is not an abusive transaction, which would apply to most provisions of the tax law. The proposals modifying the substantial understatement penalty for corporate tax shelters and denying certain tax benefits to persons avoiding income tax as a result of "tax avoidance transactions" set forth a too-vague definition of abusive uses of the income tax laws that must be clarified. Anti-abuse legislation should be directed at transactions that are mere contrivances designed to subvert the tax law. The Treasury proposals move beyond the scope we think is appropriate to reach transactions that are described vaguely as "the improper elimination or significant reduction of tax on economic income." This criterion, whatever meaning is ascribed to it, is certain to capture transactions that would not be considered abusive by most and other transactions that have been undertaken for legitimate business purposes. We believe that greater clarity is possible, and would like to work with the staff to develop a clearer, more objective standard for identifying abusive transactions that can be used for most provisions of the tax code. A clearer standard would provide advantages to tax administrators and taxpayers alike by promoting consistency in its application. In addition, we would like to reverse the proliferation of highly subjective terms such as "significant," "insignificant" "improper," and "principal" which are used in the Treasury proposals and current law. While we doubt that it is possible to eliminate them all, it would be a laudable goal to minimize their number.
While the crafting of a clear standard is indeed a difficult task, perhaps we can begin to approach the issue by trying to agree on what types of transactions should not be considered abusive. It should be considered a fundamental principle that Congress intended the income tax laws to apply to all transactions, without penalty, that either are undertaken for legitimate business purposes, or which further specific governmental, economic or social goals that were contemplated by discrete legislation. Therefore, a transaction undertaken for reasons germane to the conduct of the business of the taxpayer, or that is expected to provide a pre-tax return which is reasonable in relation to the costs incurred, or that reasonably accords with the purpose for which a specific tax incentive or benefit was enacted should not be considered abusive. While our discussion below criticizes the Treasury standard for abusive conduct, we do not have our own fully developed definition to propose to you at this time. However, we have asked a task force of our Tax Executive Committee to examine this issue and we are hopeful that we can submit our specific recommendations to you and to Treasury in a timely fashion. We would be pleased to have the opportunity to work with you and them to see if it is possible to develop a standard that could be used for most purposes of the Code.
The budget proposals provide putative sanctions on "tax avoidance transactions" and Treasury's explanation of the proposals defines such transactions to include those where reasonably expected pre-tax profit is "insignificant" relative to reasonably expected tax benefits. It is the softness and inadequacy of this definition to deal with the breadth of the transactions swept into the sanctions, combined with the extreme nature of the weapons given the IRS, which create our concern that legitimate tax planning will also be caught up in this maelstrom. How does this concept apply, for example, to a host of business decisions that do not involve profit motive, but rather are to defer income or accelerate deductions? (We do recognize that there is a proposed exception under which a transaction would not be considered "tax avoidance" if the benefit is "clearly contemplated" by the applicable provision. However, "clear contemplation" is generally in the eye of the beholder, and if that contemplation is intended to reflect what Congress had in mind when the provision was passed, we would respectfully suggest that many provisions in our highly complex tax laws have no "clear" congressional contemplation.)
A second major concern (alluded to earlier) is that these proposals would result in an alarming shift in authority from Congress to the IRS. These proposals would result in a grant to the IRS of virtually unbridled discretion in the imposition of penalties and other sanctions, and this would come only one year after Congress had concluded there was a need to rein in an agency that had proved itself overzealous in pursuing taxpayers. The obscure manner in which the proposals define the term "tax avoidance transaction," combined with the wide range of penalties and other sanctions that could be invoked upon a finding of such a transaction, would provide IRS auditors with enormous opportunities and incentives to assert the existence of "tax avoidance transactions" almost at will. Unfortunately, within a few years we would expect aggressive agents to use this weapon as a means of forcing corporate taxpayers to capitulate on other items under examination.
Our third concern is that the provisions are so broad they could negatively affect legitimate tax planning. Without backing away from our earlier point regarding abuses of the tax laws, appropriate planning to minimize taxes paid is still a fundamental taxpayer right that must be defended. "The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted ..." (Gregory v. Helvering, 293 US 465 (1935)). We think the budget proposals provide so many powers to the government there is a real likelihood that, if enacted, they could prevent advisers and taxpayers from undertaking or considering tax-saving measures that are not abusive.
We are also concerned that increased and multiple penalties, based on a loosely defined standard and with no abatement for reasonable cause, should not apply in a subjective area where differences of opinion are the norm, not the exception. We believe that penalties should be enacted to encourage compliance with the tax laws, not to raise revenue. The enactment of new penalties must be carefully developed with consideration for the overall penalty structure and any overlaps with existing penalties. We also believe that there should be incentives for taxpayers to disclose tax transactions that could potentially lack appropriate levels of authority and that penalties should be abated with proper disclosure and substantial authority.
