October 05,2000

Roth, Moynihan Request Comments on Revised Tax Shelter Discussion Draft

WASHINGTON -- Senate Finance Committee Chairman William V. Roth, Jr. (R-DE) and Ranking Member Daniel Patrick Moynihan (D-NY) today released a revised bipartisan staff proposal on tax shelters.

"Today, Sen. Moynihan and I are releasing a revised staff proposal to address the growing problem of tax shelters. On May 24, 2000, the Senate Finance Committee released a bipartisan draft proposal regarding this issue. During the four months following the release of that proposal, the Committee received sixteen submissions containing extensive commentary. During this period, the Committee has carefully evaluated the issues raised in the submissions and the concerns expressed by taxpayers.

"The submissions contain many thoughtful comments from the business community, professional organizations, and members of Congress on how to stem the use of tax shelters. It is clear from the submissions that tax shelters present significant and complex issues for legislation and enforcement. Clearly, tax shelters should be curtailed without affecting legitimate business transactions. We have directed the staff to revise the original draft proposal with that point in mind, and welcome your comments on the revised staff proposal.

"We welcome comments on today's draft. Please direct your comments to Mr. Frank Polk, Majority Staff Director, and Dr. David Podoff, Minority Staff Director, of the Senate Finance Committee, 219 Dirksen Senate Office Building, Washington, DC 20510."

Attached is a technical background memo on this issue. Copies of the revised draft proposal will be available in 219 Dirksen and on the Finance Committee website.

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Press Briefing Memo
Revised Tax Shelter Staff Discussion Draft
October 5, 2000

On May 24, 2000, the Senate Finance Committee released a bipartisan legislative proposal designed to curb the growing problem of corporate tax shelters. The proposal created a new penalty structure for large corporations engaged in tax shelter arrangements and set forth a new definition of a corporate tax shelter that was based on a series of "indicators" deemed characteristic of a tax shelter arrangement. The legislative proposal imposed a 40% penalty on corporate tax shelter understatements. This penalty could be reduced or eliminated depending upon whether (i) there was a material non-tax business purposes for the transaction; (ii) certain disclosure requirements were met; and (iii) the taxpayer had a reasonable belief that its tax treatment either "will," "should," or would "more likely than not" prevail. The proposal imposed penalties on parties that promote, organize or otherwise participate in corporate tax shelters. The proposal also contained provisions regarding opinions rendered by tax advisors who have an underlying financial interest in the tax shelter arrangement.

The Committee requested comments regarding the draft legislative proposal. During the four months following the release of the proposal, the Committee received sixteen submissions. During this period, the Committee has carefully evaluated the issues raised in the submissions and the concerns expressed by taxpayers.

Nearly all of the submissions stated that the definition of a corporate tax shelter arrangement was overly broad and would subject legitimate business transactions to the tax shelter penalty and disclosure provisions. Similarly, commentators were concerned that the shelter definition and the various reasonable belief standards created such ambiguity, that the proposal would be difficult to administer for both taxpayers and the IRS.

Concern was also expressed that the proposal was not appropriately coordinated with recently released Treasury regulations regarding the tax shelter disclosure, registration, and investor list requirements. Taxpayers and others also stated that, before further tax shelter legislation is initiated in areas covered by the regulations, additional time should be allowed to permit those regulations to take effect

Other commentators expressed confidence in the ability of the courts to redress the tax shelter issue, and cited several recent court rulings that overturned shelters lacking economic substance or a material non-tax business purpose. The Finance Committee agrees with this view.

Concern was expressed regarding the amount of the penalty, which was imposed at 40% of any corporate tax shelter understatement. Taxpayers asserted that a penalty should be proportionate to conduct, and that this penalty was too high when applied to dealings that, from a taxpayer's perspective, could be viewed as a legitimate business transactions. These taxpayers recommended retention of the current 20% penalty regime.

The submissions generally praised the proposal's efforts to ensure the ethical behavior of tax advisors and the independence of opinions rendered by them to taxpayers. Similarly, most submissions encouraged efforts to address the aiding and abetting of tax shelter transactions by promoters and organizers.

Finally, several commentators questioned why the proposed tax shelter legislation was limited to corporations. This issue was raised in reference to recent reports that tax shelter products are aggressively marketed to high net worth individuals.

