Over the last week or so, I collected a few articles from the New York Times and Wall Street Journal dealing with tax shelters of one stripe or another. It might be interesting just to see what the news stories are picking up.
First, back on May 18, Lynnley Browning reported in "Wider Look at Tax Shetlers Offered by Deutsche Bank," New York Times at C4, on Deutsche Bank's role in the currency option tax shelters that made the news when the Senate investigative report revealed KPMG's audacious tax shelter department and its cavalier attitude towards laws requiring registration and disclosure of tax shelters. See this earlier posting on A Taxing Matter about the shelter scandals and the Senate Investigative Subcommittee Report. The option shelters involved offsetting foreign currency option trades designed to produce artificial loss to offset a shelter investor's unrelated gains. KPMG agreed to a $456 million settlement that defers criminal prosecution so long as the firm abides by the monitoring arrangements. HVB, another German bank involved in shelter promotion, also arranged a settlement. Deutsche Bank has not yet settled and prosceutors continue to examine the "COBRA" (currency options bring reward alternatives) strategy that it sold to "more than 1,100 wealthy investors" between 1999 and 2000, as well as two related "son of Boss" deals called "HOMER" (hedge option monetization of economic remainder) and "MLD" (market-linked deposit). See Times article, above. More details about Deutsche Bank's shelters have been revealed in litigation between the bank and investors over the bank's promotion of the shelters, including a powerpoint presentation detailing the 9 steps that law firms and clients were expected to follow in creating the trade sequences to create artificial losses. According to one of the attorneys for investors, "Deutsche Bank was the driving force behind every tax strategy that involved digital options, and without Deutsche Bank, none of these tax shelters could have been sold and implemented." But clearly the shelters couldn't have been done without the complicity of law firms like White & Case and Jenkens & Gilchrist, which provided documentation and legal opinion letters.
This aggressive shelter promotion activity indicates that some taxpayers and some of their advisers will always be willing to enter into aggressive transactions to cut their tax bills. Enforcement efforts like the current tax shelter enforcement are necessary, but we also need to do something about the corporate climate in the financial community--bank, law and accounting--to re-instill a broader sense of ethics and responsibility to maintain the integrity of the tax laws. How we should go about doing that is not an easy question, but I have suggested that one thing to consider is raising the standard for tax reporting across the board to require taxpayers and tax advisers to report the tax treatment that they honestly believe is more likely than not correct. I have also suggested that we should remove the attorney-client privilege (and work product, to the extent that some circuits extend work product protection back that far) for tax planning. It is clear that we should also be wary of big financial institutions' claims that they are acting appropriately under the rules applicable to them. Deutsche Bank's involvement in aggressive tax shelters is, in other words, just one more reason not to finalize a safe harbor fora "book-tax conformity" method of broker-dealer reporting of derivatives gains under the mark-to-market accounting required in section 475.
There was also action just last week on the civil class-action lawsuit by investors against KPMG and Sidley Austin LLP in relation to their tax shelter activity. Milberg Weiss, the class-action law firm that was indicted this month for funneling kickbacks to plaintiffs in class-action suits had brokered a $153 million settlement between KPMG and tax shelter investors. It seems that KPMG has suggested that one of the plaintiffs in the case had also be promised more money for acting as lead plaintiff. Lawyers that object to the terms worked out by Milberg are hoping the controversy will support tossing the settlement. See David Reilly, Judge to Rule on KPMG Case Tied to Tax-Shelter Class Action, Wall Street Journal, May 27, 2006, at B4.
Second, the private law firms aren't the only ones misbehaving. Last week a judge also ordered the IRS to repay almost $36 million in taxes, penalties and fees collected from investors (mostly airline pilots) who had participated in an old tax shelter, because IRS attorneys had apparently cut deals with witnesses in the cases. So because of the IRS's misbehavior, taxpayers who had engaged in the dubious shelters are made whole, and the federal fisc suffers. Not a good deal for anybody but the pilots. See Robert Guy Matthews, Judge Orders IRS to Repay Millions in Tax-Shelter Case, Wall Street Journal, May 24, 2006, at A10.
The Third item is truly frustrating. Congress, in passing the new tax cut package (that could rightly be considered a welfare package for the wealthy), included an obscure provision that undid the work that had been done to reduce the abusive use of tax provisions to give investors a cash buyout under the guise of a tax free reorganization. Thanks to the new May 17 tax law, big companies can now do "cash-rich split-offs" with almost 75% cash! There had been plans to limit the cash portion to under 50%, and the Joint Committee on Taxation even argued (as I would) that the cash should be restricted to 20% of the deal. But lobbying by the big guns like Time Warner paid off, and Congress permits a split-off when only 25% of the company is an active business. The Journal outlines the tax savings in Time Warner's cash-rich split off of the Atlanta Braves. Time Warner transfers the Braves plus $1.38 billion in cash, to a new subsidiary. Then the stock of the subsidiary is transfered to Liberty in exchange for $1.84 billion of Time Warner shares. Neither company pays any income taxes, but Liberty ends up $1.38 billion in cash richer in exchange for the shares. As the Wall Street Journal article notes, "in effect, Liberty shareholders are exchanging Time Warner stock largely for a pile of cash--not so different from an open-market sale." There were questions about whether these deals would withstand cscrutiny, but now the Congress had made it a whiz. As tax guru Robert Willens notes (as quoted in the Wall Street Journal article:
Of all the different techniques we've had through the years for corporate tax management, this is probably as good as I've seen. ...When else can you sell a highly appreciated asset for cash and never pay tax? What more could you want from a technique? It's not like you're deferring the tax on the cash; you're permanently avoiding it. It's fantastic."
Congress's tax giveaways in the May legislation represent an irresponsibility that cannot be excused, in this period of high military costs due to endless wars and huge trade and budget deficits. This corporate giveaway is just one more example of their unwillingness to ask corporations, and their wealthy shareholders, to bear their fair tax burden.
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