ataxingmatter

Citizens United and Concepcion: Big Money, Speech, Taxes, and Individual Freedom

[edited 4/28 to add Angry Bear link]

Money isn't speech. 

In spite of that, the Supreme Court continues to expand its initial holding that treated expenditures of money to purchase speech as equivalent to speech and therefore protected by the Free Speech clause in the Bill of Rights, literally giving away elections and issue education to the top dollar, which will generally be the wealthy elite and the big corporations that own and manage. 

This idea--that money is the same as the speech that money can buy--is at heart a radically anti-freedom idea.  By equating money with the speech that it can buy, the Supreme Court has ensured that genuine speech rights will wither away, and that money will be able to buy elections and legislation to suit the source of the money.  The Court failed to understand that while speech can be bought by money, that purchased speech is merely one mechanism for distributing speech.  Speech is much more than the purchased speech that is bought by money.  If you don't limit the ability of money to purchase election speech, you are in effect disenfranchising all other types of speech that can't compete with purchased speech.  By equating the speech itself with the money that purchases it and claiming that the Free Speech clause applied to the money expenditure, the Court empowered purchased speech and empower Big Money, while it disempowered individual speech and made non-purchased speech practically irrelevant.

Since the Supreme Court's Citizen United decision expanding on this "money can purchase speech, therefore money used to purchase speech is protected in the same way that speech is protected" idiocy, it has been quite clear that Big Business carries a gigantic Big Stick that influences elections through anonymous issue ads and direct campaign contributions. 

The people are misled, since the ads are often purportedly sponsored by groups with titles that suggest little people working for the common good. 

The politicians aren't misled, because they get the Big Money that will allow them to flood the airwaves with similar stuff and they know where it comes from.

The result is that Big Money, from the few super-rich and the big corporations that they own and manage, can heavily influence critical legislators on deregulation and tax provisions favorable to the rich and Big Business. 

• There is a reason that the fringe right elected to Congress in 2010 is pushing for repeal of the health reform and Dodd-Frank financial reform provisions--those reforms require Big Business to operate in ways that protect individual freedoms and limit the way that those Big Businesses can push their costs off into externalities to create socialization of losses, privatization of gains  (e.g., high premiums paid only to find delay or denial from health insurance companies, risky casino speculation in derivatives from interconnected banks that lay their losses off on the public while raking in cheap financing provided by the public). 
• There is a reason that Big Business got its wish list in the 2003 tax legislation pushed through by the Bush Administration, and then got more and more of its new wish lists in the following years Bush tax legislation and in the Republican  provisions fought for in the "compromise" on stimulus funding in the first year of the Obama administration.  Those tax provisions provide tax reductions for corporations that increased the deficit and required additional borrowing (including bonus expensing, the active financing exception permitting deferral of income for certain controlled foreign financing subsidiaries, new cross-crediting provisions that permitted U.S. multinationals to subsidize their foreign operations by reducing their US tax rate, and many others).

Imagine an issue ad by "People in support of Removing Bad Regulation" that puts out misleading, non-factual claims about how Big Business X (maybe a resource-extractive business) will be done in if the "bad" regulation is continued, and that all kinds of little people will be harmed if Business X is harmed.  The facts are otherwise.  Big Business X engages in extraordinarily harmful mining practices that level the mountains, leave toxic debris in streambeds, and put miners in harsh, unhealthy conditions that don't meet anybody's standards of a decent working environment while preventing unionization to allow collective bargaining and bombasting the region with warnings about how jobs would drop if any of these bad practices are regulated.  And Business X is actually providing all the funding for "Little People".  And Buiness X also contributes $400,000 to several  congressional politicians who are on key committees that oversee Business X's industry.  It engages in both of these activities anonymously. 

How would people react if they knew that Business X was funding the ads that appear to be from a local concerned citizens' grassroots organization and at the same time was contributing huge sums of money to key politicians voting on those issues.  They would be more likely to ask questions and more likely to doubt the veracity of the information in the ads, knowing the source of the money behind them.

