May 10,2002

Grassley Works to Stop Abusive Tax Shelters, Corporate Flight

WASHINGTON – Sen. Chuck Grassley, ranking member of the Committee on Finance, is the lead co-sponsor of new legislation to rein in abusive tax shelters and the sponsor of a pending bill to prevent companies from moving overseas to avoid U.S. taxes.

“Average working Americans can’t pull up stakes and move to Bermuda or set up a fancytax shelter to avoid paying taxes,” Grassley said. “Companies that do this make a sucker out ofworking Americans and companies that stay in the United States and pay their fair share of taxes.”

Grassley and Sen. Max Baucus, chairman of the Committee on Finance, last night introducedthe Tax Shelter Transparency Act (S. 2498). For many years, tax shelter promoters and participantshave played a game of hide-and-seek with the Internal Revenue Service, burying their shelters inlayers of detail or simply sealing off detection through a web of conspiracy, Grassley said.Grassley said the new legislation will flush out tax shelters so the IRS can identify them andshut down illegal operations. The bill builds on a proposal from the Department of Treasury thatsets clear parameters on what transactions have to be disclosed. Grassley said mere disclosure doesnot mean that the transaction is a shelter – it simply means that it has the potential to be a tax shelter.

“We can only determine whether it’s a tax shelter by giving it a close review,” Grassley said.“A tax shelter is a little like pornography. You can’t define it, but you know it when you see it.Our bill will make sure the IRS gets to see it."

Grassley said the legislation is important because shelters and their promoters are hiding.The 2001 tax filing season produced only 272 tax shelter return disclosures from only 99 corporatetaxpayers, a fraction of transactions that should have been disclosed, Grassley said. Under the TaxShelter Transparency Act, a refusal to disclose a potential shelter will carry heavy consequences.The bill subjects shelter promoters and participants to large cash penalties, increased penaltyassessments, and for public companies, mandatory reporting of their shelter activities to theSecurities and Exchange Commission.

The tax shelters bill is the second major piece of legislation from Grassley and Baucus to reinin abusive tax practices. Grassley is the sponsor of the Reversing the Expatriation of ProfitsOffshore (REPO) Act (S. 2119), introduced on April 11. The bill, pending in the Finance Committee,would limit the ability of companies to relocate in name only to a low-tax country such as Bermuda.This week, shareholders of tool maker Stanley Works narrowly approved relocating the company’slegal residence to Bermuda, a move that will allow it to avoid some of its U.S. tax obligation.Today, company officials temporarily delayed the move after employees and state officialscomplained.

Grassley said several factors give Congress unprecedented political will to tackle corporatetax abuses: the publicity of a corrupt corporate culture at the Enron Corp.; disclosures that therecession and the war on terrorism helped companies move overseas to avoid U.S. taxes; andrevelations that large accounting firms and large law firms enable and promote abusive tax practices.“Company officials might say that our international tax rules are flawed,” Grassley said.“Sure, our tax system has problems. But the individuals and companies who cheat never try to getthe problems resolved. They just do their own thing to get out of paying their fair share. It’sobviously time to end abusive tax shelters, and this is the year to do it. We have more political willthan ever to get it done.”

Attachment: Description of the Tax Shelter Transparency Act (S. 2498)


MAY 10, 2002


Senate Finance Committee Chairman Max Baucus and Ranking Member Chuck Grassleyyesterday introduced legislation to help combat the proliferation of tax shelters. The Tax ShelterTransparency Act is a result of efforts which began over two years ago with the work of then-Chairman William V. Roth, Jr. (R-DE) and Ranking Member Daniel Patrick Moynihan (D-NY).At that time, the Secretary of the Treasury stated that tax shelters represented the most significantcompliance problem currently confronting our voluntary system of taxation. The Secretary said thattax shelters not only reduce the tax base, they breed disrespect for the system by participants andobservers, and waste valuable public and private sector resources.

When these comments were made, there was a more positive outlook regarding thegovernment’s ability to curb the promotion and use of abusive tax transactions. The TreasuryDepartment issued regulations requiring disclosure of certain transactions and requiring developersand promoters of tax-engineered transactions to maintain customer lists – and to make these listsavailable to the IRS. Also, the government had prevailed in several court cases against the use ofabusive tax transactions.

Even though it appeared some progress was being made, Chairman Baucus and RankingMember Grassley believed that additional legislation was needed to strengthen the government’sability to identify and address abusive tax avoidance practices. The uncertainty associated with thedisclosure regulations, coupled with the absence of meaningful sanctions, created an environmentfor noncompliance. Recent events have demonstrated that the Committee’s concerns werewell-founded. The corporate tax returns that were filed during the fall 2001 filing season were thefirst to be fully covered by the disclosure regulations. On March 21, Treasury and IRS officialstestified before the Finance Committee that only 272 transactions by 99 different taxpayers weredisclosed. Moreover, IRS’s recent disclosure initiative produced the following example: the IRSinquired of a promoter and received a list of 17 investors. All 17 of the investors should havedisclosed their participation to the IRS, but only 5 of the investors actually disclosed. The facts areindisputable: the small number of disclosures has made legislation more important now.

