Wednesday, April 30, 2008
Tax Risk - SOX 404 ........ RED HAT INC (CIK - 1087423 /SIC - 7370) Warning!
They may not be able to accurately or timely report, identify and reduce fraud, resulting in their financial position being potentially being harmed, causing a negative effect on their share price. They have obviously not heard of the 7 Habitual Tax Mistakes.
Here is the link to the report:
We may be exposed to potential risks if we do not have an effective system of disclosure controls or internal controls or fail on an ongoing basis to properly address Section 404 of the Sarbanes-Oxley Act of 2002.
We must comply, on an on-going basis, with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX”), including those provisions that establish the requirements for both management and auditors of public companies with respect to reporting on internal control over financial reporting.
We cannot be certain that measures we have taken, and will take, will be sufficient or timely completed to meet the Section 404 requirements on an on-going basis, or that we will be able to implement and maintain adequate disclosure controls and controls over our financial processes and reporting in the future, particularly in light of our rapid growth, international expansion and changes in our products and services, which are expected to result in on-going changes to our control systems and areas of potential risk.
If we fail to maintain an effective system of disclosure controls or internal control over financial reporting, including satisfaction of the requirements of Section 404 of SOX, we may not be able to accurately or timely report on our financial results or adequately identify and reduce fraud.
As a result, the financial position of our business could be harmed; current and potential future shareholders could lose confidence in us and/or our reported financial results, which may cause a negative effect on our trading price; and we could be exposed to litigation or regulatory proceedings, which may be costly or divert management attention.
Tax Risk - S Corporations and different voting stock & a voting stock trust
I prepared a SH agreement for a client company with 2 shareholders. I drafted it such that if either of the SHs gets a divorce, and the ex-wife is awarded any of the shares, then the company has the right to buy the shares from the ex-wife and the ex-wife must sell to the company. After some discussion, the 2 shareholders want to revise the SH agreement so that if either of them gets a divorce, the ex-wife can keep the shares, but upon the award of the stock to the ex-wife, the shares convert to non-voting stock. This way, the ex-wife's have ownership in the company, but absolutely no control/voting rights.
All of the stock of the corporation is common stock. Can this be done?
The comments that follow are NOT advice but for information purposes only that must first be checked by a professional:
1. It can be done, but the advisability of doing it is another matter.
I assume one class of stock now exists. Amend the articles of incorporation
to create a two series of common stock, one voting and one non-voting with
an equal number of shares authorized for each series. The existing shares
are converted into voting stock on a share for share basis. No non-voting
shares are issued at this time.
In the agreement, which each wife must sign, the parties agree that upon the
wife becoming a shareholder, she agrees to exchange her voting stock for
non-voting shares. I don't think that there would be any tax issue with the
exchange, but I really don't know for sure and would research that issue.
I would recommend that the wife be given the option to compel a buy-out of
2. would have to add a caveat to the comment that it can be done. You do
not mention whether the corporation is a C corp or an S corp. If it is an
S corp (and has pass through taxation) then it can only have one class of
shares. Converting some of the shares to a second class would destroy the
S Corp eligibility. So if it is an S Corp make sure the client
understands the implications and still wants to go forward.
3.This can be done. If this is implemented, create a class of non-voting
common stock at the same time the SH agreement is finalized. This is
permissible even if the corp is a Sub S corp as long as that is the only
difference between the 2 classes (i.e. no different dividend rights,
redemption rights, etc.).
4.The tax regs allow an S Corp to have voting stock and non-voting stock
provided the vote is the only difference between the "classes".
5. Why not have the stockholders all sign a voting trust agreement (not sure whether your state allows them, CA does)? Then contractual require new stockholders to agree to the trust, with one of the clients as the trustee. In effect, trasnfering the voting rights to the trustee. Then you don't have to create new series/class of stock or deal with the sub S issues.
6. I agree with the consensus of previous comments. What is proposed (either variation) can be done but in many cases would not be a good idea. Usually the non-deceased business owner doesn't want the spouse and/or heirs of the deceased owner involved in the business, AND the flip side is that the business owners (when they're alive) don't want to stick their spouses and/or heirs in a situation with no vote, no participation in the business (i.e., no salary and benefits) and no cash since there is no market for the stock. The best answer in most cases is an automatic buyout funded by life insurance. But life insurance is not always readily available at a reasonable price, depending on the health and age of the principals. There is not one right answer for this type of situation, and tricks of the trade and nuances are more numerous than can be reasonably discussed on a listserv. The starting point should be what are the co-owners real-life intentions and desires, not their usually ill-informed notion that they should pursue a particular legal strategy that someone told them about. Some clients are more savvy about these things than others.
What is a reverse shell company?
What is a "reverse shell", how does it work, and why is it a bad thing?
