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The Rich: CapGemini on Ultra High Net Worth Individuals

Merrill Lynch and CapGemini have put out their 11th annual report on the wealth of the wealthy--high net worth individuals.  It's called World Wealth Report 2007, and available to anyone who registers at the CapGemini site.

The number of wealthy individuals in the world has increased--there are now about nine and a half million individuals who have worth more than $1 million in financial assets (not counting their primary residences).  Not surprisingly in this age of flat taxes on consumption and declining taxes on corporations or capital gains, the amount of the world's assets that are held by these few individuals has continued to skyrocket.  The growth of wealth is concentrated in the "ultra HNWIs" with financial assets of more than $30 million.  There are not quite 95,000 of those people in the world, and those few thousands hold assets worth $13.1 trillion dollars.  The amount of the world's assets held by people of such enormous wealth has increased by 16.8% between 2005 and 2006.   As the report puts it: "Global wealth is rapidly consolidating among this ultra-wealthy segment."

North America ranked number one in both number of HNWIs and the amount of accumulated assets those HNWIs hold.  For a society that was able to create incredible broad-based growth, this is in many ways a revolting development.  We are a nation of increasing inequality, as wageearners take home a smaller pie and those at the top are spending their millions on Boeing wide-bodied jets outfitted as "mobile mansions" in the sky (the report notes orders worldwide for f 11 of them at about $150 million apiece).

So what's the great source of these gains?  The report notes that real GDP and market capitalization are huge factors.  It also states that the "main driver was government consumption, which grew at an overall rate of 2.1% in 2006, up from .9% in 2005."  Sounds like the lucky contractors who get no-bid contracts for useless trailers in Louisiana and high-paying security work in Iraq are making lots of hay.  Of course, there are also the "gentlemen farmers" who reap hundreds of thousands of dollars of taxpayer money out of a farm bill gone crazy.  See this op-ed by Timothy Egan on "Red State Welfare" in the June 27 New York Times.

And what do these ultra HNWIs spend their money on?  Try luxury collectibles (vintage yachts, airplanes), jewelry, art, sports (professional teams, racehorses) and other collectibles.  Playboys playing.  They also invest their money and get more money--increasingly overseas, for US HNWIs.

To be fair, the report notes that really wealthy individuals, especially  those in the US, also spend a fair portion of their assets--between 7 and 10%--on philanthropy, often with "donor-advised funds."  Entrepreneurs tend to give considerably more than those with inherited wealth (almost double).

So should we just note anecdotally this interesting information, a kind of celebrity-following that we can gaze on for a minute and then forget and go our way.  I think not.  I think we need to come to grips with the impact on society of having such obscenely wealthy individuals who are favored now by our tax system that taxes capital gains at less than half the amount of the highest tax on compensation income.   As Warren Buffet noted when he spoke at a Clinton fundraiser, see this item in the Washington Post, there is something wrong with a tax system that lets someone who has more than $45 million in taxable income pay tax at a rate (17.7%) that is only about half the rate that a clerical employee in that person's firm pays.  We should eliminate the capital gains preferential rate.

We could also get rid of the many ridiculous subsidies for industries that are making windfall profits--many of the tax subsidies for the oil and gas and other extractive industries must be eliminated.  Some stalwart souls in Congress tried to do that, but the lobbyists were successful in pushing back and casting the long overdue elimination of excessively favorable tax provisions as though it were a tax increase.  Here's how Citizens for Tax Justice described the reluctance to at least shift subsidies from oil and gas to renewable forms of energy in its June 22 newsletter.

Experts can certainly debate whether or not energy policy should be implemented through the tax code, but perhaps the more important point is that Congress has already showered oil and gas companies with numerous tax breaks that CTJ has criticized in the past. The energy tax legislation being debated now would generally shift some tax breaks away from oil and gas towards more sustainable types of energy. Lobbyists from the oil and automotive industries convinced many Senators that the tax package would "raise taxes" on oil and gas companies, but most of the provisions would really close loopholes for these companies that have no justification.

