ataxingmatter

Kuretskis Seek Certiorari at Supreme Court about Tax Court

Peter and Kathleen Kuretski submitted a 2007 tax return showing they owed almost $25,000 but they didn't pay a penny.  In the administrative process within the IRS, they sought approval of an "offer in compromise" where they would pay $1000 of the tax liability over five years and nothing more.  The IRS asked them to pay the full amount over a term of nine years, but they refused.  So they got a Notice of Deficiency and intent to levy, including penalties for nonpayment and interest on late payment.

At that point, they could have paid their tax liability and challenged the I tax liability through a refund action in district court (although on what basis isn't clear, since their own tax return admitted they owed it).  They chose instead not to pay and to challenge the IRS in Tax Court. They lost. Kuretski v. Comm'r, T.C. Memo 2012-262. 

They then appealed the Tax Court decision to the D.C. Circuit Court of Appeals and raised a new argument--that their case should be reheard in Tax Court because their judge might have been biased because the legislation establishing the Tax Court as an Article I court allows the President to remove Tax Court judges for cause.  They lost.  You can read the DC Circuit opinion at this link: 755 F.3d 929 (June 20, 2014).

In its decision, the DC Circuit Court considered the taxpayers' claim (not made in the court below) that the Supreme Court decision in Freytag, 501 U.S. 868 (1991) (summary with links to case on Justia, here) --which considered an Appointments Clause phrase referring to "Courts of Law" and "Department Heads" and concluded that the Tax Court was a "Court of Law" that exercises judicial power for Appointments Clause purposes-- requires that the Article I Tax Court must have the same independence from the Executive Branch that Article III courts have.  The DC Circuit looked at a number of other Article I courts and found the Tax Court not so different from them.  It pointedly distinguished Article III courts.

So the Kuretski's have filed a petition for certiorari which essentially claims that the Tax Court is --in spite of its jurisdictional limitations--equivalent to an Article III court. 

If the Kuretski's win, the result is

• the President's removal power set out in IRS section 7443(f) is unconstitutional, 
• the Tax Court's decision in their case (and presumably in any other Tax Court case) is improperly tainted by that never-exercised section 4773(f) removal power; and
• the Kuretski's should get a re-hearing under a judge no longer 'biased' by the improper removal power.

The Kuretski case has nothing to do with their expectation that they should not have to pay their tax liability--it is clear that they owe the taxes, the late payment penalty and the interest on the late payment, and they presented no statement for reasonable cause for not paying it (as required by regulations).  A rehearing before a new Tax Court judge (or the same judge who no longer faces the purported intimidation of the presidential removal power) will result in the same holding in that regard that the original Tax Court came to.  

Thus, the rationale for these years of litigation (and expense to taxpayers) is something else.  The Kuretski's will have gained some fame and at least 7 (maybe 8) years of nonpayment (a  time value of money benefit).  

But more importantly (and perhaps  more damagingly to the government's ability to collect taxes), a victory in the suit would appear to bolster use of separation-of-powers arguments to thwart efficient government procedures and eliminate existing differences between Article III courts and Article I executive branch adjudicative determinations, with potentially wide-ranging consequences for adjudication within agencies, turning the full force of zealous advocacy in adversarial proceedings on all agency hearings. 

The distinction between Article I and Article III courts certainly must mean something constitutionally.  It appears that a significant difference lies in the fact that Article III judges are protected from executive removal by a requirement for impeachment and conviction.  The Constitution does not seem to provide in its text such absolute independence to Article I courts, and Congress in legislating those courts has not opted to provide that protection to many Article I judges who exercise an executive branch version of judicial power. 