So there has been a movement in support of individual freedom that demands that at the least we must have disclosure of the Big Money behind the purchased speech that has disemplowered the free speech of the people.  Yet, Senate Republicans defeated a Disclose Act proposal in Congress last year through the now common route of requiring a supermajority of 60% to get to a vote, even though 59% of the Senate voted for cloture.  See Open Congress on Senate bill; seel also Disclose Act (wikipedia). 

Now the Obama administration is apparently considering an executive order that would require those Big Businesses seeking federal contracts to disclose their purchase of direct or indirect campaign contributions.  In other words, when they buy election-related speech that clearly serves as a quo inviting a quid from the elected officials aided by such speech. they should disclose it so that we the public can evaluate whether they get the invited quid.

Big Business doesn't want to lose its anonymity--especially when it comes to getting the lucrative federal contracts even though it may be supporting fringe politicians who claim to want to cut government spending.   (And of course, Big Business will likely use its money to support those politicians who talk about cutting government spending but mean only cutting spending for programs that form part of the social net for vulnerable citizens, not cutting spending on lucrative military contracts or other lucrative federal spending programs that create instant billionaires, like Eric Prince and his Blackwater security contracts in Iraq).

Big Business doesn't want to engage in real speech, but in purchased speech that can be hidden from the public with the use of misleadingly labeled front groups like the fictitious organization in my hypothetical.  And it intends to use all the formidable weapons in its arsenal to ensure it can continue to pour money into election campaigns without revealing its role. So Josten, head of the U.S. Chamber of Commerce, a major organization supported especially by the U.S.'s biggest multinational corporations, says "all options are on the table" to ensure that Big Business can contribute anonymously.  See Lichtblau, Lobbyist Fires Warning Shot over Donation Disclosure Plan, NY Times, Apr. 26, 2011.  Josten threatens that "all options are on the table."  Big Business will apparently do almost anything to protect its right to spend to elect its politicians of choice while not letting real voters know what it is doing.

 Meanwhile, of course, the Supreme Court continues on its tear of decisions that uphold Big Businesses' rights to conduct business as they want, no matter what impact that has on the freedoms of individual citizens of this country that fought a revolution to ensure those freedoms.  AT&T Mobility v Concepcion is only the latest foray in this direction.  In this case, the Court holds that we little people have no right to join together in a class-action against corporations that have misled us, even when the contract through which we became the corporation's customers was a contract of adhesion and the relinquishment of the right to a class-action is an interpretation by the corporation of the arbitration "term of contract" that we signed to get the service that the corporation provides.  Contracts of adhesion are "take it or leave it" contracts.  Most customers don't have the ability, let alone the money, to figure out what the terms mean.  Even if someone did finally persevere and reject a contract of adhesion because the terms took away individual freedoms, that person would find no better contract at any other service provider, since they all incorporate essentialy the same corporate-friendly terms in their contracts of adhesion.

The Supreme Court's inability to understand that the constitutional protection of individual freedoms was intended to prevent just this kind of corporate tyranny will be costly for this nation.  I predict that more and more people will get angrier and angrier about the extraordinary empowerment of Big Business and the extraordinary disemplowerment of ordinary people through this kind of corporatist agenda. 

For another Bear's perspective on the AT&T case, see Beverly Mann, The Fine Print, Angry Bear, Apr. 28, 2011.  It begins this way:

It’s hardly a secret that Chamber of Commerce types have co-opted a bare majority of the Supreme Court as their proxy in their war against business litigation, and that the most potent categorical weapons are arbitration as a forced substitute for lawsuits and the effective elimination of class actions.

In a manipulative, far-reaching opinion that the Court issued Monday, the five corporate proxies killed both birds with one stone.

And it includes a good description of how this decision turns our past understanding of arbitration  on its head.

Breyer, though, writing for the four dissenters, pointed out that Congress’s actual stated purpose was to require courts to treat arbitration agreements as contracts, for the purposes of enforcing them and, when required under contract law, voiding them—and that that is what the text of the FAA says.

Scalia also said that class arbitration defeats the purpose of arbitration. Which I suppose is true if the purpose of arbitration, or at least arbitration as the only option under law, is to undermine any real threat of meaningful penalty for corporate wrongdoing.

