ataxingmatter

Total Tax Contribution: PricewaterhouseCoopers' New PR Push

Robert McIntyre, of Citizen's for Tax Justice, has an interesting op-ed titled "Transparently Dishonest", American Prospect Online (Aug. 30, 2006), highlighted in today's Tax Digest.  He notes that PricewaterhouseCoopers has a new project, called the "Total Tax Contribution framework" that is claimed to "enhance transparency in corporate tax reporting" but actually is an effort to obfuscate by puffing claims of corporate taxpaying with the "taxes they don't pay, such as those paid by their customers, workers, suppliers, and so forth."  Id. (emphasis in original).  McIntyre provides an example of this TTCf project at work:  ExxonMobil's claim, in a Washington Post ad, that its "total U.S. tax bill was $57 billion, exceeding our total U.S. earnings [over the past five years] by $22 billion."  Similarly, McIntyre notes, the ad claimd that "ExxonMobil earned about $36 billion, but incurred $99 billion in taxes worldwide."  Id.

If the ad (and the PwC approach) were truthful, it would be a cause for grave concern for American businesses, especially the extractive industries like ExxonMobil.  It would mean their profits are swallowed in whole by their tax obligations, resulting in losing businesses that portend ill for the American economy.  But this would be very strange in light of the recent coverage of the windfall profits experienced by companies like ExxonMobil with Katrina and other forces causing gas prices to skyrocket across the country.  See, for example, this Oct. 28, 2005 CNN article, Oil Industry Under Fire, about the talk of a windfall profits tax, and this New York Daily News Aug. 31, 2006 report, Pay's a Gusher, about the huge compensation windfalls for oil company CEOs.  Note in particular the report about (former) CEO Raymond of  Exxon Mobil, the U.S.'s most profitable company in 2005.

Indeed, McIntyre reviewed ExxonMobil's annual report for 2005, available here, and found that the figures in the ad were simply misrepresented. Those $36 billion in worldwide "earn[ings"?  Actually, that's only the after-tax profits.  "The company's pretax profit ... was $59 billion."  Transparently Dishonest.  That $99 billion paid in taxes?  Actually, that includes about $75 billion paid by its customers in gasoline taxes and other foreign levies and not paid out of its profits.  Id.  McIntyre notes that ExxonMobil's actual taxes paid in the U.S. were considerably higher than in recent history, because its "recent windfall profits from high oil prices have been so big that the company simply ran out of loopholes to shelter them."  Id.  McIntyre ends with a comment about PwC's increasing lack of credibility in light of these misleading PR strategies, on top of its tax-shelter work over the last decade.

I second McIntyre's concern about the creditiblity of PwC in light of this TTC "framework." I think the framework and the ExxonMobil ad are worth noting for two other issues, as well.

First, big corporations (and their allies) are constantly engaged in lobbying Congress for tax policies that favor their businesses.  An ever-present piece of the campaign is the claim that high U.S. taxes, often emphasizing the statutory rates, make U.S. corporations uncompetitive.  But few U.S. corporations pay effective taxes at the 35% statutory rate.  In fact, during the 1990s many corporations had developed extensive tax shelters so that they paid no income taxes.  See, e.g., this Center for American Progress report on the Corporate Tax Dodge (April 2004) and this Boston Globe article titled  "Most U.S. Firms Paid No Income Taxes in '90s" (April 2004) covering a recent GAO report.  The article states:

The report by the General Accounting Office raises questions about whether the corporate income tax burden is too light and distributed unequally. It could undermine arguments that US companies are overtaxed and provide ammunition to politicians and activists who claim companies are using loopholes to avoid paying their fair share.

The United States is generally at the lower--rather than the higher--taxed end of the tax scale among OECD nations, and corporations in the U.S. generally pay a smaller share of the U.S. tax burden now than they did in the past, even though corporate tax payments did increase in 2005 beyond the exceptionally low rates to which they had declined in recent years.  See, e.g., Citizens for Tax Justice International Tax Comparison 1965-2003 (April 2005) and this New York Times July 9, 2006 article by Edmund Andrews. 

Ads like ExxonMobil's therefore will require extra vigilance by ordinary citizens to ensure that Congress sees these ads' tax statistics for what they are--an attempt to create an unrealistically dire picture of the tax burden on major U.S. corporations. 

Second, Sarbanes-Oxley (S-OX) was passed after a high-profile spate of accounting scandals at major corporations, including WorldCom and Enron.  Among other things, it resulted in a stronger focus on the accountability of audit firms, including restrictions of tax services.  See my article about the accounting scandals and need for restrictions of tax services, and the SEC's approval of new PCAOB rules restricting tax services. 

Some commentators now urge that S-OX should be relaxed.  See, e.g., Larry Ribstein's article evaluating Sarbanes-Oxley after three years (suggesting that S-OX was passed in a fit of "sudden acute regulatory syndrome" and that markets can effectively self-regulate, perhaps even in areas of fraud).  In contrast, I believe that PwC's promotion of the TTC framework suggests a need for continued vigilance of regulatory agencies dealing with audit firms, in particular. When audit firms are actively marketing PR schemes that misleadingly report important information, it suggests that there may also be a lax approach to the various discretionary decisions that they may make as auditors of public reporting companies.  The S-OX rules imposing greater oversight of auditor indepedence continue to be important.