Comments follow posted by various persons, which IS NOT legal advice, but mere general information to be verified by a professional:
1. A Google search leads me to think he is referring to a public shell corporation involved in a reverse merger. Here's one explanation: http://www.venturea.com/shell.htm
2. A reverse shell merger is a shady way for a corporation to go public on a national stock exchange. Basically, someone sets up a shell corporation (no assets/operations) and registers it with the NYSE/NASDAQ/OTCBB etc.
Then after it has built up some history as a seemingly legitimate registered corporation, the owner starts to market it as a reverse shell available for sale. A company comes along who wants to get listed on a national stock exchange but without all the hassles of actually applying for registration with the SEC and regulatory bodies.
So the company meets the reverse shell owner, they work out a merger whereby the company is merged into the shell and company stock is exchanged for shell company stock. In the end, the company stockholders and the shell company owner become joint stockholders in the merged entity.
The ratio of shares is driven by the value of the merged company relative to the price which the shell owner is charging for his shell.
Usually, companies which become listed via reverse shell merger are tainted by the shadiness of the process, although some of them have gone on to become successful, well-known companies. Most companies opt to go public via the usual, more orthodox route of registering directly.
3. While the view above is correct for some reverse mergers, as he notes, it is not true for all.
The problem is not the process itself, and there is nothing shady about the process, it is a perfectly acceptable process, permitted by all securities regulations.
What is "shady" is some of the players who are in the space.
I usually urge my clients who want to do a reverse merger into a shell not to do so, but it can work. In some instances we have spent more time doing due diligence on proposed merger partners than we would have spent taking the company public from scratch!
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Tax Risk - The tax and other implications of forming a parent company
I have clients who own several corporations and an LLC. They want to form a parent corporation of all their other companies. How does one reverse the existing companies into the new parent company?
Would the clients assign their stock holdings to the parent corporation, so that the newly created parent corporation owns all the stock or do the individuals have to sell their shares to the parent company?
If they have to sell the stock to the new corporation, does it have to be at fair market value or can it be a nominal amount?
Are there any tax implications?
Comments follow posted by various persons, which IS NOT legal advice, but mere general information to be verified by a professional:
1. First, get a written tax opinion on all the tax aspects of such transaction.
Generally, you can contribute property to a corporation on a tax-free basis if you meet certain hurdles. IRS §351 is the provision for corporations.
A Subchapter S corporation in the mix may complicate things. One issue as to selling stock v. Making contributions is whether you want to avoid a gain or recognize a loss.
I would defer to the CPA as to issues regarding consolidated tax returns and consolidated financial statements and related party transactions for tax purposes.
Other considerations would be whether they should roll these entities up into one corporation or LLC. The reduction in accounting and tax preparation fees and franchise taxes may be substantial.
2. The clients can contribute their stock in the existing corporations (and their membership in the LLC if that is to be included) to the new corp in exchange for the new corp issuing to them stock of the new corp. The new corporation will be the parent by virtue of now owning all the stock of the existing corps (and membership interests if the LLC is included). To transfer the stock in the existing corporations, all they need to do is endorse the certificates over to the new corp and deliver them.
The exchange would normally be tax free under IRC §351, but there is an exception to tax-free treatment in the case of forming an "investment company." The definition of "investment company" used to be limited to holding readily marketable securities, but because of congress's concern about Wall Street exploiting "loopholes" by creating swap funds, the definition was changed to include any stock. Therefore, someone will have to study §351(e) and any regulations carefully to determine whether the exchange will be a taxable event.
If any of the existing corps are S corps, they may lose their S corp status by being owned by a corporation. An S corp can elect to treat a wholly owned subsidiary as part of the S corporation for tax purposes, but then the transaction is probably treated as a taxable liquidation of the subsidiary.
3. The first question for the client is, "Why? What are you trying to accomplish?" Depending on the answer, it may or may not be a worthwhile idea. Unless there are specific advantages (e.g., must have business A operating in state X in separate domestic entity to qualify for state contracts or whatever), I don't think there's generally any compelling reason for this kind of reorganization to be done for privately-owned businesses). If they're looking to consolidate the value of different enterprises into one entity to attract outside investors or in anticipation of going public, it could make sense, but only in the context of realistic plans and expectations of being able to go in such a direction.
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Foreigners coming in to form parent/subsidiary companies:
Tuesday, April 29, 2008
House of Representatives passes bill to end private collectors collecting taxes for the IRS
Similar legislation was passed by the House last year but the Senate did not act.