The Tax Shelter Transparency Act strengthens the disclosure regime and will alter taxpayers’cost-benefit analysis when they consider participating in such transactions. The bill is similar inapproach to the August Finance Committee staff draft and incorporates many of therecommendations proposed by Treasury in March. In fact, new legislation is designed specificallyto reinforce the Treasury Department’s existing and proposed administrative enforcement regime.The bill gives Treasury broad new authorities to define transactions for purposes of disclosure andauthorizes IRS to impose sanctions against those who participate in or promote abusive tax sheltertransactions.

Tax shelters generally are highly aggressive positions taken by taxpayers on their tax returnsto avoid or evade taxes. Under current law, there are specific sections of the tax code and severalpenalty provisions that attempt to curtail abuses and encourage compliance. Unfortunately, thesespecific sections have been enacted on an ad-hoc basis and are generally after-the-fact fixes whichconstantly keep the Treasury Department and the IRS years behind in their enforcement efforts.Furthermore, the penalty provisions do not encourage taxpayers to disclose questionable items ontheir tax return nor sufficiently deter them from entering into abusive tax shelters. In most cases,taxpayers have been able to get out from under the penalties either through negotiation or relianceon advisor opinions of dubious quality.

The players involved in abusive tax avoidance transactions include the taxpayer who buys,the promoter who markets, and the tax advisor who provides an opinion “endorsing” thetax-engineered arrangement. The legislation introduced today focuses on the role each plays andproposes to impose meaningful sanctions for engaging in conduct that continues to undermine theintegrity of our federal tax system.

The Tax Shelter Transparency Act emphas disclosure. Chairman Baucus and RankingMember Grassley believe that disclosure of questionable transactions to the IRS is critical to theGovernment’s ability to identify and address abusive tax avoidance and evasion arrangements. Ataxpayer that fails to disclose a transaction in the hopes of hiding in the weeds – hoping to avoiddetection by IRS – will be liable for significant sanctions, and in some cases, disclosure to theSecurities Exchange Commission (SEC).

The legislation will provide certainty to taxpayers and their tax advisors about registration,list maintenance and disclosure on tax returns. The legislation is intended to remove guesswork and,therefore, the ability of taxpayers and their advisors to manipulate or ignore the current system.Taxpayers and their advisors will know, with a large measure of certainty, what their obligations areunder the new regime. There will be no question about whether a particular transaction should beregistered or disclosed. To quote the Treasury Department, “If a promoter is comfortable withselling a transaction, a taxpayer is comfortable with entering into that transaction, and a taxpractitioner is comfortable with advising that the transaction is proper, then they all should becomfortable with the IRS knowing about and understanding the transaction.”

Under the bill, a transaction will be classified into one of three types of transactions forpurposes of disclosure and accuracy-related penalties: Listed Transactions, Reportable Transactions,and Other Transactions.


Listed Transactions

Listed Transactions are particularly egregious transactions that Treasury considers to beabusive tax shelters. Treasury publicly discloses these transactions so that taxpayers can readilydetermine whether any of their transactions are Listed Transactions.

Because Listed Transactions are publicly known, the Tax Shelter Transparency Act imposessignificant penalties for non-disclosure of Listed Transactions. Diagram 1 depicts the penalties thatare imposed on listed transactions. Failure by the taxpayer to disclose the transaction results in anautomatic flat dollar penalty of $200,000 for large taxpayers (i.e., any corporation, partnership, ortrust with gross receipts over $10 million and individuals with net worth over $2 million) and$100,000 for small taxpayers. Additionally, if the taxpayer is required to file with the SEC, thepenalty must be reported to the SEC. These penalties are based solely upon the failure to disclose,and do not depend upon the ultimate success of the taxpayer in challenging the merits of their ListedTransaction.

In addition, any underpayment that is attributable to a nondisclosed Listed Transaction willbe subject to a 30% strict liability, nonwaivable accuracy-related penalty which must be reported tothe SEC. On the other hand, if the taxpayer discloses the Listed Transaction, any tax underpaymentthat is attributable to the transaction will be subject to a 20% accuracy related penalty.

Reportable Transactions

Reportable Transactions are transactions that meet one of the objective criteria establishedby the Department of Treasury. Because the criteria are objective, an obligation to disclose thesetransactions should be readily discernable. Based on current regulations, and the proposals putforward by the Administration, we anticipate these transactions would include, but would not belimited to: significant loss transactions; transactions with brief asset holding periods; transactionsmarketed under conditions of confidentiality; transactions subject to indemnification agreements;and certain transactions with a certain amount of book-tax difference.