With the inequality gap growing ever wider, our tax policies should shift from ones that favor wealthy individuals and Big Oil to ones that favor ordinary Americans.  From AMT reform (make capital gains a preference item, protect those who make less than $75,000 from the AMT but dont' worry about those that make more than $150,000) to energy tax reform (eliminate most if not all of the numerous tax subsidies for extractive industries; consider incentives for renewable energy instead) to basic tax policies that promote a more egalitarian society (tax income, not consumption; keep a reasonable estate tax at a 45% rate that exempts no more than about $2 million in assets), there are a number of issues that Congress should be considering from the perspective of ordinary Americans.  Will Congress find its spine anytime soon?

KPMG attorney fee litigation (and tax shelter case): DOJ seeks dismissals

The investigation into KPMG's tax shelter practice led to indictment of various individuals at KPMG and related parties such as R.J. Ruble (formerly of Brown & Wood) for their role in developing and promoting "cloned" tax shelters.  KPMG avoided criminal prosecution by taking various actions to change its practices, and it refused to fund the defense of the former KPMG partners.  The judge hearing the case at the district court level (in New York's Southern District) opined that the government's policies regarding cooperation had deprived the defendants of their constitutional right to counsel, and indicated that the defendants should pursue their claim for defense costs against KPMG in his court.   In its May 23 opinion, the Second Circuit Court of Appeals disallowed that remedy.   See earlier postings on this blog here, here, here, here (discussing Thompson Memorandum), here, here (discussing Rivkin's guilty plea) and here,

So the question is--what now?  Given the district court's strong statements that failure to fund the indicted defendants' defense expenses constituted a constitutional violation, the DOJ apparently decided that the best solution is to seek dismissal so that the constitutional claim itself can be litigated.  On June 23, in its opposition to the defendants' renewed motion for dismissal of the indictment, the government conceded that dismissal of the indictments against thirteen of the KPMG defendants in United States v. Stein (SDNY) would be appropriate, stating its disagreement wih both the findings of fact and conclusions of law in the earlier opinion but noting that "given the Court's previous rulings, it appears that the only action the Court could take consistent with those rulings would be dismissal of the Indictment."  Id. at 1-2.

The Second Circuit was careful to state that its decision on the appropriateness of the remedy devised by Judge Kaplan was not a statement on the correctness of the Judge's constitutional decision.  I am not a constitutional lawyer, but I find it difficult to believe that these defendants should be entitled under the Constitution to the best lawyers money can buy when most indigent defendants seem to be entitled only to a living body that has a law degree, even if the body sleeps during crucial moments of the trial.  It will be, at the least, interesting to see the next development in this case.  (Given the Supreme Court's recent decisions--including its conclusion of no standing for taxpayer claims when the executive spends to support favored fundamentalist Christian religious activities and no violation of free-speech rights when a public school principal punishes a student for unfurling a banner at an off-campus parade that suggests Jesus might support drug use--, I am not very hopeful that the Justices will get this one right.)

Economic Propaganda from the JEC's Republican Minority

Jim Saxton, now the leader of the Republican minority on the Joint Economic Committee, has issued another of his perennial reports that seem to have as their objective to convince Americans that taxes are bad and, in particular, that taxes on the capital income of the wealthiest Americans are especially bad.  It's available at this link:  "Excess Burden of Federal Taxes Imposes High Economic Cost". 

The report states a broad range of traditional economic assumptions as fact: that taxes are always a deadweight loss that "distort the behavior of individuals and firms," reducing investment and entrepreneurial activity, that people may choose less productive jobs if more productive jobs are taxed at higher rates, that higher taxes may prompt workers to forgo training or changing occupations, that savings are taxed "multiple times" under our tax system and that "this multiple taxation creates a bias against saving and investing in favor of consuming" that "undermines" "capital formation", with various theoretical corollaries also stated as fact--e.g., that US corporations retain earnings rather than pay dividends because of the taxation of dividends, that funds are diverted to other investments because of the taxation of US corporations, that US corporations have higher debt because of tax; and that capital gains taxes delay investment in entrepreneurial activities. 