SILO transactions: Wells Fargo Loses

Wells Fargo engaged in a number of SILO (sale-out, lease-in) transactions--26 in all  that figured into a substantial refund claim in 2002.  In a Jan. 8 opinion, the Court of Federal Claims held that the transactions lacked economic substance, scuttling the company's claimed deductions. See  Larson, Wells Fargo Loses $115 Million Tax-Deduction Lawsuit, Bloomberg.com (Jan 12, 2010).  The court noted that prominent law and accounting firms Ernst & Young and King & Spalding had merely performed "window dressing ... to generate fees and lengthy documents to give the SILOs an appearance of validity."  Id.

In the late nineties and early "aughts", SILOs were the "new" tax shelter, whereby a municipality or other tax-exempt entity transferred assets such as public transit buses or telecommunications equipment or metro-rail cars to a taxable party and then leased the assets back.  The taxable party would claim ownership that allowed it a depreciation deduction on the assets, reducing its taxable income and hence resulting in significant tax savings.  The municipality didn't suffer from the loss of the depreciation deductions, since it wasn't taxable in the first place.  The municipality generally ended up with an upfront payment, essentially its fee for facilitating the tax shelter for the taxable corporation.  That fee (and similar payments to other parties who facilitated the transaction by creating documents, etc.) was generally the only money that changed hands in SILO deals--all the rest were circular flows of funds,  or mere accounting entires, under the  purported sales documents and the purported lease documents.

In Wells Fargo's case, it claimed more than $115 million in depreciation, interest, and transaction cost deductions for 2002 connected with participation in 26 SILO deals.  The parties dealt with five specific transactions at trial--four involving public transit agencies (in New Jersey, California,  Houston, and Washington)  and one involving cellular telecommunications equipment (Belgacom Mobile, S.A.).  The court ruled that Wells Fargo did not have ownership of the property under the SILO transactions and that they lacked economic substance, since their only goal was to lower the company's tax liabilities.

This case comes after the American Jobs Creation Act of 2004 limited the use of SILOs (Section 848 of the Act) and their designation as an abusive tax shelter in Notice 2005-13.  The IRS provided some transition relief from the 2004 crackdown in Notice 2007-4 (at page 260) (extending the transition relief of earlier notices 2006-2 and 2005-29 for one year).  The IRS also offered a settlement deal to corporate taxpayers, letting them keep 20% of the tax savings from lease-back transactions.  Two-thirds of the 45 companies targeted accepted that offer.  See Schroeder, Federal Judge Rejects Wells Fargo's Bid to Get Deduction for SILO Deals, The Bond Buyer (Jan 12, 2010).

The work of King & Spalding here--that which the court calls mere "window dressing" for a tax shelter deal--is an example of the perverse result of overemphasis among the tax bar on the tax minimization norm.  Attorneys spend time contriving to fit a transaction--one that does not originate in the business but in the desire to avoid taxes--into the "letter" of the tax law, even though they know that it is a transaction that is undertaken solely to generate tax benefits and is undertaken with lots of strings and whistles to confuse auditors or create the appearance of a genuine business transaction. 

We academics bear some blame for the widespread attitude that there's nothing wrong with super-aggressive tax advice that permits taxpayers to undertake transactions that are not germane to their businesses solely for the tax benefits claimed to accrue.  This pushes the tax minimization norm well beyond a reasonably prudent limit.  We should suggest to our students that they and their clients might consider standing far enough back from the "tax minimization" tracks that they are sure they will not be ploughed under when the audit train comes through.

Textron's SILOs and its tax accrual workpapers: First Circuit Sides with the Service

[edited to add link to case]

In a 3-2 en banc ruling in United States v. Textron, the First Circuit today reversed the earlier three-judge panel decision on the accessibility of Textron's tax accrual work papers to the government.  It held that the IRS should have access to tax accrual workpapers prepared in 2001, at the time that the aerospace conglomerate had undertaken various SILO (sale-in, lease-out) tax shelters, involving telephone networks and an overseas railway system, to lower its tax liability.  The IRS, the court noted, "serves the legitimate, and important, function of detecting and disallowing abusive tax shelters."  See, e.g., Saunders & Levitz, Court Lets IRS Access Textron Leasing Papers, Wall St. Journal (Aug. 14, 2009) (subscription required); Donmoyer, Textron Ordered by Appeals Court to Give IRS Tax Shelter Papers, Bloomberg.com (Aug. 14, 2009).

