Disclosure and Civil Penalty Rules in the U. S. Legal Response to Corporate Tax Shelters

Disclosure and Civil Penalty Rules in the U. S. Legal Response to Corporate Tax Shelters

Description

Historians and sociologists frequently debate American exceptionalism, or the “view that America can be understood only by appreciating its singular origins and evolution.” In some areas, ranging from the death penalty to the Bush Administration’s embrace of torture and preemptive war, American exceptionalism has been emergent in recent years rather than a historical constant. In other areas, if the U.S. initially looks different from other economically advanced countries, it may simply have traveled down a common pathway first, without actually being exceptional at all. Prominent recent scandals and debates in the U.S. regarding aggressive tax planning and breakdowns in corporate governance—the main topics at this conference—reflect, at most, the U.S. getting somewhere first. The U.S. had the Enron scandal; Europe the Parmalat scandal. In the U.S., then-Treasury Secretary Lawrence Summers said in 2000 that the “rapid growth of abusive corporate tax shelters” was “the most serious compliance issue threatening the American tax system today.” European tax authorities increasingly have similar concerns, albeit more focused on income-shifting within the European Union than on the loss-creating transactions that have drawn the greatest attention from U.S. authorities. Since the U.S. government response to corporate tax shelters has been unfolding for almost a decade by now, Europeans may naturally want to ask what lessons can be learned from the U.S. experience. Should U.S. responses be adopted more broadly? Could they be improved significantly? In evaluating the U.S. legal response to corporate tax shelters, two types of issue arise. The first concerns the legal requirements for tax-reducing transactions to be treated as tax-effective. If a company has sufficient leeway under the law to create tax losses by simply shuffling paper and creating circular cash flows, then all the audit review and penalties in the world may not suffice to make it pay tax on its income. Once the substantive rules that define permissible sheltering are in place, however, the issue shifts to one of compliance. How often do companies take reporting positions that would not be upheld if carefully scrutinized, how often are they caught, and what penalties do they face if caught? This paper seeks modestly to advance inquiry into the compliance issues by reviewing and evaluating some of the main U.S. rules that address tax shelter reporting and penalties. I will argue that the disclosure rules do not impose unreasonable burdens. Moreover, while it is unclear how much audit benefit they actually offer the Internal Revenue Service (IRS), other than in directing auditors’ attention to “listed transactions” that the IRS has publicly identified as problematic, they may more generally help the IRS in formulating responses to newly developed transactions. However, the effectiveness of the disclosure rules may be compromised by taxpayer over-disclosure, which might be designed either to avoid penalties for under-disclosure or to overwhelm the IRS with too much of a good thing. The expanded book-tax reconciliation reporting that must be furnished by corporate taxpayers on newly developed IRS Schedule M-3 likely does more to offer auditors a useful overview of the likely soft spots on a given tax return. The penalty rules‘ main flaw, I will argue, is that they focus excessively on the taxpayer’s state of mind regarding the likelihood of prevailing on audit, as a prerequisite for imposing civil penalties. Mens rea is, of course, an important element of any criminal offense that could send someone to jail. But there is little need for it in the context of a company facing the chance of, say, a 20 percent addition to the tax deficiency it will face if a given tax return position is rejected upon audit. Here, a penalty merely worsens the company’s betting odds on taking a controversial tax return position—odds which may remain unduly favorable even with the risk of a penalty. Nothing should shock the conscience about such an adjustment to “audit lottery” payoffs. If we are uneasy about exposing the company to additional downside risk when it acts in apparent good faith, the answer is to permit insurance, rather than, in effect, to provide the insurance for free by simply not charging a penalty to begin with.

Source Publication

Tax and Corporate Governance

Source Editors/Authors

Wolfgang Schön

Publication Date

2008

Disclosure and Civil Penalty Rules in the U. S. Legal Response to Corporate Tax Shelters

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