 

American pediatrics group addresses children in gay marriages

Just as the Supreme Court is preparing for oral argument regarding the validity under the Equal Protection clause of same-sex marriage restrictions on the 26th (Hollingsworth v. Perry, the ith Circuit case dealing with California Proposition 8) and the 27th (Windsor, the NY same-sex widow's estate tax claim that DOMA is unconstitutional), the American Academic of Pediatrics joined a number of other organizations of experts in family and child welfare to adopt an official policy of endorsing same-sex marriage, for the benefit of children.  See Mary Elizabeth Williams, Doctors prescribe a does of marriage equality, Salon.com (Mar. 21, 2013); Catherine Saint Louis, Pediatrics Group Backs Gay Marriage, Saying It Helps Children, New York Times (Mar. 21, 2013), at A18.

The policy statement adds to the considerable weight of data and expert opinion that the primary rationale that Congress relied on to enact the so-called "defense of marriage act" (DOMA)--to encourage and protect traditional marriage and to ensure that children will be in stable family units protected by marriage --does not justify the legislation.  That argument, and others, have been put forward by various proponents of DOMA, including the Bipartisan Legal Advisory Group (the BLAG), an advisory group to the House leadership which voted 3-2 (on a party line basis) to advise the House to participate in litigation on DOMA and has intervened in Windsor and other cases.  (BLAG does not represent the Congress as a whole, and even the House did not pass a resolution authorizing BLAG to represent it in DOMA legislation under January 2013, too late to actually give BLAG standing to appeal a case to the Supreme Court under traditional "case or controversy" principles.)

First, there is nothing in DOMA that encourages different-sex couples to marry or to have children within marriage.  Different-sex couples receive no benefit from DOMA, nor is in-wedlock childbirth privileged by DOMA over out-of-wedlock childbirth. 

Second, what DOMA does is not to encourage different sex marriages but rather to penalize same-sex marriage.  DOMA singles out same-sex couples to make it more difficult for them to provide the stable, committed relationships that all experts agree is important for children's wellbeing by causing federal law to treat as void same sex marriages that are recognized under state law. 

Third, nothing in DOMA even vaguely encourages states to rewrite their laws to favor only different-sex marriages--they are free to recognize same-sex marriages. 

Fourth, DOMA in some ways preferentially treats same-sex married couples over the different sex marriage that its proponents claim to be wanting to encourage.  Under DOMA, same-sex married couples continue to benefit from the tax laws in some respects that are not open to different-sex married couples (such as the ability to recognize losses on transfers between spouses while maintaining the property within the family unit). 

Perhaps the telling argument, though, is the way proponents of DOMA have tried to use procreation--and the fact that only a man and a woman can unite physically to produce a child--as a "natural" justification for their opposition to same-sex couples having the ability to have the same legal protections as different-sex couples.  Briefs for proponents of DOMA argue that by not recognizing same-sex marriage for federal law purposes, the government is in some way ensuring that accidental procreation (i.e., unguarded sex that produces a child) will more likely take place within a (different-sex) marriage and the stability that offers.  That's wrong on many scores.  As noted, there is nothing in DOMA to encourage different-sex couples to marry or to encourage procreation to take place within a (different-sex) marriage:  lots of accidental procreation happens outside marriage and will continue to do so.  No more takes place within different sex marriage because of DOMA than without it.

Further, those who argue the "accidental procreation" strand of "protect traditional marriage" ignore the real possibility that a partner in a same-sex married couple may be raped, resulting in accidental procreation within that couple.  Isn't it much better that a child of rape would be born into a committed, loving, legally protected marital relationship than that it be doomed to the instability and tensions inherent in a society that picks on same-sex couples to treat them as somehow odd for federal purposes only? The Academy is essentially speaking on this issue.  Whether orphan and unwanted children are adopted by same-sex married couples or born of a rape or result from a surrogate pregnancy on behalf of the couple, those children will be better off if their parents can marry and have all the securities of that marriage than if they cannot.