Textron had claimed (among other claims) that the papers were protected work product--i.e., prepared in anticipation of litigation.  The First Circuit adheres to a lax work product standard, first set forth by the Second Circuit in the Adlman case, that merely requires that the material be prepared "because of" litigation.  Since tax standards require an assessment of the likelihood of success on the merits, success on this claim would likely result in most any materials prepared in connection with accounting issues about tax accruals being protected.  At trial, Textron had produced testimony that its workpapers were used to determine "whether Textron was adequately reserved with respect to any potential disputes or litigations that would happen in the future.  On appeal, the First Circuit panel treated resolution of disputes even in preliminary administrative proceedings before the IRS--which are often cooperative and at best only quasi-adversarial-- as satisfying the definition of "litigation" for work product purposes and the need to estimate success to determine accrual reserves as "anticipation of litigation," rejecting the government's position that business and regulatory objectives for preparation of material per se defeats a work product claim.

The en banc court, however, recognized that the doctrine "does not protect from disclosure documents that are prepared in the ordinary course of business" rather than for litigation.  That is the right answer, and in accord with Supreme Court precedent.  Further, the court acknowledged that the IRS "serves the legitimate, and important, function of detecting and disallowing abusive tax shelters" (see Bloomberg.com)--something very important, in these days of right-wing tax-protest mobs who  apparently don't understand the centrality of taxes, and an adequately informed IRS, to their well-being.

This is an important decision and one that was correctly decided.  It is time the court's recognized the boundaries to work-product protection.  Tax accrual workpapers do not merit protection.  Textron should hand over the workpapers and determine to engage in less aggressive tax planning in the future. 

Aside:  The company was faced with another lawsuit today, as investors complain that it faked back orders to make its business look better.  Sounds like the company could use a primer in basic integrity--after all, buying telephone networks is not exactly germane to the business of the world's largest corporate jet manufacturer, is it?

Some background on the Textron challenge to the IRS workpapers summons:

The district court case, United States v. Textron INc., 507 F. Supp. 2d 138 (D.R.I. 2007) held that the tax accrual workpapers were protected.  For contemporary commentary summarizing the case, see, e.g., McDermoot, Will &  Emery, Textron Protects Tax Accrual Workpapers from IRS Summons (Sept. 4, 2007); Pawlow, Ryan & Spencer, Hands Off My Tax Accrual Workpapers: Textron, Fin 48, and Related Issues, Fall 2007 The Tax Executive Magazine 421.  For my own analysis (and a link to the district court's decision), see ataxingmatter, Textron, Inc: Tax Accrual Workpapers, Attorney-Client Privilege, and Work Product Protection (Aug. 30, 2007)

The First Circuit heard the case on appeal with two circuit judges and one district court judge.  The panel affirmed the trial court's decision on general applicability of work product doctrine to tax accrual workpapers, but remanded for consideration of waiver.  See, e.g., Greenhouse, Spencer, and Selby, Textron Decision Deems Tax Accrual Workpapers Protected Work-Product, Mondaq Business Briefing (Feb. 16, 2009).  Circuit Judge  Boudin dissented, arguing that "tax accrual work papers are not protected because they are prepared for reasons independent of the need to prepare for or conduct litigation." 

The First Circuit vacated the opinion and ordered rehearing en banc on March 25, 2009 (No. 07-2631). See, e.g., Sullivan & Cromwell, First Circuit to Reconsider Work Product Privilege for Tax accrual Workpapers (Mar. 27, 2009).

ABA Tax Section and Economic Codification

The ABA Tax Section issued a report this month supplementing its 2003 comments on the proposal to codify the economic substance doctrine.  See this link.  The comments were approved by the Tax Section's Council and "represent the views of the Section" but certainly not of all attorneys (such as me) who may be a member of the Section and have had no opportunity to comment on the report before its filing.  It is one of those things that I sometimes resent about the way the ABA (and NYSBA, for that matter) function:  executive committees of people who have been invested in the organization for a long time decide the position that the Tax Section will adopt, without plenary sessions or other means of gathering a sense of the members on the issue.