Most of these assumptions about responses to taxation are not established fact, however much they are repeated by mainstream economists.  They are, in fact, somewhat speculative.  It is difficult, if not impossible, to single out taxation from other contextual forces that impact human behavior, especially given the difficulty and paucity of research using plausible controlled experiments to contrast the presence of a given tax with its absence under identical conditions.  Complex contexts, that is, make it very difficult to reach easy conclusions about the effects of tax on behavior.  For example, Steven Bank recently published an article about dividends and tax policy, entitled "Dividends and Tax Policy in the Long Run," 2007 Ill. L. Rev. 533.  Bank notes the "traditional view" that corporate decisions to pay dividends are influenced by tax policy and the "new view" that taxes generally don't affect such decisions.  Although the 2003 reduction in dividend rates appeared to cause a rise in dividend payouts, Bank argues that the long term relationship between dividends and tax rates is much more complex, suggesting that a permanent cut in the rate may have the opposite result. 

Beyond that, the broad statements in the report also depend on certain conclusions about the appropriate base for taxation--is it only individual human activities that may be taxed (which would lead to a conclusion that any entity taxation is "double taxation" of the owner of the entity) or is it appropriate to tax entity profit-making behavior?  The claim that taxing savings is "multiple taxation" of the same income is true only under the assumptions that the only taxable item is earnings from labor and that taxes on earnings from investments of those labor earnings are inappropriate because they must be viewed as an additional tax on the same underlying labor that earned the money that was invested.  The fact that investment earnings can be described in this way doesn't, however, require this conclusion. In fact, it suggests that the only way to have a fair tax system is to tax investment earnings:  since we don't all earn the same amounts and we won't all make the same decisions about investing our savings, each of us will have different results.  If we want a progressive system based on ability to pay, we'd be fools to ignore the investment earnings and let those who have enough to earn most of their income from investments live essentially tax-free. 

Beyond the validity of the underlying assumptions in the report, there is the question of the estimates of the economic costs of taxation.  About the only one that is based on any kind of empirical evidence is the cost of the administration of the tax system--in 2006, that was about $10.7 billion or one half of one percent of federal tax receipts.  Compare that to most charities' administrative costs, and you will have to conclude both that the IRS is efficient and that US taxpayers are generally very compliant.  That is a low price to pay for the necessary collection of revenues to fund important government efforts, from education to medicare to disease control to the armed forces that are supposed to defend our country.

The rests of the estimated costs set forth in the report are more speculative.  $100 billion or 9.4% of tax receipts is estimated for compliance costs--but that estimate (and it should be stressed that these are merely estimates) includes record-keeping and accounting fees that would likely be done for other reasons and "time" costs that may in fact overrestimate the time spent by ordinary Americans on taxes.  The deadweight loss estimate--at 40% of tax receipts--is even more speculative, based primarily on an earlier (1999) JEC report.  I personally have always doubted that many people reject a higher paying job because they will pay higher taxes as a result or buy a cheaper item solely because of the higher tax on the more expensive item.  Even former Treasury Secretary John Snow made fun of the claims that businesses make their primary business decisions based on taxes, and Warren Buffet has expressed similar skepticism about the impact of taxes on these decisions. The report relies on a 1995 study by Feldstein to claim that  each dollar of federal spending "costs" $1.76 because of the negative economic impact of income taxation.

Taxes probably do distort human behavior on the margins, but so do gross inequalities and unfairness in the distribution of economic and other resources.  To talk about economic distortions due to taxation without considering the impact on underfunded government functions misses important data. Similarly, government action can be stifling to entrepreneurial activity, but it can also create a stable legal and financial environment, with a well-educated workforce, that favors the development of entrepreneurial activity and beneficial economic growth.  What is interesting to me is that US history has shown our economy doing best at times when tax rates have been the highest.  That suggests that the economic message in the JEC's report is too one-sided to be of much use in policy debates about the proper amount of taxation. 

