Tax Shelter Fallout

Treasury Department, Congress look to crack down on corporate abuses.
Marie LeoneOctober 29, 2001

As political footballs go, tax shelters seem to encourage a lot of punting. But that doesn’t mean CFOs can just sit back and watch.

To crack down on abuse, the House and Senate are pushing for tax shelter legislation. But the bills are Clinton Administration holdovers, so politicking ensues. Meanwhile, the Treasury Department refuses to support any legislation until department officials figure out whether their first disclosure-rule filing, due last month, produces the intended result — identification of tax abuse. It could just generate a mountain of reporting on legitimate business operations.

Still, Washington’s tax players aren’t entirely unserious. For one thing, a July 26 Treasury notice shut down a basis shift shelter that helped U.S. entities avoid tax liability by generating and inflating large paper losses through foreign subsidiaries that recorded stock sales as dividends instead of capital gains. The notice also informs shelter promoters of their obligation to register transactions and keep customer lists. It’s still too early for Treasury to calculate the amount of unpaid taxes this particular loophole represented, but the sophisticated scheme was used at least 200 times by multiple taxpayers, both individuals and corporations.

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Experts say companies would be hard-pressed to justify such moves as having some legitimate economic or business purpose. “Many of these transactions are mere fig leaves that would probably lose if challenged in court,” says David Hariton, a tax partner with the law firm of Sullivan & Cromwell, in New York. “The question for CFOs to ask, therefore, is, how vigorously will the Administration oppose these transactions?”

Currently, the penalty for understatement is 20 percent of the tax liability, plus interest. And although interest can add up over the years, the cost tends to be measurable, but not severe. “If the penalties are low and the enforcement is lax,” adds Hariton, “it’s hard to blame corporations for considering the shelters.”