Many of the briefs in the Windsor case asking the Supreme Court to uphold DOMA focus on an argument not well made when Congress adopted the law--that Congress was interested in creating a uniform definition of marriage.  But DOMA essentially undoes the uniform definition that existed--one that relied on the state law definition (and expected states to give "Full Faith and Credit" to each others' determination when a person moved from one state to another).  And the definition DOMA imposes is a spiteful one that appears born out of animus to a group that has historically suffered discrimination in this country, whose identifying characteristic doesn't in any way impair the group members' ability to function in society yet is one that manifests itself in the very context of issues that lead to discrimination, and who is rendered politically powerless to prevent that discrimination.  Those are the four factors that support strict scrutiny under the 1985 City of Cleburne case, and suggest that Windsor may have a strong claim, even before this court on which a majority of Justices are Roman Catholic, a religion in the news just this month for a new Pope who has condemned same-sex marriage as being against God's plan.

Statements in the record certainly suggest a strong element of animus towards gays at the time of passage of DOMA.  What is good to see is that this is gradually falling away. Bill Clinton, who signed DOMA into law in September 1996, and Hilary, who opposed gay marriage during her campaign for the presidential nomination, have now both come out in support of it.  Even Sen. Portman, a conservative Republican, has acknowledged he was wrong to oppose it.  Many Republicans who voted for it in 1996 now say they were wrong.  And many organizations, like the pediatrics academy, have done an about face to recognize that facts support same-sex marriage as a societal support for children.

Related articles

Same-Sex Marriage In Illinois? No Basis for Objection

Gay Marriage Legal In New Mexico, Santa Fe Mayor David Coss Argues

Majority supports U.S. benefits for same-sex couples: Reuters/Ipsos poll (Reuters)

Bill Clinton says anti-gay marriage law he signed should be overturned

DOMA Gives Gay Politicians 'Free Pass' On Ethics, Says Watchdog

CREW: DOMA Allows Ethical Violations For Gays, Lesbians

Soon-to-be Google litigation with IRS over 2003-4 returns?

Bloomberg dug into Google's annual SEC 10-k filing to discover that the company plans to litigate an issue from the 2003 and/or 2004 tax years.  No suit has yet been filed, and there is no information regarding the substance of the dispute or the amount at stake.  See Googloe Plans Litigation Against U.S. Tax Authorities over Audit, Bloomberg.com (Feb. 6, 2013).

Google has been in the news lately because of its ability to offshore profits to low-tax countries like Bermuda using treaty countries like Ireland and the Netherlands.  Because most of Google's assets are intangibles, it is relatively costless to claim "sales" through intracompany transactions that offshore the intangible and then attribute the profits to other countries.  Valuation of such sales of intangibles is inherently manipulative--no company would actually sell such invaluable essential business property to a third party, and there are strong arguments that our laws should not permit companies to make such "paper-only" transfers of intangible properties to offshore affiliates that have the primary result of creating complex structures that achieve lower US taxes,  like the "Double Irish" and "Dutch Sandwich". 

As the report notes, Google's 10k reports an overall (state and federal) effective tax rate of only 19.4% in 2012, down from the 21.2 reported in 2010, even though the federal statutory rate on profits is 35%.   In 2012, at least $9.8 billion in profits shifted to a Bermuda subsidiary.  These tax-haven subsidiaries are often just token offices with some paper-pushing and no real business reason for existing.  The difficulty for the government here is action taken by the Bush administration--"In 2006, the IRS signed off on a 2003 intracompany transaction that moved foreign rights to Google's search technology outside the U.S."

 

Related articles

Goggle's Bermuda hideaway/HSBC's too-big status: time to rein in the corporations!

Intangible assets hard to tax--France has an idea...

UBS and other ? offshore bank accounts

The government's dismissal of a criminal information against UBS filed in Florida-- United States v. UBS AG, No. 09-600333-CR-COHN, Dismissal of Information, Oct 22, 2010-- leaves the tax cognoscienti wondering what the next step in its fight against secret offshore bank accounts will be.  Bryan Skarlatos of Kostelanetz & Fink says that "the UBS case was the beginning of the end of Swiss bank secrecy.  We don't know whether it's the beginning of the end of IRS activity, or only the beginning." BNA Daily Tax RealTime, (Oct. 25, 2010).