The ABA Tax Section report essentially argues for a limited approach to any codification--one that would merely "clarify" how a court should apply the doctrine in two rather narrow ways.  The claim is that anything more would disrupt "legitimate business transactions" and harm "tax planning."

“[W]e continue to believe that any codification of this judicial doctrine should be limited to clarifying that when a court determines that the economic substance doctrine does apply, (i) the taxpayer must establish that the non-tax considerations in the transaction were substantial in relation to the potential tax benefits; and (ii) in evaluating the potential economic profit from the transaction, all costs associated with the transaction (including fees paid to promoters and advisers) should be taken into account.”  Id.

The second item is clearly necessary to the adequate functioning of economic substance as an anti-abuse doctrine.  If the promoter fees and other amounts necessary to smooth the transaction (getting a bank to go to the trouble of treating a regular financing as though it were a partnership equity interest, for example) were not taken into account, a transaction might appear to have had a potential for a pre-tax profit even when it was actually a losing business.

The first item is more troubling.  Saying that non-tax "considerations" must be "substantial" in relation to tax considerations is at most providing a vague notion that some economic substance might be lurking somewhere in the transaction.  "Substantial" is far less than a "principal purpose" test.  It doesn't even measure up to "must predominate" as a test.  In fact, it may be nothing more than a statement that non-tax "considerations" were not "de minimis" in the deal.  Should that be enough to legitimize twisting of statutory provisions to provide a tax benefit that was never contemplated by the drafters and that clearly pushes the boundary of permissible use of the Code to generate lower tax liabilities?  I'm not so sure.  That test seems rather self-serving for tax professionals, to me.

The ABA Tax Section expresses its particular concern with the requirement that the transaction be a "reasonable means" of accomplishing the taxpayer's stated business purpose.  Does the ABA Tax Section Council really think that taxpayers should be able to use unreasonable means of accomplishing their business purpose in order to get tax benefits that it would otherwise not be entitled to?  The section's objections are couched in terms of the importance of avoiding uncertainty.  Again, I am not so sure that certainty merits elevation to the pedestal on which the ABA Tax Section Council places it.  If there is some area of uncertainty regarding the degree of aggressiveness permitted, taxpayers are likely to be somewhat more cautious than they would otherwise be.  That's not a bad outcome. I've used the analogy before of the yellow strip next to the subway in New York City.  Stepping there is not a per se death decision, but it surely places one in considerably more jeopardy than the safe position back of the strip.  Why not encourage taxpayers to stay in the safe zone when they are determining how to shape and report their business transactions?  Is it really necessary for "legitimate business" that we encourage "tax planning" that steps right up to (and therefore inevitably sometimes over) the line? 

Similarly, the ABA Tax Section Council argues that a 40% strict liability for transactions lacking economic substance is "overly harsh".   What that means is that tax practitioners know such a penalty would do even more to discourage those borderline transactions.  Again, why not?  There is little, if any, social merit in encouraging aggressive tax planning transactions.  If a high penalty would actually encourage taxpayers to try to get it right, that is an argument for the penalty, not an argument against it.  The report argues that increased penalties under recent legislation (in particular, the (misnamed) 2004 "American Jobs Creation Act") are all that's needed.  But clearly those penalties remain much too low to be effective in most cases.  Given the extremely low audit rates and the extremely low chances of detection of errors on audits, you might need penalties in the1500% range before one could truly hope a rational tax avoider would pay attention to the penalty possibilities.  Heftier strict liability penalties are a reasonable tool against the aggressive tax avoidance planning that still goes on, from the "family limited partnerships" used to retain control of assets while ostensibly creating "valuation discounts" that let those assets escape the estate tax to the disguised financings using the flexbility of partnership allocations to give the lending bank a slightly higher interest rate in return for acting as an accommodation party to the deal.