In a blow to religious freedom, the Supreme Court has ruled that taxpayers cannot challenge use of government general monies to fund a program furthering Mr. Bush's "faith-based initiative."  See the decision in Hein v. Freedom From Religion Fundation, Inc. 

As the Court's synopsis indicates, Bush created various federal offices to promote use of government funds to support so-called "faith-based" initiatives, without any Congressional authorization for those programs.  The various conferences and programs in support of Bush's initiatives appear to be designed to promote use of government funding for religious groups and to favor funding for religious groups over funding for secular ones, in violation of the Establishment Clause of the Constitution.

Perhaps we should not be surprised to see the Bush administration willing to violate the Establishment Clause of the Constitution, given the many ways in which this imperial presidency has acted to end Constitutional protections for ordinary Americans, from illegal surveillance and wiretapping to use of torture to promotion of preemptive warfare that has taken tens of thousands of lives (including uncounted thousands of Iraqi women and children).  Perhaps it is also not surprising to see a Supreme Court now dominated by a group of activist right-wing judges (Alito, Roberts, Thomas, Scalia, Kennedy) that is apparently incapable of understanding the severe threat to our Constitutional stability when a government group promotes a particular brand of religion (almost all of the "faith-based"religious initiative funding goes to Christian--and particularly to fundamentalist Christian--groups).

It is nonetheless disheartening to see the Court rebuff such a taxpayer challenge to such a clearly unconstitutional executive program.  In essence, the Court's opinion limits taxpayer challenges to the constitutionality under the Establishment Clause of federal spending to those particular programs for which funding is appropriated by Congress, and leaves the more egregious misuse of federal funds by an unfettered executive branch promoting its own particular brand of religion without remedy!   In an period when we have administrative officials with the stated objective of increasing the power of the office of the president in ways including intentional refusal to execute or comply with the laws of the land, this decision adds one more way in which the administration can act unaccountably to the people that it is supposed to serve.  Shame on the Court for narrowing taxpayer standing on Establishment Clause issues in this way.

Private Equity Funds

Representative Rangel has announced that he will hold hearings after July 4 on the various tax issues that have arisen regarding the taxation of private equity funds.  These funds currently enjoy a tax advantage in that they are organized as partnerships and, even if publicly traded, would enjoy the exception to the corporate treatment of publicly traded partnerships because their business consists of managing investment income.  However, that competitive edge compared to financial service institutions is not equitable, and results in a significant tax loss to the Treasury.  The second issue is the highly advantageous tax treatment garnered by fund managers on their "carried interests" (often called just "the carry"): these partners end up being taxed only on capital gains even though the gains are essentially their compensation for services. 

The House and Senate are both considering eliminating the application of the publicly traded partnership exception to these funds and the possibility of legislation to change the treatment of the carried interest.  Rangel , chair of the House Ways and Means Committee, indicated today that he will hold hearings after July 4th on these issues, and it sounds like he will take a harder-nosed approach even than Baucus and Grassley have in the Senate, where transition provisions delay implementation until 2013.  I like the elimination of the transition.  And I hope that Congress acts to make both of these changes.

The New Tax Return Preparer Standards

In late May, Congress passed the Small Business and Work Opportunity Tax Act of 2007 (H.R. 1591) as part of the supplemental appropriation, in Public Law 110-28. Tax provisions included various incentives for small businesses, such as the expansion of expensing, the work opportunity tax credit, child care grants, and provisions favoring family businesses and S corporations.

The business incentive provisions were offset by a variety of revenue raisers.  Two deal with tax reporting standards, set forth in sections 7546 and 7547 of Title VII, Subtitle C, Part II of the bill.  These two sections impose penalties for tax return preparers and refund claimants if the reporting does not satisfy the standards provided.