Monday, April 28, 2008
Justice Scalia's 60 minute interview and an extract from his new book - Making your case
"Scalia has said that "the Constitution is an enduring document but not a 'living'
one, and "its meaning must be protected and not repeatedly altered to suit the whims
of society." Scalia states that an originalist or a textualist takes meaning
from the Constitution "from its text, and that meaning does not change." The
text itself should be augmented only by examining what the Framers of the
Constitution intended at the time, not by what a majority in society today might
prefer. Scalia believes that his approach is the only way we can preserve the
Constitution's guiding principles. Judges who do not adopt an originalist or
"textualist" approach, according to Scalia, have no judicial philosophy and issue
rulings based on the majority view of society at the time. He believes that the
answer for advocates of controversial issues is to gather enough support from the
public and pass laws, rather than to have the Supreme Court Justices continually
revise their views of the Constitution in order to satisfy society." (from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=463664)
Follow the following links:
For an extract of the book :
For the interview:
Scalia Part 1
Scalia Part 2
Saturday, April 26, 2008
Why Corporate Taxpayers are more like Ostriches than Tigers?
I have spent the last few year presenting workshops to multinational corporations on Tax Risk Management.
In the process, as usual, I have met some interesting individuals and corporations. All, I might add, with similar problems.
The one question asked of me, which came up each time I presented, was: Why would you go back in time, scratch up old problems, and then determine the finite details of the risk exposure, and then approach the IRS to disclose. In addition, by pulling all the records and compiling a collection of the facts is surely dangerous, as any IRS official could then request that you submit that information to them, which would then make their task easier in unravelling the historical issues?
Thinking on my feet often takes me to the crisp and proper answer. This time it was no different. Firstly, the entire exercise must take place under the guidance of a “qualified attorney” to ensure the immediate presence of the attorney and client privilege. This will ensure that no IRS official can lay his or her hands on the information. The brief to the “qualified attorney” must be to review all the past historical facts pertaining to the risk area, to extract those facts that are relevant and then to determine the following, in the following order:
1. has the corporation done anything unlawful in terms of the tax legislation? In which case the appropriate “soft approach” must be made to SARS to mitigate any penalties.
2. if not, in preparation for any possible approach from SARS in the future, prepare witness statements, prepare the evidence, and obtain opinions on the core issues of the tax risk area in preparation for any SARS approach. This will include a determination whether or not proper disclosure was made in the year of assessment, or in response to any subsequent enquiry from the IRS. That’s all!
Would there be any merit in approaching IRS in the second scenario? The purpose could be to negotiate a settlement on the basis that if $100 was potentially due, without going through the courts to determine the principles, and because the taxpayer has decided to “self-disclosure” in the interests of good corporate governance and certainty, the IRS may agree to accept R10.
In my view, the IRS as the collection agency for the Federal government of taxes, could not logically justify settling a taxpayer’s risk at R10, in my example, simply because the taxpayer has been forthright. The IRS must collect what is due. Either they take the view that the tax is due or not. If it is due, they are duty bound to collect it. When is it appropriate and inappropriate for the IRS to settle?
Inappropriate to settle:
1. Intentional tax evasion or fraud.
2. Contrary to law or practice, without exceptional circumstances.
3. In the public interest to have judicial clarification and this case is appropriate.
4. Pursuit of the matter will ensure tax law compliance.
5. The Commissioner is of the opinion that the non-compliance is of a serious nature.
Appropriate to settle:
1.In the interests of good management of the tax system and overall fairness, and the best use of the Commissioner's resources, especially where the law is uncertain.
2.Cost of litigation in comparison to the possible benefits (prospects and success, prospects of collection, costs associated with collection).
3.Problematic due to complex factual, quantum issues or evidentiary difficulties.
4.A group of participants in a tax avoidance arrangement that is being unwound.
5.Settlement will promote compliance in a cost-effective way.
The guidelines are clear. If the taxpayer is able to clearly bring its case within the “appropriate” guidelines, the $10 settlement route may work. If not, the evidence with opinions may best be shelved in preparation for that rainy day. Beyond all this, the value of the Tax Risk Management strategy will help the management of the corporation to understand tax holisticly, and avoid the severe implications for the business in the future.
The end to the ostrich mentality, and the re-emergence of the Tiger.
Friday, April 25, 2008
Wesley Snipes Gets 3 years for Tax Evasion - What is the relevance to Tax Risk Management
Wesley Snipes' position is typical of a targeted high profile taxpayer who did not pay proper attention to basic tax risk management strategies. These include:
1. proactively reviewing particularly any aggressive or alternate position taken on the payment or non payment of tax based on a specific set of facts;
2. strategizing around what may happen if the IRS pursues a transaction and what defenses could be raised - which would obviously have been the case with a high profile person like Wesley Snipes - including obtaining legal opinions to support the position taken after careful consideration of all the facts;
3. ensuring effective communication between the different advisors and the taxpayer to make sure all facts and changing facts are considered and reconsidered to ensure the taxpayer is not breaking the law.