Diagram 2 sets forth the penalty regime for Reportable Transactions. Failure by the taxpayerto disclose a Reportable Transaction results in an automatic flat dollar penalty of $100,000 for largetaxpayers and $50,000 for small taxpayers. There is no SEC reporting requirement for a failure todisclose. These penalties are based solely upon the failure to disclose, and do not depend upon theultimate success of the taxpayer in challenging the merits of their Reportable Transaction.

Reportable Transactions are then subject to a filter to determine whether there is a significantpurpose of tax avoidance that would merit harsher treatment of the transaction. First, anyunderstatement attributable to a nondisclosed Reportable Transaction that has a significant purposeof tax avoidance is subject to a 25% strict liability, nonwaivable accuracy-related penalty which mustbe reported to the SEC. On the other hand, if a nondisclosed Reportable Transaction does not havea significant purpose of tax avoidance, any tax underpayment attributable to the transaction is subjectto a 20% accuracy related penalty, to the extent the underpayment exceeds a certain amount, unlessthe transaction has a more likely than not probability (greater than 50%) of being sustained on itsmerits.

Second, if the taxpayer discloses a Reportable Transaction that has a significant purpose oftax avoidance, the taxpayer is not subject to a higher accuracy-related penalty (current 20% applies),the transaction must have a more likely than not probability of being sustained on the merits ifchallenged by the IRS, and heightened penalty waiver exception requirements apply. If thetransaction does not have a significant purpose of tax avoidance, the taxpayer is still not subject toa higher accuracy-related penalty (current 20% applies), the transaction need only have a reasonablebasis if challenged by the IRS, and the current law penalty waiver exception requirements apply.

Other Transactions

Transactions that are neither a Listed nor a Reportable Transaction could nevertheless besubject to the accuracy-related penalty. These transactions do not fall within the previous two typesof transactions. The legislation makes three modifications to the current law accuracy-relatedpenalty requirements: elevate standards for reporting in order to provide meaningful incentives todisclose; conform standards for taxpayers and tax practitioners; and change the floor forunderstatements. Diagram 3 sets forth the operation of these modifications. If the taxpayer fails todisclose the transaction, the taxpayer must have a more likely than not belief that the transaction willbe sustained on its merits if challenged by the IRS. This standard is higher than "substantialauthority", the standard applicable to non-tax shelter transactions under present law. ChairmanBaucus and Senator Grassley think a taxpayer should not claim a position on a tax return that thetaxpayer does not believe is correct unless this fact is disclosed to the IRS. Also, the definition of"substantiality" for purposes of determining whether there is a substantial understatement is if theamount of the understatement exceeds the lesser of $10 million or 10 percent of the tax required tobe shown on the return for the taxable year.

Frivolous Filings

The legislation increases the penalty for filing a frivolous tax return to $5,000.

Reasonable Cause Waiver

A taxpayer may not avoid the penalty through reliance on an opinion that is rendered by atax advisor who has a financial interest in the transaction or otherwise has a conflict of interest orlack of independence. In addition, a tax opinion based on unreasonable facts, assumptions, orrepresentations will be similarly disqualified, even if it is rendered by an otherwise independent taxadvisor.

Advisors and Promoters

To enhance the ability of the IRS and the Treasury Department to obtain information aboutabusive transactions, the legislation expands the types of transactions that must be registered withthe IRS and does not limit the legislation to corporate transactions. The legislation also enhancesthe government’s ability to enjoin conduct related to tax shelters.

The legislation increases the penalty imposed on material advisors who refuse to maintainlists of their transaction participants, as required by the regulations. Material advisor means anyperson who provides any material aid, assistance, or advice with respect to organizing, promoting,selling, implementing or carrying out any Reportable Transaction. If a material advisor fails toprovide the IRS with a list of investors in a Reportable Transaction within 20 days after receipt ofa written request by the IRS to provide such a list, the promoter would be subject to a penalty of$10,000 for each additional day that the requested information is not provided. The penalty wouldbe imposed for each investor list that a promoter fails to maintain or delays in providing to the IRS.The IRS would have the discretion to extend the deadline or waive all or a portion of the penaltyupon a showing of reasonable cause.

Because of the important role of tax advisors in our voluntary system of compliance, thelegislation adds a provision affirming the authority of the Treasury Department to censure taxadvisors or impose monetary sanctions against tax advisors and firms that participate in tax shelteractivities and practice before the IRS.

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Chairman Baucus and Ranking Member Grassley welcome public comment on the Tax ShelterTransparency Act. Please direct your comments to John Angell, Majority Staff Director, and KolanL. Davis, Republican Staff Director, of the Senate Finance Committee, 219 Dirksen Senate Building,Washington, D.C. 20510.

Diagrams are attached.