Base Erosion and Profit Shifting: Why Corporate Tax Receipts are in the Toilet Despite Rising Profits

Posted on March 26, 2013 by Scott A. Knott

I saw an interesting article today by the President and Publisher of Tax Analysts in which he drew attention to the role of tax professionals in the growing crisis over reduced corporate tax receipts in a time of record corporate profits. He focused his audience’s attention on a recently released study by The Organisation for Economic Co-operation and Development (“OECD”) which described the need for the international tax community to solve the problem of base erosion and profit shifting (“BEPS”). Sure, that’s a lot acronyms to the uninitiated, but at its heart this is a giant shell game of “where’s the income?”, and unfortunately for those of us living in civilized society, the offshore tax haven shell is where it’s at. Large multinationals frequently use abusive strategies, some of highly questionable legality, to minimize their worldwide tax bill. Many politicians have made hay over US based multinationals reporting billions of dollars of income in e.g. the British Virgin Islands, and hardly any here where their employees and a large portion of their sales actually are.

 

We agree that for the most part companies abide by, and optimize their behavior for, the rules that are set for them. However, the grey line is often crossed. In our Ferraro 500 last year we noticed that reserves for uncertain tax positions exceeded total US corporate tax collections*, and that’s just for the Fortune 500 companies. While moving the line to collect more revenue (while maintaining international competitiveness) and to make it more of a black line than a grey line should be the goal of legislators, governments need to get better at enforcing the existing rules. Utilizing valuable information obtained from knowledgeable whistleblowers should be a critical component of that enforcement. Without enforcement, a change in the rules is meaningless.

 

*Fiscal 2011 Fortune 500: Profits $824 billion & Reserves $187 billion; Total IRS Corporate Tax Collections $181 billion. Whereas in Fiscal 2010, Fortune 500: Profits $708 billion & Reserves $197 billion; Total IRS Corporate Tax Collections $191 billion.

IRS says whistleblower law a "game changer" in their efforts to combat offshore evasion.

Posted on December 18, 2012 by Gregory S. Lynam

Tax practitioners and government officials recently came together at the American Bar Association International Tax Enforcement Conference in New York to discuss international tax enforcement rules and procedures.  Among the topics of discussion was the federal government’s increased arsenal of tools available in combating offshore tax evasion, making its efforts stealthier and less predictable to practitioners and taxpayers, according to a panel of tax controversy practitioners.  These new tools include data mined from voluntary disclosures; cooperation by taxpayers and bankers; and notably, information obtained from whistleblowers.  

Thomas E. Bishop, Assistant Special Agent In Charge, IRS Criminal Investigation division in New York, referred to the 2006 IRS whistleblower law as a "game changer" for the IRS's efforts to combat offshore evasion.  Bishop stated that the Criminal Investigation division is investigating individuals based on information provided by whistleblowers.  The use of whistleblower information was also discussed by Sandra Brown, Assistant U.S. Attorney/Tax Division Chief (Central District of California), who said that the Justice Department has ongoing investigations because of information provided by whistleblowers.  Brown continued by saying that people tend to picture the jilted ex-spouse as the whistleblower who provides information on individual taxpayers, but that view is antiquated.  Business partners and associates are providing information as well, she said, adding, "Those who lie with dogs know where the fleas are."

Not only has whistleblower information brought specific information forward, whistleblower information, along with other tools used by the government, has created a situation where practitioners can no longer predict the next wave of enforcement, said Charles P. Rettig of Hochman, Salkin, Rettig, Toscher & Perez PC.  Practitioners used to be able to mine their own data to predict those enforcement efforts, but that's changed, he said.  Scott D. Michel of Caplin & Drysdale agreed, citing subpoenas recently issued by the U.S. attorney's office for the Southern District of New York to account holders of Bank Frey & Co., a Swiss bank.  Those subpoenas essentially "came out of the blue," with no inkling by practitioners that the bank was even on the government's radar, he said.