A strategy may have included obtaining an injunction against the IRS in compelling the taxpayer to submit tax returns in the first place (although difficult to execute), and in that way bringing the dispute to the court sooner than later, so that it does not appear as if the taxpayer is taking the law into his own hands, like many of the tax protestors appear to do. The civil outcome may have been no different, but Mr Snipes may have escaped the criminal penalty imposed on him.
The lesson here is acting on aggressive advice or direction without building the proper team around you, and managing the risks going forward carefully, will cause much more exposure than in the case of dealing with these issues proactively.
Taxpayers, particularly businesses and public company taxpayers, must look at the annual IRS Databook to see what trends are developing. Criminal prosecutions and penalties are on the rise - by 10% on 2006 figures, and more corporate taxpayers are being audited, although the overall percentage is still around 1% of corporate taxpayers. Then there is the additional statistic that if you are a Nevada corporation there is a 150% greater chance of being audited.
All these factors should be considered in any tax risk management strategy, a never ending process.
Some more interesting statistics from the IRS Data Book 2007:
4211 taxpayers were criminally investigated;
2155 were convicted;
2123 were incarcerated - 81.2% a high percentage.
These numbers are close to 10% up from the previous years statistics showing that criminal prosecutions for tax related crimes are increasing.
But then 4211 criminal investigations, out of 189 million tax returns filed where only 0.9% of those tax returns were subjected to an audit, is statistically a low figure (0.002% or 22 in a million).
Are CPA's responsible for tax risk failures? The tax risk environment is changing rapidly...
Misrepresentation or deceit?
An action for misrepresentation or deceit requires the following elements:
1.Misrepresentation of a material fact by the defendant;
2.Knowledge by the defendant of the falsity;
3.The defendant’s intent to induce reliance on that false statement;
4.Reliance by the innocent party; and
5.Damages to the innocent party.
In order for the plaintiffs to recover under an action of deceit, the plaintiff must prove that the defendant made a misrepresentation of a material fact. Any misrepresentation involving an opinion may constitute a misrepresentation of an existing fact, namely, the speaker's state of mind. And the evidence (whether direct or circumstantial) must be sufficient to show that the defendant, at the time the contract was entered into, deceived the plaintiff.
Fraud by silence can also take place in a situation where there is a fiduciary relationship between the plaintiff and the defendant. A classic fiduciary relationship exists between CPAs and their client’s, who rely on their CPAs to review their tax positions and to give them advice on those tax positions. Which client doesn’t think that with the annual audit their tax position has been reviewed as well? So often advisors do not tell their clients that a specific tax position review in a detailed manner is not part of the usual audit brief? Clients often do not know this!
If a CPA advisor realizes that their clients may be exposed to historical tax issues in their businesses that have not been previously exposed, which tax issues can be uncovered and properly dealt with in a tax risk tax risk management process the question arises whether there is misrepresentation or deceit by silence on the part of that CPA? At the very least, has there not been negligence? A duty to speak exists where there is a special relationship between the plaintiff (the taxpayer) and the defendant (the CPA or tax advisor).
Even where there is no special relationship between the plaintiff and defendant, in many cases where defects are known to the defendant, or should reasonably be known to the defendant, when a relationship is entered into between the defendant and the plaintiff, the defendant may be duty bound to make the appropriate disclosures to the plaintiff, and if not this failure may amount to a fraud. So often this is the situation with a CPA and a taxpayer client. In an audit the CPA should have brought the inherent tax risk situation that exists in most businesses to the attention of the client, so that a comprehensive tax risk management process can be followed, and it is not.
Of course, in order to be actionable, the deceit must have been material to the transaction between the defendant and the plaintiff. A reasonable person would have attached importance to the statement, or lack of statement, made by the CPA in determining their choice of action going into the future – to conduct a comprehensive tax risk management process or not.
From the defendant's point of view, the defendant must have made the false statement knowingly, or with reckless disregard as to whether it was true or false. This becomes a fairly tricky area. Except, now that CPAs are aware of the fact that there is a tax management process that can be embarked to help taxpayer clients in determining whether or not there are historical tax issues in their organization, a defense that they did not do anything knowingly, wears thin.
From the plaintiff's perspective it would be relatively straightforward to show that they had relied upon the defendant’s f false statements to their detriment. These false statements, obviously, are those made by the CPA that the client’s tax affairs are in order, when a tax risk management process has not been properly embarked upon in order to determine whether or not this is the case.
The plaintiff in an action for deceit may recover damages. In this instance the damages would be any out-of-pocket damages and benefit-of-the-bargain damages. Benefit-of-the-bargain damages includes cost of correction damages where the defendant is required to pay the plaintiff the cost of remedying the defect, together with such incidental losses.
This means that if the taxpayer client faces an IRS audit and is expected to pay an additional penalties and interest, over and above the amount of tax that should have been paid, the defendant CPA may find himself in a position where he must pay these penalties and interest charges.
