by Ken Rankin
Washington -- Stung by accusations that they promoted abusive tax shelters that drained billions of dollars from the federal treasury, representatives of three of the Big Four accounting firms told Congress that their respective organizations have halted the marketing of these controversial tax avoidance schemes.
Testifying at a Senate Government Affairs Subcommittee hearing on the role of accountants and other financial professionals in “the tax shelter industry,” Ernst & Young Tax Services vice chair Mark A. Weinberger told lawmakers that his firm has already “disbanded the group that had been involved in developing and marketing the tax products” that were under investigation by Congress.
“Our past involvement in the type of activities that are the focus of the subcommittee’s attention is not reflective of our -- and we believe your -- expectations of our role as professionals,” he said.
PricewaterhouseCoopers’ senior tax partner Rick Berry struck a similar chord in his testimony, as he expressed “regret” that his firm promoted such infamous tax shelters as “FLIP” (Foreign Leveraged Investment Program), CDS (Contingent Deferred Swap), and BOSS (Bond and Options Sales Strategy) during the late 1990s.
“In late 1999, the firm decided to get out of this business” to avoid “damage to our business reputation” and “embarrassment caused to our clients,” he said.
KPMG, which dispatched several representatives to testify at the Senate hearings, also claimed to have pulled the plug on the kind of aggressive, multiple-client tax shelter promotions that have come under fire from Washington.
Although the firm admitted “poor judgment” in some of its past tax shelter promotional activities, KPMG denied any illegal activities, arguing that “these tax strategies were consistent with the laws in place at the time and still applicable today.”
Nevertheless, Philip Weisner, the partner-in-charge of KPMG’s Washington National Tax Client Services, told Congress that the firm no longer markets tax shelters “specifically designed to be sold to multiple clients,” and that none of the tax strategies under investigation by Congress “nor anything like these tax strategies, is currently being presented by KPMG.”
Yet KPMG’s testimony was met with severe skepticism on the part of committee members, especially ranking member Sen. Carl Levin, D-Mich., who, after questioning several KPMG
witnesses, wondered if they “would ever get an honest answer from this firm.”
According to a report compiled by the committee, KPMG collected roughly $124 million in fees from shelters from 1997 through 2001 -- shelters that the report estimated cost the federal government about $1.4 billion in lost revenue.
Sen. Norm Coleman, R-Minn., the subcommittee chair, however, estimated that abusive tax shelters carried a much higher price tag to the government.
He indicated that the type of tax shelters promoted by accounting firms in recent years have cost the federal government between $33 billion and $85 billion in lost revenue.
These funds “could have financed a significant portion of our costs in Iraq,” he said. “This is not a victimless crime.”
KPMG’s role in marketing abusive tax shelters was compounded when it was discovered that its internal tax experts questioned the legitimacy of a shelter known by the acronym BLIPS as far back as 1998, only to be overruled by superiors at the firm.
The subcommittee report also called into question the firm’s ties to two audit clients, Deutsche Bank and Wachovia Corp.
While KPMG said that its relationship with each was “in compliance with the rules and regulations regarding auditor independence,” the Securities and Exchange Commission has begun a formal probe into the relationship between KPMG and Wachovia. The regulator has asked Charlotte, N.C.-based Wachovia for documents dating back six years regarding client referrals to the audit firm.
Also, Raymond J. Ruble, a former partner at the law firm of Sidley Austin Brown & Wood, invoked his Fifth Amendment right rather than answer questions from the committee on his role in selling tax shelters to KPMG.
Thank the IRS
IRS Commissioner Mark Everson put a different spin on the accounting industry’s abrupt reversal of course on tax shelter promotions, arguing that the credit for this change of heart should go to his agency.
Testifying on the second day of the two-day subcommittee hearings, Everson noted that witnesses from KPMG, E&Y and PwC had indicated that “the biggest accounting firms no longer engage in mass marketing” of abusive tax shelters.
“If this is true,” he said, “we believe that IRS efforts may have played a significant role in this development.”
According to the tax commissioner, accounting firms and their clients “may have recognized the increased risk of detection of tax returns claiming tax benefits from abusive tax avoidance transactions.”
But as major accounting firms pull out of this business, the IRS is finding plenty of other promoters that are willing to fill the void.
There are “indications that abusive transactions have moved ‘down market’ through more widely marketed promotions by lesser-known professional firms to less affluent taxpayers,” Everson said. “Such a development increases the likelihood that taxpayers may be misled or may be inadequately equipped to assess the tax avoidance proposals presented to them.”
The IRS’s Large and Mid-Size Business Division is currently investigating 118 cases of suspected abusive tax shelters, while another 41 investigations are underway at the agency’s Small Business/Self-Employed Operating Division, he told Congress.
Everson appeared before the subcommittee along with other key federal regulators who also decried the accounting profession’s involvement in the promotion of tax shelters.
Public Company Accounting Oversight Board Chairman William J. McDonough served notice to Congress and the profession that his organization will be on the lookout for abusive tax avoidance schemes as it conducts inspections of accounting firms this year.
Even though “existing laws and regulations may not ban auditors from promoting and giving tax opinions on complex, structured transactions to their audit clients, both auditors and public companies should expect heightened scrutiny of such transactions” from the PCAOB, he told Congress.
One federal regulator at the Senate hearings conceded that his agency is not equipped to crack down on tax shelter abuse by accountants or businesses.
Federal Reserve banking supervision and regulation director Richard Spillenkothen told the subcommittee that government bank examiners “are not legal or tax experts” and “are not trained to identify violations of non-banking laws or compliance with the tax code.”
The Fed representative also cautioned against holding bankers responsible for abusive tax shelter activities that are promoted by their customers’ accountants.
While banking organizations “should not, of course, participate in activities that they know or suspect to be illegal,” Spillenkothen said that, “as a general rule,” banks should not “be required to second-guess their customers’ accountants, tax or legal experts, or to police their customers’ and third-party professionals’ business activities.”
Efforts by major accounting firms to put the tax shelter abuse issue behind them were not flying with Senate leaders, who have been investigating this area for more than a year.
Levin, the panel’s ranking Democrat, engaged in relentless questioning of industry witnesses during the hearing, repeatedly pressing for details of accounting firm shelter marketing activities that he termed abusive.
‘Tenor of the time’
For their part, the accounting industry witnesses at the hearings attributed their controversial tax shelter promotions during the late 1990s to the clamor for aggressive tax reduction strategies from clients that were enriched by the booming stock market.
“The stock market boom and the proliferation of stock option awards in the 1990s created an unprecedented number of individual taxpayers with large gains and significant potential tax liabilities,” E&Y’s Weinberger told the subcommittee.
Initially, his firm “looked for legitimate and appropriate tax planning ideas” to respond to client needs, but “these efforts rapidly evolved into competitive and widespread marketing” of tax shelter strategies -- a shift that Weinberger attributed to “the tenor of the times.”
PwC’s Berry made a similar argument, noting that his firm became involved in these controversial tax strategies in the 1990s because “there was increasing pressure in the marketplace for firms to develop aggressive tax shelters that could be marketed to large numbers of taxpayers.”
KPMG’s representatives also argued that the shelters promoted by their firm in the late 1990s and early 2000s were designed in response to increased client demand for tax reduction strategies during the nation’s economic boom.
“The tax strategies being discussed today represent an earlier time at KPMG and a far different regulatory and marketplace environment,” he explained.
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