In this regard, it should be noted that the Joint Committee on Taxation and the Treasury Department are undertaking independent studies of the entire tax penalty structure, at the request of the Congress. The AICPA has recently submitted numerous comments about the penalty administration system to the Joint Committee and Treasury, and we have commented a number of times in the past few years that, the penalty system has become more difficult to administer in the past decade. We favor a review, de novo, of the penalty system, and we would suggest (as part of that review but also for purposes of the current hearing) that merely adding new or increased penalties to the law whenever Congress or the Administration wishes to curtail taxpayer activity is not the proper answer. The result is inevitable taxpayer confusion and a higher likelihood that the penalty system cannot be administered consistently by the IRS (with resulting inequities among taxpayers).
The Administration has proposed a large variety of financial sanctions on transactions that are ultimately determined to permit "tax avoidance." These include a doubling of the substantial understatement penalty to 40%, an extension of that penalty at 20% to fully disclosed positions, the ability of the IRS to disallow any tax benefits derived from the transaction, disallowance of deductions for fees paid to promoters or for tax advice about the transaction, and an excise tax of 25% on the amount of such fees received. In addition, no "reasonable cause" exception will exist to argue against the penalty part of any deficiency. Because (as we discuss below) there is little incentive for disclosure in these proposals, the 40% substantial understatement penalty plus the 35% corporate tax rate on disallowance of any tax benefit, will produce a 75% tax cost (in addition to the economic costs) for entering such a transaction--indeed a significant deterrent. For the part of the deficiency attributable to fees or tax advice, an additional 25% excise tax is imposed, for a 100% tax cost (or "only" 80% if there is full disclosure under the terms of the proposals)--again, with no "reasonable cause" exception.
We would note that these amounts equal or exceed the tax penalty for civil fraud (75%). Thus, enactment of the President's proposals would single out these transactions as equal to or worse than civil tax fraud. We recognize there may be those who believe that tax avoidance transactions are the equivalent of civil tax fraud and deserve this level of sanction. However, we would also note that the due process requirements for showing civil fraud are vastly higher than for tax avoidance transactions. For example, the government bears the burden of proof for showing civil fraud; for assessing sanctions on a tax avoidance transaction, the burden of proof is on the taxpayer (it may or may not shift to the government if the case is litigated, depending on the size of the corporation and the development of the administrative proceeding). Further, for tax avoidance transactions, these proposals would legislate away the ability of a taxpayer to argue that the position was taken in good faith and there was reasonable cause for the taxpayer to act as it did.
While respecting the views on the other side, we do not believe the case has been made that tax avoidance transactions (under the loose proposed standard discussed above) rise to the level of civil fraud. We certainly do not understand why the due process requirements in place for civil fraud are absent here.
With further respect to the issue of promoters and tax advisers, the fee disallowance and excise tax recommendations imply that there are presently inadequate deterrents in the law for those who advise on "abusive" corporate transactions. We would like to suggest that consideration be given to whether changes in Circular 230 (the Treasury regulations governing the right to practice before the IRS) could be a more effective answer to some of these problems rather than another tax and added penalties (on the disallowance of adviser fees). We recognize that Circular 230 would not apply as presently written to some promoters, but there have been some proposals in recent months regarding potential changes in Circular 230 that may be appropriate for consideration. In addition, preparer and promoter penalties under current law could be reviewed for adequacy.
We do not agree with the proposal that precludes taxpayers from taking tax positions inconsistent with the form of their transactions, but not because we believe taxpayers should be able to casually disavow the form. However, the Joint Committee on Taxation analysis of this provision raises several issues that we believe should be addressed. At this point, we are not convinced that the tax law or system of tax administration would be improved by this provision. Given the abundance of existing case law on this issue, it is not clear to us why new legislation is required at this time.
One final concern: if the Treasury is concerned that the current disclosure rules may not be effective, we are prepared to address the question of when and what form of disclosure should be required in order to identify the types of transactions with which the Administration is concerned. However, we question the lack of incentives for disclosure both under current law and the President's proposals. The Administration's disclosure proposals come on top of registration requirements that were enacted only a year ago (on which we are still awaiting regulations). For those affected by the previous registration requirements, this proposal would be overkill (requiring disclosure for registration purposes with the IRS as the transaction begins to be marketed, and additional disclosure to the IRS within 30 days of closing a transaction). We believe that provisions that do not aid the tax administrator but add tremendous burdens to preparers and taxpayers should be eliminated. We stand ready to work with you and the IRS on this issue.
Today, we can do no more than offer our first impressions of these proposals. Our analysis and study has just begun as these proposals and the areas of law that they affect are necessarily complex. However, we are prepared to devote the effort necessary to complete a full, careful and timely review in this area, to offer you our best recommendations and to work with you and your staffs to develop improvements in the law that can and should be made to deal with identified problem areas.
Editor's Note: Roby B. Sawyers is working with the AICPA Tax Division staff while on scholarly leave from North Carolina State University.
D.C. Currents is designed to heighten awareness of the Division's work and keep readers apprised of Tax Division activities involving tax policy, technical issues and other practice support matters.
For further information about this article, contact Professor Sawyers at (202) 434-9277.
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|Title Annotation:||Clinton Administration|
|Author:||Sawyers, Roby B.|
|Publication:||The Tax Adviser|
|Date:||May 1, 1999|
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