Overview of Revised Draft

The revised bipartisan staff proposal reflects the Finance Committee's careful consideration of the extensive comments submitted by taxpayers and other interested parties during the past four months. As a result of this review, the revised staff proposal contains significant changes to address the tax shelter problem in a targeted manner that will not affect legitimate business transactions.

The revised proposal has rescinded the original proposal's definition of a corporate tax shelter. Instead, the current law definition of a tax shelter will continue to apply, with a minor clarification that agreements and transactions may be included in the definition.

The revised draft also creates a special class of highly abusive tax shelters - those that lack economic substance or a material non-tax business purpose, as determined under those established judicial doctrines, which have been successfully applied by the courts. This class, referred to as "abusive tax shelter devices," will be subject to a strict liability penalty of 40% on any understatement attributable to such a device. The reasonable cause exception would not apply to this penalty. Because of the onerous nature of any strict liability penalty, the revised proposal's language has been carefully drafted to avoid any possibility that a legitimate business transaction could be covered by this penalty. The Finance Committee views abusive tax shelters as an activity that must not be tolerated, and believes that a strict liability penalty is appropriate for this type of pernicious activity.

For taxpayers that engage in tax shelters that are not abusive tax shelter devices, the current tax shelter provisions will continue to apply, as well as the 20% penalty under section 6662. Under the revised proposal, however, a taxpayer may avoid the 20% penalty if:

A. There was substantial authority for the tax treatment of the shelter;

B. The taxpayer properly discloses the relevant facts affecting the tax treatment of the shelter in its tax return; and

C. The taxpayer reasonably believes it will more likely than not prevail on the merits of its tax treatment if challenged by the IRS (a greater than 50% likelihood).

These changes significantly simplify the requirements for avoiding the 20% penalty. In addition, the changes harmonize existing law by applying this single set of rules to corporations, individuals, and other taxpayers. Under current law, corporations and other taxpayers are subject to differing penalty rules. Under the revised proposal, all taxpayers would be subject to the same tax shelter rules, including the rules regarding abusive tax shelter devices.

Under the revised draft, a taxpayer may avoid the 20% penalty if they rely on the opinion of a tax advisor who is independent of the contested tax shelter transaction. A taxpayer may not avoid the penalty when the opinion is rendered by a tax advisor who has a financial interest in the transaction or otherwise has a conflict of interest or lack of independence. In addition, a tax opinion based on unreasonable facts, assumptions, or representations will be similarly disqualified, even if it is rendered by an otherwise qualifying tax advisor.

The purpose of these requirements is to reinforce the Finance Committee's view that tax advisors should be held to high ethical standards and should not place their personal interest above a taxpayer's interest during the opinion writing process. In this regard, the Committee would authorize Treasury to impose monetary sanctions against tax advisors and firms who participate in shelter activities and practice before the IRS. In addition, Treasury would be required to publish the names of individuals and firms who are involved in inappropriate tax shelter activities and notify the IRS Director of Practice and state licensing authorities of any such violations.

The Finance Committee agrees with the view that additional time should be allowed to permit Treasury regulations regarding the tax shelter disclosure, registration, and investor list requirements to take effect. Accordingly, the revised proposal has eliminated prior provisions that may have conflicted with the regulations. More importantly, the Committee has acted to enhance the effectiveness of those regulations by invoking penalties against tax shelter participants who refuse to file a tax shelter disclosure statement with their returns, as required by the regulations (and for which a penalty does not exist under current law).

The revised proposal further reinforces the regulations by increasing the penalty imposed on tax shelter promoters and organizers who refuse to maintain lists of their tax shelter investors, as required by the regulations. The draft would increase the penalty for a promoter's failure to maintain lists of corporate tax shelter participants from $50 to 50% of the promoter's fees for each violation. Like the original draft, the revised draft expands the current penalties for aiding and abetting the promotion of tax shelters by the increasing the penalty to 50% of the fees derived by the shelter promoter or advisor.

The draft proposal also provides taxpayer safeguards against an inappropriate shelter penalty assessment. It requires the IRS to establish a review process for evaluating tax shelter assessments before they are asserted by an examining agent.