It is questionable whether the UBS case and Swiss changes to information releases are sufficient to call it the "beginning of the end of Swiss bank secrecy."    But it is likely that the government isn't finished with the topic, and that the information received through the reporting process will be tapped to target other banks and jurisdictions on the issue.  As Skarlatos noted, "the real question is whether another shoe is going to drop" or whether there will be "different strategies" going forward.  BNA Daily Tax RealTime, Oct. 25, 2010. 

 Switzerland and the UK have agreed to negotiated a new tax agreement requiring withholding on behalf of the UK on assets of UK nationals in Swiss banks and supposedly also a better provision for cooperation in tax evasion cases.   It will be interesting to see where this is five years from now--will wealthy Americans still be able to hide their assets in Swiss banks because the IRS can't get the information unless it already has enough information?  My colleage Mike McIntyre has written about the inadequacies of information exchange provisions when the government doesn't already know considerable particular information about tax evasion in progress.  See McIntyre, How to End the Charade of Information Exchange, Tax Notes (Nov. 9, 2009) (noting that banking secrecy is "not over yet").

UBS hidden account holder pleads guilty in Florida

The information from the UBS scandal is beginning to pay off in guilty pleas.  The owner of Michele Watches in Foriday pled guilty to a tax felony for failing to report offshore accounts or the income from them.   He skimmed money from his business and it was deposited in UBS accounts established in the names of nominee corporations. 

That guilty plea is accompanied by a $5 million penalty (50% of the highest amount in the accounts, which was $10 million).  The taxes Barouh would have had to pay if he had paid them appropriately amounted to about $740,000.  Not a very good deal, that secret Swiss bank account..... 

The case is U.S. v. Barouh (S.D. Fla, No. 10-20034-CR-Jordan, Feb. 4, 2010).

The statement, available on BNA here, says that Barouh had several offshore accounts in Hong Kong, Switzerland and other localities, held mostly in the names of island nominee firms.  He started skimming income from his business decades ago, in 1976.  Rather fittingly, one of the money managers that Barouh used to hide his assets for him skimmed stole millions of those same assets!  But that just led to a settlement, and then ensconcing those funds in another dummy corporation account hidden from the IRS.  Barouh started getting worried in 2007, and wanted to repatriate the funds.  So he arranged to move the assets to Hong Kong and then have dummy "consulting fees" paid (about $600,000 a year).  He even considered consulting a US tax adviser about voluntary disclosure, but the Swiss attorney and money manager told him that wasn't necessary--Swiss attorneys could initiate the disclosure, but he'd be best just moving it out of Switzerland since he wasn't on the list of accounts being disclosed.

[Aside--gee, if Swiss bankers were telling the hidden account holders that they were not in danger of being disclosed then it's bad for UBS either way--either the bank was lying to us  about not disclosing to those whose accounts would be disclosed and was actively working to perpetuate tax fraud even in the midst of the crisis or the bank had so lost control of its operations that the information it had agreed to keep secret was being shared with the account holders by its agents, who were actively working to assist tax evasion.]

Gender reassignment surgery case decided

Back in 2005 when the IRS released CCA 200603025 stating that gender reassignment surgery is not a deductible medical expense, I objected.  Gender identity disorder had been recognized by the medical profession, I argued, so why should the IRS rely on a Catholic Church authority who had fought against such surgery for its decision.  Read the post from 2006 here. 

The Tax Court ruled on the issue today, in O'Donnabhain v. Comm'r, 134 T.C. No. 4 (Feb. 2, 2010). As Caron notes on TaxProf (hat tip), the majority recognized gender identity disorder as a disease and gender reassignment surgery as treatment for a disease (though they thought breast augmentation surgery was merely cosmetic). 

