Ruling Eases Restrictions on Tax Shelters for Companies
"The I.R.S. says that abusive corporate tax shelters are its
most serious enforcement problem. Corporations have
acknowledged saving at least $14.7 billion in 2000
through the use of tax shelters, many of them illegal, the
I.R.S. said last week. The agency has described this
amount as just the tip of an iceberg and announced a
program to waive penalties for companies that
acknowledge using tax shelters and name the promoters."
The New York Times
January 3, 2002
By DAVID CAY JOHNSTON
Federal appeals court has issued a
ruling in a case involving Compaq
Computer that tax
experts say will make it much more
difficult for the Internal Revenue
Service to demolish many corporate tax
shelters.
Some experts predicted that tax shelter
promoters would quickly take advantage of the ruling to fashion new shelters for
corporations to shed billions of dollars in taxes.
"This is disastrous" for the integrity of the tax system, said David A. Weisbach, a
University of Chicago law professor who has argued in several articles that
Congress must prevent corporations from using a patina of legitimacy to justify tax
shelters.
Compaq itself agreed that the ruling narrows the definition of prohibited tax
shelters. "That seems to be the gist of the decision," said Ben K. Wells, treasurer of
the company, whose tax shelter was upheld in a ruling by the United States Court
of Appeals for the Fifth Circuit in New Orleans.
The ruling greatly narrows the sort of deals that the Internal Revenue Service can
disallow as having no purpose besides tax avoidance.
Federal law allows companies to cut taxes when they engage in legitimate deals but
not when tax savings are the sole purpose. The court, agreeing with Compaq, said
its deals involved risks, however tiny, of profit or loss and, therefore were legitimate
business transactions for tax purposes.
The I.R.S. says that abusive corporate tax shelters are its
most serious enforcement problem. Corporations have
acknowledged saving at least $14.7 billion in 2000
through the use of tax shelters, many of them illegal, the
I.R.S. said last week. The agency has described this
amount as just the tip of an iceberg and announced a
program to waive penalties for companies that
acknowledge using tax shelters and name the promoters.
None of the transactions affected by the court's ruling
involved individuals. The ruling, issued on Friday and
published yesterday in the journal Tax Notes, overturned
a 1999 United States Tax Court decision that Compaq had
improperly reduced its 1992 income tax bill through a
series of huge, rapid- fire stock trades.
In 46 trades, Compaq bought, and then immediately sold
back, more than $900 million of Royal Dutch/ Shell stock
in one hour on Sept. 16, 1992. The trades were intended
to let Compaq receive a tax credit for Dutch taxes on Shell dividends. Compaq,
which did not have to pay these taxes, used the credit to reduce its American
income taxes by $2.7 million, the court said.
Compaq says it was a minor customer of the tax shelter promoter, Twenty-First
Securities, a New York investment boutique that helps investors reduce taxes.
Twenty-First Securities said that contrary to the government's contention, tax
avoidance was not Compaq's main goal. "I obviously thought that Compaq had done
this just to make money, and it did not have a lot to do with taxes," said Robert
Gordon, the firm's president. "I am glad that the court came to this conclusion."
The crucial issue in the case was whether the trades were bona fide transactions
that carried a potential for profit and a risk of loss, as Compaq argued, or were
shams intended solely to avoid taxes, as the I.R.S. contended.
In a carefully arranged strategy, Compaq bought the Royal Dutch/ Shell stock and
then sold it moments later at a lower price. The difference in price represented the
value of the Dutch tax credit, which was about 45 cents a share.
The I.R.S. tried to show that Compaq faced little, if any, risk from the trades
because it owned the stock for only a few moments and the prices almost perfectly
captured the value of the Dutch tax credit.
The stock used in the trades belonged to pension funds and other tax-exempt
organizations for whom the Dutch tax credit was worthless because they do not pay
income taxes.
Compaq said that because the trades were performed on the floor of the New York
Stock Exchange at market prices, they involved real risk. Other traders could
exercise their right to jump into the transactions and offer higher or lower prices,
Compaq said. But none did.
Judge Edith H. Jones, in a 14-page opinion, held that just the possibility of other
traders interrupting the bidding was enough to make the trades bona fide for tax
purposes.
Judge Jones acknowledged that the risk of changes in the price of the stock in
such rapid trades was minimal. "The absence of risk that can legitimately be
eliminated does not make a transaction a sham," she wrote. Judges Jerry E. Smith
and Harold R. DeMoss Jr. joined in the decision.
Tax experts say the ruling could apply to a broad range of tax-saving transactions
in which the apparent business risks have been virtually eliminated through
sophisticated financial strategies.
David P. Hariton, a leading tax lawyer in New York, said he was neither for or
against tax shelters, but he found great significance in the court's ruling.
"The decision suggests that there are at least some financial transactions that are
permissible even though they are designed solely to obtain tax benefits," Mr.
Hariton said. "The interesting question is, which ones?"
The lawyer who argued the case for Compaq, Mark A. Oates of Baker & McKenzie
in Chicago, drew the point more narrowly. "The fact that you can diversify most risk
away, or hedge it, does not mean that you had a risk-free transaction," he said.
The latest ruling is similar to one last year involving Alliant, the old Iowa Electric
Industries. In that case the tax court held that the trades were shams, but the
United States Court of Appeals for the Third Circuit in St. Louis disagreed. In that
case, most of the trades were done in the middle of the night in a private office in
Amsterdam, where there was no risk that another trader might intervene.
Treasury and Justice Department officials said last night that they were still
analyzing the latest decision. While an appeal is possible, the Supreme Court is
generally reluctant to accept cases in which two circuit courts have reached similar
conclusions. |