Thursday, April 24, 2008
Tax Risk Management, the legal team and the tax team – their interaction
Tax Risk Management, the legal team and the tax team – their interaction. The reason why the legal department and the tax department would sometimes have different interpretations when it comes to a particular transaction is driven not so much by differences in the interpretation of the law, but in differences in the interpretation of the facts.
What that means is the tax department would sometimes be approached with a transaction and would be asked to participate in the initial planning phase of the transaction in order to give direction and guidance as to what the tax implications are going to be and ultimately what the tax result will be on conclusion of the transaction and that is done at the planning phase.
What will typically happen is the legal department, the transaction team, and the tax department will participate in the original discussions surrounding what the transaction will ultimately look like. At that point an external tax opinion, as well as other opinions, may then be obtained from tax and other specialists that have advice on aspects of the transaction. Once the parties are comfortable with what the transaction is going to look like, the next phase is to approach the commercial lawyers, either internally or externally, who will then commence drafting the lengthy documentation to record the transaction about to be entered into and concluded.
At this particular point commercial draftsmen are skilled in a broader area of law than just tax and they may in the process of drafting decide that there are issues of bankruptcy law or other legal issues that need to be more carefully addressed as the drafting process commences. The draftsmen will then inevitably involve specialists in the area of bankruptcy or banking law or whatever the particular area of concern is.
As a result they will then introduce sections to the agreements to cover the concerns, legal concerns, that they have.
Now the documents are then completed in their draft form and normally the transactor and the legal department of the firm in question or the organization in question will review those documents and ultimately conclude that they reflect what the transaction is supposed to achieve and the documents are then prepared for final dispersal or final round-robin between the different parties and inevitably the final conclusion signing process takes place and the documents are signed off.
What often does not happen is prior to signing off the documents, in concluding the transaction, where there have been these additional additions introduced into the documents, the tax department is in many instances not asked to comment again or to review the documents at that particular point in time, and more importantly having done that the external tax specialist council has also not been asked to review the documentation and to determine whether or not the transaction as it has now been recorded actually still reflects the position advised upon in the first place.
So that being the case often a tax problem enters the picture, because these amendments that were introduced to take care of other areas of law may, in fact, have a particular impact on the tax consequences that were given an opinion on when the transaction was being planned. Now that is where the problems arise between the legal departments and in the tax departments, because the tax department will then only become aware of this difference once the transaction has been concluded and it is virtually then too late to do anything about it except to go back and to rectify the agreements, which often does not take place because the mistake or the difference is only picked up some years down the line once the transaction has already run part of its course.
Then it becomes very difficult to go back and change it. So this becomes a risk area that is often not picked up and not uncovered until it is virtually too late and the problem with this potential risk, tax risk, area is that the reason why the legal department and the tax department and the organization would have obtained a tax opinion on the structure of the transaction would play a very important roll down the line in explaining to the IRS if the transaction is challenged by the IRS that this particular transaction has been the subject of careful scrutiny by specialists, who have given the green light for this particular transaction. Now if there has been amendments to what the original proposal looked like to what the final concluded agreements looked like, then the ability to rely on that opinion becomes watered down significantly and the IRS is going to try and impose negligence penalties against the organization and not allow it to rely on the opinion that was drafted in the first place.
The way in which you would resolve this particular conflict between the legal teams and the tax teams, both internally and where they are external participants, is to ensure that at the time that the documentation for a transaction has been completed, but before the signing of the documentation, that that documentation together with the original tax opinion is redistributed to the parties who participated in the initial advice being given and that they are asked to comment and express their views whether or not the final drafted documentation in any way deviates from the original opinion and advice given on the tax consequences.
The necessity for the transaction teams, the legal teams and the tax teams to communicate with each other on an ongoing basis during the different phases of a transaction such as a merger or acquisition will ensure that the information that needs to be commented on by each of those parties to ensure that the original tax plan that was proposed is at the end of the day executed, is the result of that communication.
So the communication between those parties through ongoing committee meetings forces the parties to share the information with each other and ultimately to ensure that the uncovered tax risk, which often emanates from these transactions by lack of this communication is taken care of.
Quite separately from the risks associated with the planning and final implementation of transactions another dilemma often faces the transaction parties, the legal teams and the tax teams participating in these transactions and that is whether or not the transaction must follow the spirit of the law or the letter of the law as it has been legislated by Congress. This is a moral dilemma which really is something that can only be determined at board level and by the attitude of the board as to whether or not they are going to be an organization that will attempt to follow the spirit of the law or the letter of the law.