Good decision,  except maybe for that bit about breast augmentation being merely cosmetic.  If we were talking about "Hot Lips" on Mash I'd agree.  Or even about any woman who just wants bigger breasts.  But when the subject is a male with gender identity disorder who is undergoing genital and breast surgery to make himself into the female she believes herself to be, then breast augmentation is a critical part of the picture, which the medical standards quoted in the case make clear.  I couldn't read the court's discussion of this topic without thinking--but, if you had undergone that surgery, wouldn't it be pretty important to have really good breasts?  The court essentially said there wasn't enough substantiation that the breast surgery was because of the gender identity disorder.   One of the examining physicians who concluded that the petitioners was a "good candidate" for the surgery also noted that she already appeared to have developed decent breasts (B cup) under hormone therapy.  Yet the surgery is described as "designed to make petitioner's breasts, which had experienced some development as a result of feminizing hormones, more closely resemble the breasts of a genetic female."   An expert testified how important it is for persons with this disorder to "pass' convincingly in public as female."    That does not sound like elective, purely cosmetic surgery to me, but something that is a singificant part of the change in the gender appearance of the individual-- something that "prevents or treats illness or disease"--i.e., a medically deductible expense.  The court concluded that the petitioner hadn't shown that the breast surgery "treated" the gender disorder.  It seems there was some lack of substantiation, since the recommending physician had not specifically discussed presurgical breast condition.  But I suspect the court is giving more weight to an examining physician's statement of "significant breast development" than it should--that could merely mean "compared to a man without hormone treatment" but nowhere near normal female breasts.  In fact, the physician that had noted presurgical "nice shape" also testified that he meant--compared to other males on hormones and not compared to ordinary female breasts.  That didn't sway the court that there was enough substantiation to support that breast surgery was because of the gender disorder. 

By the way, reading this from the context of a "battle of the experts" is interesting.  One government "expert", Dr. Schmidt, was one who has not had a very important role in the matter since the 1980s (not a listed author on articles, not an author of a chapter in a medical reference text on the subject, but had "participated in evaluation" of about 12 gender disorder patients a year).  He tried to have it both ways--unconvinced about the validity of the gender identity disorder diagnosis at this trial, yet testying regularly in other trials (recently) about the diagnosis and admitting that it is taught at medical schools and is something doctors are required to learn about.  The summary of his testimony reads like what one would expect a creationist to say on a stand to defend the teaching of creationism--hedging and more hedging around the fundamental admission of the disorder, the medical consensus around it, and the real basis for it.  The other government expert was a forensic psychiatrist--odd choice.  He claimed that gender identity disorder is a mental disorder but not a disease because it isn't clear that it arises from a pathological process within the body (in spite of the fact that others have suggested at least three different conditions for disease--either discomfort, or dysfunction or pathology).  So bulimia, to Dr. Dietz, is not a disease, and obsessive-compulsive disorder wouldn't have been one til it was discovered that it has a pathological cause about 20 years ago.  The tax court concluded that the government's position against treating gender identity disorder as a disease was "meritless", with no authority whatsoever other than the one expert's interpretation,  which "is flatly contradicted by nearly a half century of caselaw."  Id. at 37.  Further Dr. Schmidt's claims that the disorder is subject to some debate was found unconvincing, since the court was persuaded by "the widespread recognition of the condition in medical literature" showing that recognition of the disorder "is the prevailing view."   Even these government witnesses undermined the government's claim that the disorder was merely a "social construction" since they agreed that it is a serious condition "sometimes associated with autocastration, autopenectomy and suicide."  Id. at 43.

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.

Veritas Software (Symantec Sub) and Transfer Pricing

Transfer pricing adjustments under section 482 are supposed to assure that the Secretary can "distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among [organizations owned or controlled directly or indirectly by the same interests] if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect thye income of any of such organizations, trades or businesses."  That statutory provisions gives considerable discretion to the government to determine whether a company's allocation is a "clear reflection of income."  It is not supposed to permit companies to short-change the government by working out "transfer pricing" deals with subsidiaries that low-ball the figure in order to shortchange the tax revenues.

