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.

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.

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.

Study Urging Corporate Tax Reform Also Highlights Need for More Focused Enforcement

Posted on June 02, 2011 by Erica L. Brady

On June 1, 2011, Citizens for Tax justice issued a preliminary report [PDF] showing that 12 major United States corporations had a cumulative effective tax rate of -1.5% on $171 billion in United States profits.  The preliminary report is a preview of a larger report that Citizens for Tax Justice is putting together and expects to release later this summer.  Citizens for Tax Justice previously released a similar comprehensive report [PDF] in the 1980’s, which according to Citizens for Tax Justice, played a key role in the enactment of the Tax Reform Act of 1986.  The purpose of this preliminary report was to highlight the need for corporate tax reform to close corporate loopholes that allow the large, profitable corporations to pay little or no income taxes.  However, corporate tax reform alone will not cause these corporations to pay the full statutory tax rate on their taxable income, taxing authorities must also engage in focused enforcement to bring up the effective tax rate of these corporations.

 

The preliminary report says there is a $62 billion discrepancy between the statutory tax rate of 35% and the amount actually paid by these 12 corporations.  Meanwhile, these same twelve companies are taking aggressive positions on their tax returns, which even they do not believe these positions will be sustained by taxing authorities on audit.  These corporations had over $30 billion in tax reserves (according to their most recent 10-Ks as of June 15, 2010 and listed in the Ferraro 500) set aside for to pay the additional tax liability should the tax positions that the corporations acknowledge do not meet a “more likely than not” standard be overturned on audit. 

While the $30 billion in tax reserves does not eliminate the $62.4 billion gap between the statutory rate and the amount actually paid, but it would bring the overall effective rate for these companies up to 16.3%.  Tax reserves reflect the amount that corporations acknowledge they likely owe in additional taxes should their aggressive positions be challenged during an audit.  In the past, these positions have often gone unchallenged because the IRS was unaware of which issues the corporation was uncertain.  However, the IRS has two tools that should help them conduct more focused audits; these tools are Schedule UTP and the IRS Whistleblower Program.  Schedule UTP will give the IRS a list of a corporation’s uncertain tax positions, ensuring that the IRS can question and look at these issues during an audit.  However, the IRS will still not know why the position is uncertain.

Through the IRS Whistleblower Program, insiders can come forward with information relating to improper positions that taxpayer took on their returns.  In the case of uncertain tax positions, corporate insiders are often familiar with these positions, and where the weakness in the positions lies.  These insiders are often privy to documentation and discussions and can present the full facts of the position in a clear and concise manner, highlighting which documents the IRS should focus their attention on.  In exchange for a whistleblower’s assistance in detecting tax underpayments, the whistleblower can receive a percentage of the underpayment collected based on the information they provided. 

GE in the Spotlight for Earning $14 Billion But Paying Zero U.S. Taxes

Posted on March 28, 2011 by Hilary B. Lefko

An article on the cover of the March 25, 2011, edition of the New York Times caught our attention.  New York Times Columnist David Kocieniewski’s front-page article, notably titled, G.E.’s Strategies Let It Avoid Taxes Altogether, describes how General Electric Corporation has enjoyed multi-billion dollar profits over the past seven years, but has seen a decrease in their effective tax rate.  The New York Times story said that GE reported worldwide profits of $14.2 billion, yet owed zero dollars in U.S. taxes.  In fact, based on its public disclosures GE claimed a tax benefit last year of $3.2 billion, the story added.  The fact that GE is in the tax avoidance spotlight was no surprise to The Ferraro Law Firm, as GE recently topped The Ferraro Law Firm’s Ferraro 500 list of companies with the largest reserves for Uncertain Tax Benefits. 

Note: The Ferraro 500 is The Ferraro Law Firm’s reorganization of the Fortune 500 by the size of the companies' Unrecognized Tax Benefit reserve, known simply as the company’s “tax reserve.” Under the accounting requirements of FIN 48, a company must reserve, or in other words "hold back," earnings for tax positions for which the company thinks the IRS has a greater likelihood of prevailing than the company.  GE topped the list with a tax reserve of $8.719 billion (which includes a reserve for penalties of $99 million and interest of $1.369 billion) for the 2009 tax year.  In 2010, GE reported a tax reserve of $7.448 billion (which includes $109 million of penalties and $1.2 billion of interest).

How does GE do it?  For starters, many of the ways in which GE reduces its tax bill came from legitimate tax planning strategies.  E.g., the article discusses at length the story behind their use of the active financing exceptions of Subpart F.  However, more than $6 billion was cut from GE’s tax bill due to the uncertain tax positions they took (positions that GE thinks the IRS will more likely than not be able to challenge successfully).  GE employs one of the largest Tax Departments in the world, and the article noted that all 975 employees in this department are tasked with upholding the Tax Department’s mission, “look to exploit opportunities to reduce tax.”  With 287,000 worldwide employees and worldwide profits of $14 billion in total, the Tax Department appears to be the largest profit center in the whole company by far, which they accomplished by cutting GE’s tax bill $6 billion using uncertain tax positions and further by securing an additional $3.2 billion of tax benefits.    

As demonstrated by the Ferraro 500, GE is not alone.  In 2009, Fortune 500 companies reported more than $200 billion in uncertain tax positions, which far exceeded the $138 billion paid in corporate taxes for the same year. 

Uncertain Tax Positions Open the Door for Tax Whistleblowers

Posted on February 01, 2011 by Scott A. Knott

A recent article in the NY Times caught our attention because it describes how many of the S&P 500 companies are drastically reducing their US taxes. Columnist David Leonhardt also discusses this issue in the Economix blog.  The story relates to the low overall rate of taxation of many of the largest US companies as disclosed in their most recent financial statements.  A study done for the NY Times by Capital IQ, a research firm, indicated that thirty-nine of those companies paid a rate less than 10 percent.  How do those companies pay such a low overall rate when the corporate tax rate here in the US is 35%?  In our experience in representing many of the world’s largest companies, the answer has several parts: 1) good tax planning and using all available credits/deductions/depreciation the law allows, 2) moving intellectual property and business activities to low tax countries, 3) taking aggressive tax positions on the corporate tax return.  Notice we didn’t say “loopholes.”  That’s another topic for another day, but in short the term “loophole” is often used for both legitimate tax reduction strategies and for improper tax avoidance or evasion techniques.  There is a big difference.

Companies arguably should exploit every legal means to reduce their overall tax rate.  If for example Congress passes a law which says businesses can write off a new solar power system over a shorter period than the solar power system will actually last them, that’s fine, every company should take advantage of that law if it applies to them.  However, if the company decides to deduct it all at once by either ignoring the law or relying on an overly technical interpretation of the law, they are improperly avoiding taxes.  Many companies gamble by taking that kind of unsupported or weak position on their corporate tax return and hope they don’t get caught before the statute of limitations expires.   

When a company takes such an aggressive position of their tax return that the securities regulators don’t allow them to recognize the tax savings on their books, the accounting rules require them to establish a “tax reserve” for this position (called an uncertain tax position).  As shown in the "Ferraro 500" list, a reordering of The Fortune 500 by tax reserves compiled by The Ferraro Law Firm, there is approximately $200 billion of uncertain tax positions for those companies alone, and those reserves will get released when the statute of limitations expires assuming they don’t get caught first.  These aggressive tax positions will remain undisclosed under the final uncertain tax position regulations. We think that whistleblowers who come forward now with information regarding these kinds of significant tax underpayments are more likely to receive awards than those who wait because awards are given to the informant who first provides the information to the IRS.