Following the spirit of the law means that you would go beyond applying the normal rules of interpretation and that you would actually try and understand what mischief the legislation is attempting to cure as opposed to the manner in which it has been conveyed. Now it is often the case that with tax legislation the sections are so convoluted and so complex that it creates huge uncertainty between the various parties that participate in these transactions and therein often lies a defense to an organization that has taken a particular route of interpretation backed up by a very thorough opinion where the advisers have been given all the facts of the transactions.
If all the facts of the transactions have been carefully considered and a plausible interpretation is given in an area of tax law that is uncertain it's going to be highly unlikely that the IRS will succeed in imposing any form of negligence penalties against the organization. And therein lies the solution that organizations may not be in any way morally obliged to follow a spirit of the law interpretation but a more technical nature of the law interpretation providing it is backed up by probably considered opinions that take into account the responsibilities and duties placed on the tax advisers by Circular 230 issued by the Department of Treasury.
What this results in is that the corporation can then turn around to any critique and say that they have done what is reasonably prudent by any organization in making sure that they have obtained proper advice before embarking upon a transaction where the tax law position is uncertain.
Insofar as the responsibilities of the legal departments and the tax departments go towards board members and more specifically the executive board members such as the CEO and CFO. Legislation such as Sarbanes-Oxley and more particular the SOX 404 places the CEO and the CFO in a position where once they have signed off the financial statements and those financial statements have not been properly checked in accordance with the standards put forward by Sarbanes-Oxley and had not been properly audited in order to determine whether there are any material weaknesses, those individuals can face very lengthy prison sentences and it is here that the legal departments and the tax departments play a very very important role in ensuring that each transaction and each potential uncertain and contentious tax issue has been properly researched, probably considered and finally properly implemented along the lines of what is suggested in this article.
What is going to happen in the future depends, and one can seek guidance, from what Congress has discussed in the recent past. There is a growing concern that the tax gap in the United States of America is much too high for nothing to be done. At this particular point in time the IRS are reporting that 86% of the taxes that should be collected are in fact being collected and that there is a shortfall of 14%.
The estimated value of that 14% is in the region of $350 billion, which is a significant sum of money, and if you consider that corporate America contributes approximately, on average, 16% of the total taxes collected, that means corporate America could be in for an additional $56 billion in missing revenues. If you take that number and you then also look at the data book report published by the IRS every year, the last one being in 2007, approximately $18.5 billion was in dispute between the IRS and corporate America on field audits that took place.
So all things considered equal the amount that is missing in the coffers of the IRS and the Department of Treasury and in the Federal Government is a significant sum and that means that there are going to be increasing numbers of steps taken by the IRS to try to close that tax gap. The obvious negative sides are that there will be an increase in prosecutions, there will be an increase penalties and we are already seeing that penalties and prosecutions year on year are increasing by the rate of approximately 10% every year.
But let's look at the positive side and on the positive side Congress is suggesting cooperation between the IRS, different organizations and, of course, including corporate America. Herein lies the opportunity for corporates, particularly where there is an increased amount of transparency taking place by way of SOX404 and FIN 48 that they attempt to resolve any tax issues with the IRS long before they become the question of an audit or they become a deficiency that is picked up after the tax return has been filed with the IRS.
And this particular trend is also being followed by countries who are member states of the OECD of which the United States is the largest member. So there is an overall opportunity for increased cooperation to take place between corporate taxpayers and the IRS so that the IRS can focus its attention on those corporations that are known not to be compliance and that are very aggressive in the manner in which they execute tax planning.
Insofar as a Sarbanes-Oxley 2 or a reworking of Sarbanes-Oxley goes it is quite possible that in light of extensive criticisms being brought to bear on Sarbanes-Oxley and that it is too onerous, that it may be very specific amendments introduced to make it more palatable. Certainly from the point of view that it causes corporations to be more transparent from a tax point of view, I don't foresee that there will be any downscaling of this and if anything, international trends and accounting standard trends are following suit by ensuring that tax liabilities, even though they may be unrealized, must be quantified and in some form expressed in the financial statements of public companies and also to a larger extent as time goes by in private companies that are subject to reports.
Wednesday, April 23, 2008
On a lighter side of tax: But serious nevertheless! - It was a rainy day
The system had come a long way. The Commissioner of Taxes opened the program. The balance outstanding was 14 bn short. It was the 15th of the month. 15 more days to go and the numbers would be in. Judgment out. And the press would comment. Like they always do. The angst gripped his stomach. He had to meet the target. He did not fail, and not this time, on the eve of much political jubilation about to take place. The system delivered the truth-plain and simple. 1 bn per day. That was a lot. The rainy day had arrived. What was in store. He thought – quickly, decisively. He pressed the buzzer to call his P.A. She immediately came in … marched in … note pad at the ready.
“Please convene a meeting in an hour with my executive committee. The heads of collections, inspections and additional assessments must come armed with ‘to the minute’ report backs … Thank-you.”An hour later.