It looks like Symantec may get away with just that--"selling" a supported intangible property developed in the US for a lowball figure of a not even 200 million when the income stream (to the now-foreign owner) will be worth billions, based on the taxpayer's claim that its method of determining the worth of the product is better than the Service's income method.  See Veritas Software, 133 TC No. 14 (2009), Download Veritas Software transfer pricing case.121009 (BNA).

Folks, the primary (and often only) reason US software companies established two-tier Bermuda and Irish subsidiaries like Veritas did--i.e., Bermuda-resident subsidiaries incorporated in Ireland's low-tax jurisdiction that have  Irish-resident and incorporated subsidiaries-- was to offload income from their products to that area from the US and avoid US taxes.  If they could "sell" their software cheap, and then have a hefty royalty income stream going directly to the foreign subsidiary, they could substantially reduce US taxes.  Veritas established the subsidiaries and then assigned "exclusive and permanent rights" its existing sales agreements with European subsidiares and to various "covered intangibles" (inventions, patents, copyrights, computer programs, updates, translations, adaptations, specifications, etc.)  to the Irish subsidiary of the Bermuda-resident Irish corporation, while still agreeing by contract to provide R&D and technology support for the product to its subsidiaries and the right to use "trademarks, trade names, service marks".  This deal was done for an initial $166 million lump sum buy-in (later adjusted to $118 million) and royalties.  

The IRS thought the buy-in payment should be somewhere between $1.9 billion and $4 billion, settling on $2.5 billion in the notice of deficiency, based on the forgone profits and market capitalization methods applied by Brian Becker.  But in the court, the IRS indicated that it would no longer use Becker as a witness or rely on the market capitalization method, but rather, based on actual income figures, assert a new forgone income amount of $1.67 billion, developed by cost-sharing expert John Hatch using a discounted cashflow analysis.

The company assserted that its "comparable uncontrolled transaction method" was appropriate and that the IRS's new determination was arbitrary and capricious.  The tax court agreed, arguing that the IRS's mechanism was inappropriate because it did not refer only to preexisting intangibles in disregard of Reg. section 1.482-7(g)(2) and because it valued short-lived intangibles as though they had a perpetual useful life and because the court found Hatch's determinations "unsupported, unreliable, and thoroughly unconvincing."

This opinion illustrates yet again the problem with offering multinational corporations various "elections" about how to determine a matter relevant to their taxable income and in the variability of numbers that financial "experts" can come up with.   The opinion appears to rely very heavily on the company's description of its industry and mode of operation, resulting in a very low figure for the value of the intangible transferred.   Of course, the lack of credibility of the IRS's expert is problematic as well--the IRS needs to better prepare its cases at the early stages and the DOJ and Treasury need to work together to make sure that litigation strategies are implemented appropriately.  The Tax Court also refused to consider new regulations as relevant, when the old regulations did not explicitly cover workforce, goodwill or going concern value.

In the long run, it would be reasonable for sales of intangibles to affiliates to apply a uniform hind-sight calculation based on present valuing expected future income streams, so that the full value of an asset is taxed when it is transferred to another country.  Congress, and the Treasury, need to reconsider the value of "flexibility" in  the Code and regulations.  The Tax Court ought generally to grant greater deference to the Secretary in these transfer pricing cases--the Code makes it clear that the Secretary has authority to reallocate.

More on UBS-related indictments

At the fall meeting of the ABA tax section, government officials from Department of Justice and IRS speaking on a panel addressing offshore accounts and FBAR filing requirements were almost gleeful about their prospects for finding out just who has been hiding money away offshore.  Even the practitioners on the panel were joining in the clear message--if your client has an undisclosed foreign bank account, you'd really better be trying to get disclosure done or his goose may be cooked.  Disclose voluntarily, and you probably face only low fines.  Wait and be found, and you may go to jail, plus pay 50% of the account balance for open years.

