When the Financial Accounting Standards Board passed FIN 48 last July, public company tax executives worried that the new accounting rule would point the IRS straight at the company’s most vulnerable tax positions.
They were right.
The Internal Revenue Service is “not going to turn a blind eye” to the tax reserve details disclosed under FIN 48, said IRS chief counsel Donald Korb at a conference held on Monday in New York. Korb, who repeated that phrase at least four times during his remarks, made it clear that IRS field agents will be reviewing the new public disclosures that describe the nature and size of corporate tax reserves.
Korb’s remarks fulfill the worst fears that corporate tax directors had about FIN 48 (FASB’s interpretation of how companies should account for uncertain tax positions) because details about tax reserves could reveal weaknesses in corporate tax strategies, and act as a roadmap for the IRS to challenge certain corporate tax shelters.
“Is it fair for an [IRS] agent to know what level of reserves a taxpayer has set up for a particular issue or where a taxpayer thinks his position may have a weak point?” asked Saul Rosen, chief tax officer of Citigroup. Rosen, a panelist at the seminar sponsored by tax consultancy Seigel & Associates, said that FASB had gone too far with the FIN 48. While he applauded the standard-setter’s guidance on how to recognize and measure an uncertain tax position, he said that most tax directors viewed the disclosure requirements as “overbroad and confusing.”
Rosen also claimed that FIN 48 was creating ambiguous explanations, noting that the new crop of annual reports being filed with the Securities and Exchange Commission contain FIN 48 disclosures that are vague, at best. To emphasize his point, Rosen read from a Form 10-K of a large financial firm (not, he was careful to note, Citigroup’s): “It is difficult to project how unrecognized tax benefits will change over the next 12 months but is reasonably possible that they should change significantly.”
Harvey Pitt, a former SEC chairman and currently the CEO of Kalorama Partners, chimed in during the panel discussion, and noted that vague explanations meant that the “disclosures had been turned over to the lawyers, and they are obfuscating [the meaning.]” He chided that the “SEC abhors a vacuum,” and would likely look deeper into FIN 48 disclosures that seemed of little use to investors.
FASB introduced more transparency into tax reserves rules, in part, to cut down on the use of an abusive cookie jar technique, in which corporate executives could overstate tax reserves and then dip into the cookie-jar stash to manage earnings. But Rosen says that most corporate tax managers have legitimate gripes about revealing what goes into their reserve pot.
To be sure, tax reserves are the pot of cash that corporations set up to cover any potential tax liabilities. When calculating the reserve, company officials attempt to handicap corporate tax shelters by having attorney and accountants weigh in on the likelihood that the IRS will approve a particular strategy. In the past, companies kept those opinions, and other calculations, assumptions, and estimates related to the reserves, under wraps, as not to tip off the IRS or competitors about possible strategies or chinks in the shelter’s armor. What’s more, pointed out several panelists, exposing a shelter’s possible weakness would put the company at a disadvantage in a court case, as the opposing side would be able to prove that the company had reservations about certain strategies.
Some conference attendees questioned the panel about whether the new FIN 48 disclosure requirements would cause companies to become less competitive, and back away from legal, albeit aggressive, tax strategies. Rosen quickly answered: “If you believe in the position, believe in it. If you have to argue with the IRS or go to court, so be it.”