We note that this is anecdotal until the IRS publishes statistics on the mater, but it is encouraging to hear from Criminal Investigation and the United States Attorney’s office that they think the whistleblower program is providing them with good cases.  But this is not all together surprising as we have referred a number of cases to the IRS Criminal Investigation Division with good results.  A well-informed whistleblower can be a key asset in any tax case, not just in offshore evasion.  I will be speaking with Stephen Whitlock, Director of the IRS Whistleblower Office, at the ABA Tax Section meeting in January.  One of the talking points of our panel will be the IRS’s great successes in utilizing informant information and its impact on all levels of enforcement both civil and criminal. 

As the calendar year winds to a close we wish you and your loved ones a Merry Christmas and Happy New Year.  We look forward to another year’s hyper-aggressive tax transactions being locked in place waiting for a fresh crop of IRS Whistleblowers to bring the transgressions to justice.

2012 Ferraro 500 list ranks Uncertain Tax Position Reserves.

Posted on September 10, 2012 by Scott A. Knott

Today we released our 2012 “Ferraro 500” list, which reorders Fortune 500 companies based on the size of their Unrecognized Tax Benefit reserves. This annual study always has some interesting results and outliers. For example, Fortune 500 corporate profits are up 16%, but their tax reserves are down 5% (along with total US corporate tax collections for fiscal 11 according to the Treasury Dept.):

(in millions)

Profit

Reserves 

Collections

2010  

$708,554.10

$197,725.50

$191,437.00

2011  

$824,542.70

$187,545.60

$181,085.00

$ Change 

$115,988.60

-$10,179.90

-$10,352.00

% Change 

16.37%

-5.15%

-5.41%

 

The Tax Reserves of the top five companies are Pfizer, which set aside $7.309 billion to cover potential taxes; J.P. Morgan Chase & Co., $7.189 billion; Microsoft, $6.935 billion; General Electric, $6.384 billion; and AT&T, with $5.853 billion. The details behind these Unrecognized Tax Benefit reserves, found in the tax accrual work papers and elsewhere, often make for valuable tax whistleblower submissions.

Tax Scandals, Celebrity Style

Posted on January 12, 2012 by Scott A. Knott

In the tax world, unlike Hollywood, we really don’t get that many juicy stories.  However, when the “stars” embarrass themselves with their tax troubles, we are provided relief from yet another story about, for example, the material participation regulations' conjunctive test for determining whether an interest is treated as a limited partner interest for purposes of section 469.   Sorry, back to the scintillating stuff.

The NY Daily News just released a slideshow of the top celebrity tax scandals.  Our favorite story is about Willie Nelson, who famously released an album called the “IRS Tapes” to pay off his $32 million tax bill.  What’s yours?

IRS estimate of the United States Tax Gap shows that opportunities for whistleblowers abound.

Posted on January 10, 2012 by Erica L. Brady

The IRS estimates that the gross tax gap for 2006 is $450 billion, or 17 percent of taxes.  The gross tax gap is the amount of the true tax liability faced by taxpayers that is not paid on time.  After its enforcement efforts, the IRS estimates that the net tax gap is $385 billion, having collected $65 billion through audits of returns for the 2006 tax year.  This suggests that there are significant opportunities for whistleblowers to come forward and help close the tax gap by providing information as to which taxpayers should be audited. 

Tax Gap = The amount of money per year that the IRS thinks taxpayers owe minus what they actually paid. 