To a packed audience (very unusual for a Saturday panel), the government speakers noted their clear delight with the unprecedented release by UBS of banking account information and the agreement, in response to the summons, to release  information on more than 4000 additional accounts/accountholders.  By the way, we're not only going after account holders, they noted, but also their bankers and lawyers.  And everybody we go after is being asked to  give us names of anyone else they know about. 

It's like that "six degrees of separation from everybody on the planet" idea.  Once the DOJ has its foot in the door, it has a good chance of kicking it wide open and revealing everything that is inside.  A person with an account can lead to a party in Hong Kong that helped the person establish a corporation to hide assets.  That party in Hong Kong can lead to 40 more people who hid assets, each of whom may provide a link to another party in the secrecy parade who can provide links to yet more individuals who hid assets.  While one suspects that the accounts revealed by UBS will be the largest ones and ones that expressly stated that they did not want their tax information revealed to the US, the account holders who are revealed through the investigative tracing of these many revealed links will also include a number of relatively small fry.  So those who established such accounts should come clean by the "last chance" October 15 deadline.  Or else they are playing a very high risk version of the audit roulette.

At the session, it was particularly interesting to see the kinds of cases that the practitioners thought were sympathetic.  Every attendee that I talked to told me that they had "lots" of clients struggling with the question whether to come forward voluntarily or not.  (Many of these practitioenrs with FBAR clients were as gleeful as the government reps--there is business to be had doing tax law, they told me, even in down times.  Something of which I frequently remind my students...)

One or two said their clients had quite substantial sums secreted abroad and were trying to decide the odds of their being revealed as the DOJ investigation goes forward: it was clear that, for these clients, there was no desire to comply with the law, no valuing  of the integrity of the tax system, but rather it was purely a matter of self-interest and the odds of getting caught (and paying, perhaps with a criminal prosecution) versus continuing to enjoy the tax-free status of income on the secret offshore account. One doesn't feel much sympathy with such taxpayers.  I could only think to myself "Go, DOJ."  Hope those leads take you to these guys."

But several said they thought their clients had good cause for not having reported the accounts--they were elderly Jews who had left Europe to avoid the Holocaust and just never  had done anything about accounts left behind, or they were unsophisticated taxpayers who'd inherited a small account and simply had no idea about the reporting requirement, or the accounts didn't really earn much income anyway, etc.  One came to the mike to ask about her client, who had immigrated to the US from a home country where the client felt politically persecuted.  The client had left family behind.  The client happened to have some money (I got the impression the figure was perhaps one or two million but I'm not sure that was stated and I don't have the audio tape) in a foreign bank account that had never been declared in the US.  The client indicated to the tax adviser that he didn't use it for himself but, according to the practitioner, had retained signing authority on the account since his folks back home really needed the money and he was the only one who could safely sign for the money and have it made available to them.  This sounds like a more sympathetic case--maybe even one in which DOJ prosecutorial discretion might come into play.  Interestingly, a panelist was not so accepting of the tale.  Noting that clients almost always seem to claim some sympathetic reason for having the account, he added that almost always when you dig deeper into the facts you find some additional information that may not be so sympathetic--for example, that the client used the funds in the account for himself.  And the government authorities reiterated that the voluntary disclosure program was for a specific penalty, and that should be contrasted with the potential for much stiffer penalties and even criminal prosecution if the taxpayer doesn't take advantage of the voluntary disclosure program.

The DOJ is continuing to build pressure on taxpayers to come forward.  Just yesterday, we learned about the guilty plea of  retired Boeing sales manager Roberto Cittadini, who secreted nearly $2 billion through UBS using a Hong Kong corporation set up with the help of the Swiss banker Schumaker (already charged in August) and Swiss lawyer Rickenbach (also indicted in August).  Cittadini was accused of filing a false tax return and failing to report the account.  He faces up to 3 years in jail and a fine of $250,000 as well as a civil penalty of 50% of the highest account balance between 2001-2007, per the DOJ release.  See Former Executive Guilty in Swiss Tax Scheme, NY Times, Oct. 5, 2009.

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).