For tax return preparers, the change is substantial.  Prior to the bill's enactment, section 6694 of the code applied only to "income tax return preparers."  Now it applies to all "tax return preparers", including those who prepare estate and gift tax returns.  Prior to enactment, the penalty under the section was $250.  It has been increased to $1000 or 50% of the income derived in respect of preparing the return.  These are significant and necessary changes, though the penalty may remain too low to provide a sufficient compliance-enhancing incentive.

The most important change, however, is the standard.  Prior law permitted preparers to recommend undisclosed return positions that merely enjoyed a "realistic possibility of success on the merits".  In probablistic terms, that meant that a preparer/adviser would face no penalty for recommending a tax position on a return even if the preparer thought the position might have only about a one in three possibility of success on the merits (i.e., without regard to the possibility of audit or detection on audit).   In practical terms, that meant that there was considerable leeway for preparers to recommend aggressive positions that were unlikely to succeed before the IRS or the courts, but might well avoid scrutiny because of the extremely low audit rates and the strong possibility that the aggressiveness of the position would not be detected even if there were an audit.   Under the legislative change, a preparer faces penalty for "unreasonable positions", defined as a position of which the preparer knew or reasonably should have known for which there was not a "reasonable belief" that the position was "more likely than not" to be sustained on the merits and the position was not disclosed or, if disclosed, there was not a reasonable basis for the position.  This is essentially a "more likely than not" (MLTN) standard requiring a more than 50% confidence level for undisclosed positions and a "reasonable basis" confidence level for disclosed positions.  The MLTN standard is appropriate, though the failure to change the standard for taxpayers at the same time so that both are consistently held to a requirement to attempt to get the "right" answer leaves a difficult inconsistency between taxpayer and tax preparer that has been the hallmark of the penalty provisions for some time.  Further, the continuing allowance of super-aggressive tax positions on returns when they are disclosed--through the promulgation of a lower "reasonable basis" standard for disclosed  positions--remains a problem.  Although the "reasonable basis" standard is higher than "nonfrivolous", it is considerably lower than either the realistic possibility of success or MLTN. 

I continue to believe, as I argued in my article on raising standards and denying evidentiary privileges, that Congress needs to bite the bullet and require taxpayers and tax return preparers alike to report positions according to their reasonable belief as to its being the "right" answer--in other words, a MLTN standard with a substantial authority and good faith requirement.  It is hard to justify a relaxation of the standard for disclosure, but even with a MLTN standard it will be important to enhance disclosure by requiring "uncertain" positions to be specifically disclosed.  Our current system encourages taxpayers to take aggressive positions and hope the audit lottery--or at least the time delay before they have to ante up the tax--work in their favor to reduce their tax liabilities.  We should expect them to file their returns according to their best analysis of the correct tax liability for the transaction they have undertaken, and then permit them to file an expedited refund claim to argue for a modification of the law, if they so desire. 

The second change enacted in May creates new section 6676 of the Internal Revenue Code, which imposes a 20% penalty for filing erroneous refund claims for an "excessive amount", if there is not a reasonable basis for the claim.  An "excessive amount" is any amount in excess of the amount actually allowable under the Code.  Thus, the effect of this provision is to penalize taxpayers who make claims for refunds that are not reasonably based on an analysis of the amount of refund actually due to them.  In the past, the lack of a penalty for this type of claim acted as an incentive to taxpayers to take a chance on exaggerated refund claims.  Given the low staffing in the IRS, refund claims apparently are often paid with little more than a cursory review of the claim, thus benefiting aggressive taxpayers.  This new penalty should help, though again it is likely too low to discourage typical aggressive taxpayers who are well informed about the odds of detection.

Michigan's Tax Woes

Michigan abolished its Single Business Tax and still hasn't come up with a substitute.  Facing a budget deadline and a big budget shortfall, the legislators and governor hammered out an emergency agreement on May 25.  They won't raise taxes (yet) or slash funding for schools, but they will enforce cuts and delay funding and otherwise try to make it by without a tax increase.

