October 28, 2006
"The Tax Shelter War is Over."
Posted by Victor Fleischer

"The tax shelter war is over.  The government won." 

So began the remarks of Pam Olson, a Skadden partner who formerly worked at Treasury as Assistant Secretary for Tax Policy, at yesterday's conference on "The Future of Tax Shelters."  Ms. Olson attributed the victory to, among several other factors, the impact of Sarbanes-Oxley.  Companies are too busy dealing with section 404 auditors to have time for tax shelters. 

Later in the day, I presented my Essay on Options Backdating, Tax Shelters, and Corporate Culture.  In the Essay, I suggest that process-oriented solutions (like SOX section 404) can be effective in creating a culture of compliance.  Perhaps too effective.  Some of the evidence from backdating suggests that there may be a trade-off between creativity and product innovation on the one hand, and compliance on the other. 

In the Q&A, Brett McDonnell asked me an interesting question about the extent to which we should use internal financial controls to serve goals other than creating shareholder value.  I wasn't sure how to answer that.  Tax compliance is good for the public.  But it may not be so good for shareholders, who would prefer that corporations keep the money rather than pay it to the government.  Or maybe it is good for shareholders; tax avoidance is associated with earnings management, which is usually bad for shareholders.  (See here.)   How do we determine the optimal level of tax compliance?

Brett pointed me to this paper by Larry Cunningham, which discusses using internal controls to serve goals like national security.  Along somewhat similar lines, Don Langevoort describes how SOX is pushing outside directors to act as representatives of the public interest and not just protectors of shareholder value. 

I'm finding this a fascinating question in part because it forces us to question the extent to which we think of corporations as social/public institutions (if at all).  If you think corporations are purely private institutions, just efficient contractual devices for aggregating capital, then you'll tend to resist using internal controls or outside directors to serve any interest other than increasing shareholder value.  If, however, you think that corporations are also important public institutions, you may be more willing to impose public-oriented duties on directors, officers, and auditors.  Compliance with the law has always been an expected part of the duties of fiduciaries like directors and officers.  But  should we also ask them to be on the lookout for fraud beyond what the normal shareholder cost-benefit analysis would suggest?  If so, how much do we want them to detect?  How much of the government's tax enforcement duties can be outsourced to outside directors and auditors? 

My knowledge of the tax literature is deeper than my knowledge of the corporate governance literature.  Any suggestions for further reading?

Thank you to Kristin Hickman, Claire Hill, and to the University of Minnesota for a great conference.

Taxation | Bookmark

TrackBacks (0)

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8345157d569e200d834c063bd53ef

Links to weblogs that reference "The Tax Shelter War is Over.":

Comments (7)

1. Posted by Jake on October 28, 2006 @ 18:14 | Permalink

Ms. Olson may be correct in suggesting the tax shelter war is over. As she is fully aware, however, billions of tax dollars still remain at stake as shelter investors, promoters, and IRS litigate how to divide the spoils.


2. Posted by James on October 29, 2006 @ 1:19 | Permalink

We recently had to add a footnote to our N-CSR filing to reflect FIN 48.

This footnote, combined with SOX, would make me think twice about signing the required SEC certifications if we were playing games with our taxes.

The footnote reads:

"Uncertainty In Income Taxes - On July 13, 2006, the Financial Accounting Standards Board("FASB") released FASB interpretation No. 48 "Accounting for uncertainty in Income Taxes" ("FIN 48").

FIN 48 provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the financial statements.

FIN 48 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Fund's tax returns to determine whether the tax positions are "more-likely-than-not" of being sustained by the applicable tax authority.

Tax positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax benefit or expense in the current year. Adoption of FIN 48 is required for fiscal years beginning after December 15, 2006 and is to be applied to all open tax years as of the effective date. At this time, management is evaluating the implications of FIN 48 and its impact on the financial statements has not yet been determined."


3. Posted by andy on October 29, 2006 @ 14:10 | Permalink

"The tax shelter war is over. The government won."

I'm not as sanguine. As long as the courts continue to invent "doctrines" to alter the plain meaning of Code provisions, and as long as they apply those doctrine erratically and inconsistently, the confusion will continue. A transaction lacking "economic substance" is one thing in the DC circuit but a different thing in the 5th and a different thing in the 8th, etc. The Supreme Court has never articulated an "economic substance" test anything at all like the ones applied by the circuit courts. Hopefully the Court will finally step in, pat the circuit judges on their heads, and reiterate the principle that a taxpayer's "purpose" is entirely irrelevant unless the statutory language makes it relevant. Until then we will continue to battle over subjective tests versus objective tests, etc. etc.


4. Posted by Jake on October 29, 2006 @ 18:26 | Permalink

I doubt the Supreme Court has any good reason to wade into the "economic substance" debate (even assuming there is one). The Circuit Courts are not "inventing" doctrines, but rather, implementing Gregory v. Helvering according to the demands of individual cases. And the recent trend in tax shelter case law reflects a convergence, not a divergence, of appellate opinion. Any perceived differences are wrinkles, not inter-circuit splits of authority the SCT must step in and referee.

