Risk & Compliance

More GAAP-Tax Disclosure Recommended

Testifying before a Senate committee, one panelist makes a strong pitch for the public release of Schedule M-3 forms.
Helen ShawJune 14, 2006

Better disclosure of the reconciliation between a company’s tax figures and its financial statements was the subject of testimony on Tuesday before the Senate Finance Committee.

Edward Kleinbard, an attorney with Cleary Gottlieb Steen & Hamilton, opposed mandating the public disclosure of corporate tax returns in their entirety, suggesting that such a practice would do little other than offer information on a company’s strategic and budgetary decisions to its competitors. Kleinbard (whose testimony represented his personal views) instead recommended that companies be required to publicly release their consolidated Schedule M-3s, which would provide useful data for investors and policymakers without revealing confidential business information.

Schedule M-3 requires large corporations to disclose transactions that produce a significant book-tax difference. (A significant book-tax difference exists if the treatment of any item for federal income tax purposes differs by more than $10 million on a gross basis from the treatment of the item for book purposes in any tax year.) Schedule M-3 forces corporate taxpayers to provide vastly more-detailed information to the Internal Revenue Service; it was first required for corporations filing Form 1120 starting with the tax year ending on or after December 31, 2004.

Kleinbard maintained that investors should have the same three-dimensional view of a company’s economic performance and tax profile as the IRS. But today, he added, they “do not enjoy the more nuanced understanding of corporate financial results that the Schedule M-3 would provide.”

For example, Kleinbard elaborated, the cash tax liabilities of companies are not well known because the financial statement “current” tax liability provision is not equivalent to cash taxes paid and payable in respect of that year. He also noted that the existence of reserves for contingent tax liabilities presents, theoretically, an opportunity for earnings management.

To focus on those issues, Kleinbard suggested that Schedule M-3 forms be released with a reconciliation of cash taxes paid to a company’s tax provision — providing a three-dimensional view of corporate financial performance, reducing the possibility of earnings management, and allowing more-targeted analysis of a company’s tax expenses. Public M-3s, he added, might also help limit abusive corporate tax-shelter transactions by making them more visible. Further, “the public release of the M-3 also should make more apparent those cases, like that of Enron, where corporations design complex structures to hold assets ‘off balance sheet’ that they simultaneously view as owned by themselves for tax purposes,” said Kleinbard.

Lastly, the public release of Schedule M-3s could benefit the overall tax and financial accounting systems by shedding light on the sources of the gap between corporate pre-tax financial-statement income and taxable income as reported to the IRS, said Kleinbard — a gap that amounted to some $200 billion in 2002. That information, he suggested, might prompt Congress to review whether current tax law accurately captures the industry’s annual economic results or encourage the Financial Accounting Standards Board to consider whether its guidelines need revision.