That's really short-sighted.  Tax money is needed to fund schools and universities across the state, among other needed state services.  Michigan should adopt the proposal put forward by my colleague Michael McIntyre a few weeks ago--raise the income tax to the maximum rate now, then change the Michigan constitution (which does not permit progressive rate structures) so that the Michigan income tax will be a progressive tax.  That would permit the state to raise the extra money it needs primarily from those with the money to spare. 

Governor Graenholm had proposed a 2% tax on services, but that did not make it through the Senate.  BNA notes that Matt Marsden, spokesman for Senate Majority Leader Mike Bishop (Republican), has admitted that a compromise position will have to be worked out for the future.  Let's hope the Michigan legislature recognizes the necessity of raising enough money through taxation to let the state grow.

Baucus and Grassley Letter to Paulson

Ever since the push for better compliance began in the late '90s, a focus of Congress has been on increased disclosure and transparency as the primary tool to encourage compliance.  The corporate tax shelter regulations, codified in the American Job Protection Act of 2004, were an important example.  Now, the disclosure drive is pushing hard against the charitable organization industry.  Senators Baucus and Grassley have put their concerns into a May 25 letter to Treasury Secretary Henry Paulson.  The gist of the letter is the need for enhanced transparency for tax exempt organizations--especially large institutions such as hospitals and universities--through an updated Form 990.

The letter expresses several specific concerns that have been in the news lately.

1. executive compensation:  exempt organizations' CEOs have begun to receive high pay commensurate with many private companies, and that pay has taken various forms--travel percs, housing, deferred compensation, loans--that make it harder for the public to understand the full extent of the pay.
2. endowments:  many exempt organizations have raised substantial endowments, but it is not clear that those endowments are being used for exempt purposes to the extent that one would think would be required under the "commensurate" test.  Worse, endowment funds are now often held offshore, beyond the reach of US taxes.
3. related organizations and joint ventures:  these organizations raise concerns of potential misuse of the charity for private benefit.
4. governance: charities sometimes are "off track" because of fiduciary failures
5. dollars raised vs dollars used for charity:  Baucus and Grassley consider this a key statistic that must be transparent to taxpayers.
6. hospitals:  there is particular need for more detailed reporting about hospitals, in light of their complexity.

Baucus and Grassley end with the plea to move expeditiously to improve transparency for tax exempts.

"[A] new and improved Form 990 and supplemental information should be a top priority to be completed and implemented. While we always hear that sunshine is the best disinfectant, sunshine can’t do its work unless we open the blinds. The sooner we open those blinds the better."

Heinz Loses Basis Shifting Case

On May 24, the Court of Federal Claims decided a tax refund suit against the Heinz company, finding a sham transaction that should be disregarded for tax purposes. 

The transaction was a basis shifting transaction to generate an artificial capital loss that could be used against prior gains.  Heinz used a subsidiary to purchase its shares on the market.  Shortly thereafter Heinz redeemed all but a few of the shares for a convertible note.  Heinz claimed that the redemption should be treated as a distribution, and the basis in the redeemed shares should jump to the few shares retained by the subsidiary under section 317 of the Code.  When the subsidiary sold the retained shares to a third party, Heinz claimed a substantial capital loss that it used to claim a refund for prior years.

The court did not buy Heinz's claim that it was merely structuring a business transaction in a way that produced the better tax results.  It quoted Learned Hand's famous statement about tax avoidance, but went on to note that “there is a material difference between structuring a real transaction in a particular way to provide a tax benefit (which is legitimate), and creating a transaction without a business purpose, in order to create a tax benefit (which is illegitimate).” (quoting the decision in the Coltec case).

