A crackdown on abusive tax shelters that includes codifying the economic substance doctrine would create legal booby traps for small businesses and open the door for new abuses by unscrupulous tax shelter promoters, the American Institute of CPAs warned Congress.
In comments submitted to the Senate Permanent Subcommittee on Investigations, the AICPA raised concerns that new statutory language specifically outlawing transactions with no economic purpose other than tax benefits "would have a long-term negative effect on both taxpayers and the government."
Worse still, codification of the murky judicial doctrine of economic substance could backfire by making it easier to design abusive shelters that skirt the rules, AICPA Tax Executive Committee chair Thomas J. Purcell III warned.
"As past experience with abusive tax shelters shows, fixed rules are often easy to avoid and can lead to new abuses," he said in the institute's comments.
The subcommittee, however, called for just such an expansion of the economic substance doctrine in a report issued earlier this year that fingered several of the nation's largest CPA firms as major promoters of abusive tax shelters.
In that report, Senate investigators cited case histories of a series of tax shelters promoted by KPMG, PricewaterhouseCoopers, and Ernst & Young from the late 1990s through 2003, and concluded that "these firms took steps to conceal their tax shelter activities from the tax authorities and the public, including by failing to register potentially abusive tax shelters with the IRS."
Citing estimates from the Government Accountability Office, the report suggested that the abusive tax shelter activity cost the treasury an average of $11 billion to $15 billion annually from 1993 to 1999.
To curb this abuse, the subcommittee recommended a number of steps, including new federal legislation "to clarify and strengthen the economic substance doctrine and to strengthen civil penalties on transactions with no economic substance or business purpose apart from their alleged tax benefits."
Although the Senate report also recommended other measures to curb tax shelter activity - including new Public Company Accounting Oversight Board rules restricting accounting firms from providing "aggressive tax services" to their audit clients - the AICPA's comments raised no objections to those proposals.
Purcell praised the report for contributing "to the transparent discussion of tax system abuse," and stressed that the AICPA is cooperating with the Internal Revenue Service in an effort to "eradicate" abusive tax shelters.
"CPAs are sensitive to potential abuses, and firms are increasingly designing and implementing control systems to responsibly evaluate tax strategies," he said.
But the AICPA made it clear that the profession's cooperation will stop short of supporting the subcommittee's plan to codify the economic substance doctrine.
Calling that proposal "counterproductive," Purcell warned that codifying the economic substance doctrine "would deprive the tax system of the flexibility needed to keep pace with the changing economic environment," and open the door for new "statutory complexity," and create "traps for small businesses and a broad cross-section of taxpayers."
The AICPA wasn't alone in raising objections to an expansion of the economic substance doctrine. Other groups, including the Financial Services Roundtable and the Tax Executives Institute have also raised objections to the plan, and IRS officials themselves have expressed concerns.
IRS chief counsel Donald L. Korb, for one, has called for limiting the use of the economic substance doctrine to address tax shelter issues, arguing that it would be an inappropriate tool in all but a "distinct minority" of cases.
"The economic substance doctrine is not supposed to be a general anti-abuse rule to be trotted out by the IRS every time it confronts a tax shelter transaction it simply does not like," he stated in an address to the University of Southern California Tax Institute earlier this year. "In fact, in the vast majority of cases, the IRS does not need to raise the argument" of economic substance, because "the technical arguments it already has available to it are more than enough to carry the day."
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