(In the interest of full disclosure, I should state that I am now associated with Wayne State University, where Robert McIntyre's brother Michael McIntyre is a member of the tax faculty.)

Back in the Saddle

Perhaps I should address this entry to "Dear Readers" to explain my lengthy absence from the blogosphere.  After a few weeks of packing and unpacking of boxes and my many house plants (would you believe I have a 5-year-old impatiens and a 35-year-old rubber plant?),  I am now relocated in Detroit, Michigan with my office at Wayne State Law School and a home (albeit temporary) in Grosse Pointe Farms.   I am excited and invigorated upon becoming a part of Detroit's renaissance efforts and look forward to teaching as a part of Wayne's wonderfully collegial and excellent faculty.

While my adventures over the last few weeks have kept me busily distracted and unable to pay sufficient attention to anything not made of cardboard, the tax world has continued to spin by in some interesting developments.   In particular, a trifecta of appellate decisions in significant tax cases has revitalized the economic substance and business purpose doctrines and reinforced the important role of the Commissioner in determining clear reflection of income in tax cases.

• The appellate court reversed the trial court decision in Coltec, one of the contingent liability shelter cases.  The appellate decision is available here. The trial court decision is available at the Federal Claims Court website, here.  The trial court decision delivered a blow to the IRS's anti-shelter litigation strategy, coming as part of a triple whammy delivered by the decisions in the GE "TIFD" case and the Black & Decker contingent liability shelter case.  See this New York Law Journal article, this article by Yoram Keinan, and this Tax Prof Blog entry.   The three cases suggested that the IRS's tax shelter strategy might be fated to flounder on courts' reluctance, in this new age of textualist dominance, to apply even Supreme Court-sanctioned judicial doctrines to gainsay literalist statutory interpretations.  With the evident evisceration of economic substance doctrine widely visible, two academic scholars, Zelenak and Chirelstein, recommended that Congress adopt a broad noneconomic loss disallowance rule to replace it.  See this article. The appellate decision thankfully puts some wind back in the sails of the economic substance and business purpose tests, which the trial courts had deflated with almost casual insouciance.  The IRS is pleased with the result, which--if not ultimately reversed by the Supreme Court--should provide support for the use of business purpose and economic substance arguments broadly against cloned and customized tax shelters, see hereand here (Miller & Chevalier).  That is, the Federal Circuit's language should serve as a warning to tax practitioners that adopt literalist interpretations to justify aggressive tax positions that they ignore statutory purpose at their peril.

• Interestingly, the Federal Circuit decision in Coltec was joined by the Second Circuit's decision in the GE TIFD case (which I will refer to  here by the name "Castle Harbour"), finding that there was no partnership created and thus the shelter based on allocating taxable income (but not the actual cash) to a foreign accommodation bank was ineffectual.   (This was not a foregone conclusion, as Lee Sheppard's Tax notes discussion of the case prior to the appellate court's opinion reflects.) Writing for the Second Circuit, Leval hit the critical issue head on in the first sentence, noting that the case addressed "the power of the Internal Revenue Service to examine and recharacterize an interest which accords with its ostensible classification only in illusory or insignificant respects."   As I argued in my own analysis of the purported Castle Harbour partnership (see Tax Advice Before the Return: The Case for raising Standards and Denying Evidentiary Privileges, 25 Va. Tax Rev. 583, 588 n.14 (2006)), the court concluded, that "the banks did not meaningfully share in the business risks of the partnership venture and their interest was overwhelmingly in the nature of a secured interest."  The Justice Department's brief comment on the release of the Castle Harbour opinion warns taxpayers that "illusory" allocations of income to tax-indifferent parties through purported partnerships won't be successful.   As Quatloos notes, this decision represents the demise of another Babcock & Brown [customized] tax shelter, following in the footsteps of the Second Circuit's decision in Long Term Capital Holdings (see this BNA tax management memorandum).

• The Seventh Circuit reversed and remanded the tax court's Bank One decision on mark-to-market accounting of interest rate swaps. JPMorgan Chase & Co., successor in interest to Bank One Corporation, vs. Comm'r of Internal Revenue, Slip Opinion No.s 05-3730 & 05-3742 (7th Cir. Aug. 9, 2006).  The appellate court concluded that the tax court had failed to apply the appropriate analysis under Code section 446's "clear reflection of income" requirement.  The tax administration has broad discretion to determine whether a taxpayer's  method of accounting clearly reflects income, with decisions subject to an "abuse of discretion" standard of review.  Considerable deference is due the Commissioner's determination, both as to whether a taxpayer's method clearly reflects income and as to the appropriate method for the taxpayer to apply.  Under Seventh Circuit precedent, the commissioner's method is upheld so long as it is "workable."  Am. Fletcher Corp. v. United States, 832 F.2d 436, 442 (7th Cir. 1987).  See my article on the Bank One case for a fuller discussion of this case and other issues under section 475's mark-to-market requirement.  Linda M. Beale, Book-Tax Conformity and the Corporate Tax Shelter Debate: Assessing the Proposed Section 475 Mark-to-Market Safe Harbor, 24 Va. Tax Rev. 301, 423 n.353 and 424 n.354 (2004).

Finally, a fourth tax case opinion was just released that will undoubtedly garner significant attention in the next few days.  In Murphy v. United States, the court apparently concludes that the section 104(a)(2) treatment of damages for non-physical personal injuries is unconstitutional.  More on that case later.