The court made short shrift of Heinz's arguments for real business reasons for having a subsidiary buy and then immediately redeem Heinz parent company shares.  Heinz claimed that its subsidiary acquired its shares as an "investment" and to add substance to its dealings for state law purposes (it was a shell that had no employees or operating expenses and so was likely to be disregarded under increasing state law scrutiny).  The court scoffed at those claims, noting that "both claims have decidedly hollow rings."  The investment purpose was belied by the fact that Heinz had already hired Goldman Sachs to design the note that would be used to repurchase most of the shares in the claimed redemption that would purportedly permit HCC's basis in the redeemed Heinz shares to jump to the few Heinz shares retained, resulting in a high basis and a loss on the sale of those shares to a third party.  Moreover, the court notes, HCC acquired the Heinz stock on the open market, incurring interest expense and other transaction costs, even though it knew it would have to dispose of the stock shortly in a private sale at a discount.  As to the state law claim, the court found it "strain[ed] credibility" because there was no contemporary evidence that it was a consideration, the transaction was conducted at the same time that Heinz planned to terminate the subsidiary structure anyway (and could not make up for the past years of lack of sbustance), and, in the final analysis, the conduit nature of the transaction couldn't provide real substance to the subsidiary.

The court concludes the sham analysis with a blistering indictment of the tax shelter.

This court will not don blinders to the realities of the transaction before it. Stripped of its veneer, the acquisition by HCC of the Heinz stock had one purpose, and one purpose alone - producing capital losses that could be carried back to wipe out prior capital gains. There was no other genuine business purpose. As such, under the prevailing standard, the transaction in question must be viewed as a sham - a transaction imbued with no significant tax-independent considerations, but rather characterized, at least in terms of HCC's participation, solely by tax-avoidance features.

The court also found that the step transaction doctrine would apply to deny the company the benefit it expected from the purchase and redemption of its shares.  A direct purchase by Heinz wouldn't have permitted the basis shift that provided the tax benefit and Heinz would have reported a gain rather than a useful capital loss. "Plaintiffs may not avoid this result by employing mere formalisms thinly designed to mask their true intentions."

The spate of tax shelter cases won by the IRS in recent months suggest that the courts are more inclined to apply judicial doctrines appropriately to recognize transactions that have no economic substance and are essentially shams designed for tax avoidance purposes and nothing more.  That's good news.  The question is how to ensure that courts continue to take this approach to tax cases.  If Congress codifies the economic substance test, it is possible that it will actually narrow it considerably and force the courts to apply only that narrow test, rather than the more broadly reasoned analysis that is beginning to appear.  That would be a pity.

The Times Mirror-Reed Elsevier Transaction

Back in 2001, the IRS sought $615 million in taxes and $315 million in interest from the Tribune Company in connection with the Times-Mirror sale of its Matthew Bender legal publishing unit to Reed-Elsevier and a similar transaction involving a health unit.  See this LA Times story.   The transactions involved a structure that was cast by its investment bank inventors as a form of corporate reorganization, in order to avoid taxes of about $500 million on about $1.4 billion of gains.  Yet the result in the Bender transaction as structured was that Times-Mirror received control over the sale price  while the provider of those funds received control over the sold asset (Matthew Bender).  The substance of the deal was a sale, not a reorganization, and the Tax Court so held.  See Download Tribune. Times-Mirror Reed-Elsevier Transaction .TC.WPD.pdf.

The Tribune Company (which had reserved only a little more than $200 million for the possible tax liability, and took a hit to its stock value) appealed the Tax Court decision to the Seventh Circuit.  Arguments were scheduled to begin this week.  Last Friday, however, the Tribune Company announced an expected settlement with the IRS, whereby it will be refunded about $350 million of the approximately $1 billion it had paid to the IRS. 

Apparently, the terms of the refund are confidential, though the news releases indicate that more information will be forthcoming later.  The IRS should provide a clear explanation of its decision to refund some of the payment made by the Tribune Company on a deal that was in substance clearly a sale and not a reorganization.  In fact, it is against the public interest for the full settlement agreement not to be made public immediately upon its finalization.  Such information should be open and available to the public, so that we can assess the way in which the government is carrying out its tax adminstration responsibilities.