“Gentlemen. Ladies… We are 14 bn off our budgeted collection. I … we, are not going to fail. We have 15 days left. That is 1 bn per day. What do you have in store for me?”
Collections started. They had pulled all steps out. All additional assessments exceeding 1 m had been contacted, threatened and in some instances executed through bank account and creditor account attachments. Resistance was forthcoming from about 8% of their collections total involving some die-hard corporates’ who had all put forward convincing submissions that the additional assessments were incorrect, in fact or in law. And that the Commissioner was obliged (despite his discretion) to suspend payment, pending resolution of the dispute. The amount affected exceeded 20 bn.
“Are non of these taxpayers prepared to settle for smaller sums?”
The head of collections looked blank. It wasn’t her responsibility. She glanced at the head of additional assessments.
“Well .. huh … Mr Commissioner, the list is made up of predominantly major corporates. We have drummed up assessments, made up alleged outstanding taxes (the capital portion) 200% penalties in all cases, with on average an additional 40% interest over the average 5 year revised assessment period. Between these parties, we have an average 1 bn additional assessment per taxpayer. All have put forward submissions that penalties and interest should be remitted as there has been no intention to evade or avoid tax. In all cases they say that the reason for the revised assessments is interpretation of the law differences between them and us. A large portion of capital relates to the deductions claimed for writing off intellectual property. As you know the Department of Finance commissioned a report from an independent professional association to research and give guidance on the tax deductibility of this intellectual property. The report says that our legal interpretation to date is wrong. If we are to insist on our legal interpretation, they have guided us to how to amend the legislation. The report, of course, is confidential.”
“Mmm … what do you recommend …”
Passing the envelope …
“I believe that if we attach a weighting to the correctness of our legal interpretation, 100 being the strongest and .0 being the weakest, I believe we sit at about 20, in light of the commissioned report … of the 20 bn, we should attempt to collect 4 bn …”
“Fine … please get the department heads to approach the taxpayers concerned … Investigations, what have you got …”
The head of legal reflected on the discussion that had just taken place. How clever their leader had been. 5 years ago there was nothing in the law books that entitled the Commissioner to even contemplate negotiated settlements. The specialized investigation units with their aggressive approach to closing the tax gap that had developed over the years, had created the depth of potential taxes to collect … the strategic planning done 5 years earlier had paid dividends. 15 days before the financial year-end – it was a rainy day!
Tuesday, April 22, 2008
US Treasury Comprehensive Report on reducing the Tax Gap
Executive Summary In fiscal year 2005, Federal receipts totaled over $2.2 trillion. More than 95 percent of net receipts were collected by the Internal Revenue Service (IRS) through its administration of the income, transfer and excise tax provisions of the Internal Revenue Code. The vast majority of these receipts is collected through our voluntary compliance system, under which taxpayers report and pay their taxes with no direct enforcement and minimal interaction with the government. The overall compliance rate achieved under this system is quite high.
In 2001, the compliance rate was over 86 percent, after including late payments and recoveries from IRS enforcement activities. Nevertheless, an unacceptably large amount of the tax that should be paid every year is not, requiring compliant taxpayers to make up for the shortfall and giving rise to the “tax gap.” The Administration is committed to working with Congress to reduce the tax gap.
This document outlines the Administration’s aggressive strategy for addressing the tax gap. The strategy builds upon the current efforts of the Treasury Department and the IRS to improve compliance. As part of the deliberations in preparing the Administration’s fiscal year 2008 budget request to Congress, the Treasury Department and the IRS are working with the Office of Management and Budget to further develop this strategy to reduce the tax gap.
This document is intended to provide a broad base on which to build. The more detailed elements of the tax gap strategy are, in part, contingent upon the budget process for fiscal year 2008 and beyond. Accordingly, the Treasury Department and the IRS will provide a more detailed outline of steps they will take to address the tax gap following release of the Administration’s fiscal year 2008 budget request early next year. Four key principles guided the development of this strategy:
• First, unintentional taxpayer errors and intentional taxpayer evasion should both be addressed.
• Second, sources of noncompliance should be targeted with specificity.
• Third, enforcement activities should be combined with a commitment to taxpayer service.
• Fourth, policy positions and compliance proposals should be sensitive to taxpayer rights and maintain an appropriate balance between enforcement activity and imposition of taxpayer burden.
These principles point to the need for a comprehensive, integrated, multi-year strategy to reduce the tax gap.
Our practical and effective overall strategy includes the following seven components:
1. Reduce Opportunities for Evasion. The Administration’s fiscal year 2007 budget includes five legislative proposals to reduce evasion opportunities and improve the efficiency of the IRS. The Treasury Department’s Office of Tax Policy is working with the IRS to develop additional legislative proposals for consideration as part of the fiscal year 2008 budget process. The Treasury Department and the IRS will also continue to use the regulatory guidance process to address both procedural and substantive issues to improve compliance and reduce the tax gap.