While attention has been given to the tax positions taken by large multi-national corporations and billionaires, these may not be the worst offenders when it comes to not paying their tax liability.  Most of the net tax gap, 84 percent, is due to underreporting of income.  Nearly one third of the net tax gap, $122 billion, is attributed to underreporting of business income by individuals.  Business income reported by individuals includes income from partnerships, s corporations, and sole proprietorships.  Whether the underreporting of income is intentional or not, it is relatively easy for these taxpayers to underreport their income by not including all of their receipts in income, overstating their expenses, or claiming incorrect amounts of credits due to lax reporting requirements.  The IRS noted that compliance rates are highest when there is third-part reporting of income; compare the one percent of income that is not reported when subject to substantial information reporting requirements to the 56 percent of income not reported when the income is subject to little or no information reporting (see the chart below from the IRS).  This suggests that the areas ripest for whistleblowers are areas with little or no information reporting.

 http___www.irs.bmp 

Billionaires are paying an even lower marginal rate than previously thought.

Posted on November 22, 2011 by Erica L. Brady

Bloomberg News/Businessweek’s Jesse Drucker makes an astute observation about how billionaires either delay or escape income taxes in his article “U.S. Billionaires Avoid Reporting Cash to IRS.”  The article describes how several people on the Forbes 400 list have used sophisticated and complex transactions to characterize the cash that they receive from the sale of capital assets as something other than taxable income.  Transactions similar to those described in the article are often misused to artificially create a tax benefit, allowing billionaires to engage in tax alchemy to recharacterize what should be taxable income into something else.

Study Shows Corporate Tax Dodging Is Common

Posted on November 07, 2011 by Scott A. Knott

The IRS needs whistleblowers now more than ever.  A recently released study by the Citizens for Tax Justice and the Institute on Taxation and Economic Policy examined 280 of the current Fortune 500 and found a general pattern of decreasing tax rates, with 78 of those taxpayers paying no tax at all in one of the last three years.   This study was picked up by some of the mainstream media [including The New York Times, 280 Big Public Firms Paid Little U.S. Tax, Study Says; Bloomberg, Thirty Top Companies Profited Without Paying Tax, Study Finds; and The Washington Post, Study: Big corporations use loopholes, dodge taxes], and we think they are in the right to be alarmed. 

Our annual Ferraro 500 list of corporate tax shenanigans [see our list from last year] shows a similar pattern of potential corporate malfeasance, but we focus on reserves for Uncertain Tax Positions, which are monies set aside to cover issues that the taxpayers themselves think they should lose if the IRS challenges them.  We believe that studies like this, which are based on audited financials of the country's largest taxpayers, show the IRS, Congress, and U.S. taxpayers where they should focus their energies in corporate tax compliance.  Where there is smoke there is usually fire.

25 Companies Who Pay Their CEO's More Than They Pay Uncle Sam

Posted on September 01, 2011 by Scott A. Knott

The recently released study by Institute for Policy Studies that identified 25 Fortune 500 companies who's CEOs were paid more last year than they paid in federal income tax naturally piqued our interest, and created a buzz in the media as well.  David Kocieniewski at the NY Times and others addressed this issue, which dovetails in somewhat with his prior stories on GE not paying taxes despite billions in profits and our Ferraro 500. 

While it is an interesting phenomenon that some executives are paid more than their company's U.S. tax expense, we hardly found that surprising.  However, the study and the "solutions" it proposed focused on the executive compensation as the cause of the meager tax payments, and to us that seems like their view of the forest is obscured by the trees.  While policy makers and Congress can debate the merits of letting companies deduct Chief Executive level compensation and perks, the fact is that even if the law was changed to completely eliminate those deductions, these companies would still not be paying a reasonable amount of taxes.  They are all taking proper, and in some cases improper, tax breaks and aggressive positions that absolutely dwarf the executive compensation deductions.  For example, International Paper cumulatively claimed $2.1 billion in bogus tax credits for black liquor in 2009 & 2010 compared to Mr. John Faraci’s $19.3 million cumulative salary for those years.  Mr. Faraci earned less than one cent for every dollar of tax credit claimed for black liquor.  The IRS, Congress, and the public need to focus their attention where the real money is in tax avoidance, such as abusive use of tax credits, transfer pricing, and other aggressive tax planning schemes.