Now, I am not saying that I support economic substance codification, especially in the weak form that the Senate bill proposes.  I think it is absolutely appropriate for courts to apply judicial doctrines in the federal common law area of tax law--without that, taxpayers would always be able to distort the statute and stay a step ahead of the government.  The courts should continue what they can indeed do very well--looking to statutory purpose, the coherent interpretation of the statute in context, whether a transaction is germane to the taxpayer's business, and other issues tied in to the "substance over form", step transaction, business purpose, sham and economic substance judicial doctrines in their various manifestations in the courts. Courts should apply these doctrines judiciously, but they should not excuse aggressive transactions merely because there is a business purpose if there is no reasonable expectation of a pre-tax profit (and they should treat foreign taxes as expenses in making those determinations). 

The Substance of the Law

The tax law, as almost everybody knows, is long-winded.  The Internal Revenue Code covers individual, partnership, trust and corporate taxation, the taxation of U.S. taxpayers with international businesses and the taxation of foreign residents with U.S. businesses, the taxation of marriage and divorce, various kinds of special investment vehicles like REMICs (real estate mortgage investment conduits) and RICs (regulated investment companies--i.e., mutual funds).  Needless to say, it takes quite a few rules to cover all those different situations, and a few more to cover the various kinds of abusive schemes that taxpayers, and their tax advisers, have cooked up over the years to try to avoid taxes.  The result is a complex system of rules that is not always easy to interpret.

Many tax practitioners will say that all a taxpayer is expected to do is comply "literally" with the words of the tax statutes.  They tweak structures of transactions to come within or without particular rules and claim to avoid taxes in situations where ordinary taxpayers would expect to pay taxes on a gain realized or income received.  They rely on Learned Hand's famous statement in an old tax case to the effect that no one is obliged to pay more in taxes than is due--and they read into that a "pass GO and collect $200" card that legitimizes super-aggressive tax planning to work around the intent of the Congress in enacting particular rules.

A recent article by Burgess Raby and William Raby in Tax Notes, the weekly journal that is read by just about every tax lawyer and tax accountant in the country, discussed one of the schemes developed by creative tax advisers to get around the rules disallowing deductions for potential future liability losses--the contingent liability shelter in the Black & Decker case.  See 109 Tax Notes 1037 (Nov. 21, 2005).  The trial court held for the taxpayer, who claimed to have complied with the literal terms of the statute even though the transaction undertaken was clearly done to lower taxes.  Responding to the Raby piece, a letter writer calling himself (or herself) A Nonymous made an important point about the interpretation of statutes, revealed in the quoted excerpts below.

"The law is not simply the words on the page.  The law is what the legsilature intended those words to mean." .....

"Noting that in Black & Decker the IRS contended that 'the substance of what took place cannot possibly be what Congress intended,' the Rabys then observe: 'That is probably true--but should it matter?'  The answer is yes, it should and does matter.  The legislature makes law.  It expresses the law in words, which are imperfect tools for conveying meaning but are the only tools available in practice.  When a taxpayer's transaction iws not within the meaning of the relevant words as used by the legislature ... --then those statutory words do not apply to the transaction." .....

[I]f the legislature enacts a tax exemption for vehicles with solar-power[ed] motors, for the purpose of encouraging people to switch from gas-powered vehicles to sloar-powered ones to reduce air pollution, the courts should deny the tax exemption to gas-powered vehicle that have been cleverly designed to include a small solar-power[ed] motor, even if such vehicles are described by the statutory language read literally."  109 Tax Notes 1369 (Dec. 5, 2005).

A Nonymous has it right.  Tax laws, like any law, must be interpreted in terms of their purposes--what the legislature intended to accomplish in passing the law.  They must also be interpreted as part of a coherent whole.  Even though there are gaps and flaws in the way the tax laws fit together over the vast array of transactions and activities to which they apply, interpreters (be they taxpractitioners or judges) should try to make the laws fit coherently.  Literalist interpretations are a little like solving a Sudoku puzzle by stopping after filling in the numbers in one square.  The square "fits" the rules for Sudokus, but without attempting to conform the remaining squares of the puzzle, the numbers in the square are questionable at best. 

But isn't it curious that A Nonymous, who is identified as "a tax lawyer who prefers to remain anonymous," considered making a statement about the importance of purpose to interpretation of statutes something with which he (or she) could not be identified?  Has it actually become such a cutthroat world in practice that lawyers who understand the importance of a substantive interpretation have to hide behind anonymity to discuss it?