2. Make a Multi-Year Commitment to Research. Research is essential to identify sources of noncompliance so that IRS resources can be properly targeted. Regularly updating compliance research ensures that the IRS is aware of vulnerabilities as they emerge. New research is needed on the relationship between taxpayer burden and compliance and the impact of customer service on voluntary compliance. Research is also essential to establish accurate benchmarks and to measure the effectiveness of IRS efforts, including the effectiveness of this comprehensive strategy to reduce the tax gap.
3. Continue Improvements in Information Technology. Continued improvements to technology would provide the IRS with better tools to improve compliance through early detection, better case selection, and better case management.
4. Improve Compliance Activities. By improving document matching, examination, and collection activities, the IRS would be better able to prevent, detect, and remedy noncompliance. These activities would increase compliance not only among those directly contacted by the IRS, but also among those who would be deterred from noncompliant behavior as a consequence of a more visible IRS enforcement presence.
The IRS continues to reengineer examination and collection procedures and invest in technology, resulting in efficiency gains and better targeting of examination efforts. These efficiency gains translate into higher audit yields, expanded examination coverage, and reduced burden on compliant taxpayers.
5. Enhance Taxpayer Service. Service is especially important to help taxpayers avoid unintentional errors. Given the increasing complexity of the tax code, providing taxpayers with assistance and clear and accurate information before they file their tax returns reduces unnecessary contacts afterwards, allowing the IRS to focus enforcement resources on taxpayers who intentionally evade their tax obligations. The statutorily mandated Taxpayer Assistance Blueprint, the next phase of which is expected to be delivered in January, will include a process for assessing the needs and preferences of taxpayers and will develop a decision model to prioritize service initiatives and funding. The IRS is also working to provide service more efficiently and effectively through new and existing tools, such as the IRS web site.
6. Reform and Simplify the Tax Law. Simplifying the tax law would reduce unintentional errors caused by a lack of understanding. Simplification would also reduce the opportunities for intentional evasion and make it easier for the IRS to administer the tax laws.
For example, the Administration’s fiscal year 2007 budget includes six proposals to simplify the tax treatment of savings and families by consolidating existing programs and clarifying eligibility requirements.
The Office of Tax Policy is developing other simplification proposals for consideration in the Administration’s fiscal year 2008 budget request. In addition, the Treasury Department is evaluating the report of the President’s Advisory Panel on Federal Tax Reform and is considering options for reform. These initiatives will continue to be supplemented by IRS efforts to reduce taxpayer burden by simplifying forms and procedures.
Use the regulatory guidance process to address both procedural and substantive issues to improve compliance and reduce the tax gap.
7. Coordinate with Partners and Stakeholders. Closer coordination is needed between the IRS and state and foreign governments to share information and compliance strategies. Closer coordination is also needed with practitioner organizations, including bar and accounting associations, to maintain and improve mechanisms to ensure that advisors provide appropriate tax advice.
Through contacts with practitioner organizations, the Treasury Department and the IRS learn about recent developments in tax practice and hear directly from practitioners about taxpayer concerns and potentially abusive practices. Similarly, contacts with taxpayers and their representatives, including small business representatives and low-income taxpayer advocates, provide the Treasury Department and the IRS with needed insight on ways to protect taxpayer rights and minimize the potential burdens of compliance strategies.
The success of this comprehensive strategy will depend, in significant part, on IRS resources and the agency’s efficient and effective use of such resources. The IRS has made significant progress toward improving the efficient use of its allocated resources, especially in targeting enforcement efforts to areas where they will have the greatest direct and indirect impact on compliance. The IRS will continue to seek ways to make its operations more efficient and thus free resources to fund new compliance initiatives. In implementing this strategy, the Treasury Department and the IRS recognize that it will be important to establish benchmarks against which progress on each element of the strategy can be measured.
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The Tax Gap problem solution proposed by US Treasury includes co-operation
Executive Summary Extract 7. Coordinate with Partners and Stakeholders. Closer coordination is needed between the IRS and state and foreign governments to share information and compliance strategies. Closer coordination is also needed with practitioner organizations, including bar and accounting associations, to maintain and improve mechanisms to ensure that advisors provide appropriate tax advice. Through contacts with practitioner organizations, the Treasury Department and the IRS learn about recent developments in tax practice and hear directly from practitioners about taxpayer concerns and potentially abusive practices. Similarly, contacts with taxpayers and their representatives, including small business representatives and low-income taxpayer advocates, provide the Treasury Department and the IRS with needed insight on ways to protect taxpayer rights and minimize the potential burdens of compliance strategies.