The fact of the matter is that the lower courts are taking an appropriately skeptical view of transactions that are questionable but for tax savings. The suggestion that the SCT should discourage the intermediate courts of appeal from actually thinking about and scrutinizing such dubious deals, rather than swallowing whole whatever defenses the shelter consumers and the promoters they deal with serve up, is beyond comprehension.


5. Posted by andy on October 29, 2006 @ 20:39 | Permalink

"I doubt the Supreme Court has any good reason to wade into the "economic substance" debate (even assuming there is one)."

The massive confusion caused by the circuits in these cases is a pretty good reason. Why are IES, Compaq, and UPS not shelters but Coltec is? The court's application of these doctrines has amounted to nothing more than a "smell test."

"The fact of the matter is that the lower courts are taking an appropriately skeptical view of transactions that are questionable but for tax savings."

Well, I agree that there are loopholes that need to be fixed, and should be fixed. And, maybe Congress needs to be more aggressive in making retroactive changes to the tax code. But, that lawmaking authority belongs to Congress, not the courts. The current judicial approaches amount to nothing more than "smell" tests.

"The Circuit Courts are not "inventing" doctrines, but rather, implementing Gregory v. Helvering according to the demands of individual cases."

I think the Supreme Court-- if it considers the issue and it is presented effectively-- would be inclined to think differently. The Supreme Court, in cases like Knetsch and Frank Lyon, use "economic substance" analysis to determine if a given transaction falls *within* the meaning of a statute. The Supreme Court uses "economic substance" analysis when it concludes that the statute at issue carries economic terms.

In Coltec, the Federal Circuit concluded that the transaction did fall within the meaning of the statute, but then invented a judicial test that applied beyond the statute's term. The Coltec court's approach amounts to not the interpretation of a statute, but the creation of one, and is about as ridiculous a decision as the D.C. Circuit's decision in Murphy.

It seems, no matter how direct the Supreme Court is, the lower courts will distort the supreme court's pronouncement under the guise of enforcing the "right" policy. Even in a case like Gitlitz, in which the Supreme Court could not have been more explicit-- ("when the statute is clear, there is no need to get into policy concerns"), some simply refuse to accept reality. Some professors have responded to Gitlitz by saying that the "plain meaning" rule does not always apply, because the taxpayer in Gitlitz merely "stumbled" onto a tax benefit, and did not actively plan for it. But that construction is nonsense-- the supreme court was resoundingly clear; apply the %@%#%#! statute, don't invent rules based on "policy." Nonetheless, some are still inclined to poke holes in the Supreme Court's unequivocal proclamation.

If I have some more time maybe I'll write an article in Tax Notes about this.


6. Posted by andy on October 29, 2006 @ 20:40 | Permalink

*within* the meaning of a statute. The Supreme Court uses "economic substance" analysis when it concludes that the statute at issue carries economic terms.

In Coltec, the Federal Circuit concluded that the transaction did fall within the meaning of the statute, but then invented a judicial test that applied beyond the statute's term. The Coltec court's approach amounts to not the interpretation of a statute, but the creation of one, and is about as ridiculous a decision as the D.C. Circuit's decision in Murphy.

It seems, no matter how direct the Supreme Court is, the lower courts will distort the supreme court's pronouncement under the guise of enforcing the "right" policy. Even in a case like Gitlitz, in which the Supreme Court could not have been more explicit-- ("when the statute is clear, there is no need to get into policy concerns"), some simply refuse to accept reality. Some professors have responded to Gitlitz by saying that the "plain meaning" rule does not always apply, because the taxpayer in Gitlitz merely "stumbled" onto a tax benefit, and did not actively plan for it. But that construction is nonsense-- the supreme court was resoundingly clear; apply the %@%#%#! statute, don't invent rules based on "policy." Nonetheless, some are still inclined to poke holes in the Supreme Court's unequivocal proclamation.

If I have some more time maybe I'll write an article in Tax Notes about this.


7. Posted by Jake on October 30, 2006 @ 19:50 | Permalink

Every taxpayer deserves to have their story told. Sometimes the story runs headlong into Gregory v. Helvering, to the taxpayer's dismay. To say that the recent appellate decisions striking down patently abusive transactions reflect no more than a "smell test" is to presume that judges must put on blinders when weighing tax cases. We are all fortunate that the judges in Coltec approached the disputed scheme with a healthy measure of skepticism, as it deserved.

I sincerely look forward to the Tax Notes article.

Post a comment

If you have a TypeKey or TypePad account, please Sign In

Bloggers
Papers
Posts
Recent Comments
Popular Threads
Search The Glom
The Glom on Twitter
Archives by Topic
Archives by Date
December 2014
Sun Mon Tue Wed Thu Fri Sat
  1 2 3 4 5 6
7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
28 29 30 31      
Miscellaneous Links