KEY ISSUES IN TAX POLICY
A 2007 TAX ANALYSTS CONFERENCE
FINANCIAL REPORTING AND CORPORATE TRANSPARENCY:
HOW DO RELEASES OF NEW INFORMATION UNDER FIN 48
AFFECT THE IRS'S DISCLOSURE NEEDS?
Friday, July 13, 2007
President and Publisher
Attorney and Adjunct Professor
Georgetown University Law Center
Former Chair and CEO, Ernst & Young, and
Corporate Board and Audit Committee
Member of Several Companies
Senior Adviser to the Commissioner of the
IRS Large and Midsize Business Division
* * * * *
MR. BERGIN: Nice to see you all. Welcome to the latest in the Tax Analysts series of discussions on key issues in tax policy.
The topic for today picks up on an issue raised during our last roundtable in April, which focused on effective tax administration and transparency. This issue is: how might transparency in the financial reporting of income taxes under FIN 48 affect tax administration?
I'm Chris Bergin, the president of Tax Analysts, the nonprofit organization that has published for many years print and online products in the federal, state, and international tax areas.
One of our relatively new online publications is Financial Reporting Watch, which covers subjects of particular relevance to our discussion this morning — the intersection of income tax accounting, financial reporting of income taxes, and corporate governance.
This is the fourth year in which we have conducted a series of discussions on tax policy and administration. If you are new to our discussions, let me say again: welcome.
Let me also take just a moment to explain our process. I will open things up with some brief remarks to introduce our topic. I will then introduce our distinguished panel of three speakers who are sitting around the table.
Each of them will address aspects of our topic. After that, we will open the discussion to all of you, and we encourage all of you to participate, whether you are seated at the table or just a bit away from it, just wave and I'll find you.
We are recording this event and will post this transcript to our Web site, as we do for all our discussions.
Also, for media purposes, we are on the record. So, when I recognize you, please tell us who you are. Also, please speak into a microphone. For those of you away from the table, we will have handheld mikes that will get quickly to you.
I will moderate the discussion, and we will go no longer than 11:00.
As I mentioned earlier, the topic for discussion this morning is financial reporting and corporate transparency, and we are asking the following question: How will the release of new information under FIN 48 affect the IRS's disclosure needs?
And speaking of disclosure, let me disclose something up front. When it comes to FIN 48, I am a novice. And I may not be the only novice in the room. That means I think I understand the basics, but I also understand that there is a lot I don't know.
For this discussion, we are going to assume that we all have some knowledge of the nuts and bolts of our new world. Since FASB announced the release of FIN 48 one year ago today, and, yes, we scheduled this roundtable for that anniversary, there have been many seminars, Webcasts, podcasts, and other tools of continuing education dedicated to the complicated aspects of the new procedures. Today, however, we want to talk more about policy.
Some of the issues that will come up will involve the policy behind FIN 48 and how that policy has developed over time; the regulatory policies that the IRS and the SEC may trigger as they receive the disclosures; and the corporate policies for complying with FIN 48 and how those policies might reduce the risks associated
with disclosing tax accrual workpapers and confidential information.
A sampling of FIN 48 disclosures for the S&P 500 — which is available through Financial Reporting Watch's tax disclosure Web page — and there's some information in each of the packets that you all have, offer some insights into the trends.
Overall, we've concluded that the current disclosures are not quite the roadmaps that some practitioners anticipated — or feared, depending on your perspective — that FIN 48 would provide to tax officials.
Also in the packet, by the way, is an article by three accounting professors from James Madison University that provides a statistical analysis of the first round of FIN disclosures. We published that in a couple of our publications this week.
Of course, the disclosures vary. The diversity and the degree of transparency that individual companies are providing is interesting, considering that one of the reasons for issuing FIN 48 was to address
"noncomparability in reporting income tax assets and liabilities."
Here are just two quick examples that I saw.
In one 10-Q, a paragraph that goes into graphic detail on what FIN 48 requires and that represents a beautiful cut and paste job in my opinion, ends with the following sentence, and I quote. "Ambac's liability for unrecognized tax benefits was not impacted as a result of the adoption of FIN 48."
Being the cynic that I can be, if I were an IRS agent, I'd probably see this as a red flag.
A second 10-Q, this one submitted by Wal-Mart, goes into significant detail in several areas. For example, and I quote again, "Additionally, the company has recognized tax benefits of $1.733 billion, which, if recognized, would be recorded as discontinued operations. Of this, $1.67 billion relates to a worthless stock deduction to be claimed for the company's disposition of its German operations in fiscal year 2007."
Now, clearly, there's room for argument on both sides of the debate about FIN 48 and corporate transparency. Is FIN 48 an unjustified — and overreaching — step toward making public some information that should not be a matter of public record, or, based on the first round of disclosures, should the SEC require companies to be more transparent, making financial statements true roadmaps to more efficient tax administration? I certainly don't have the answer, but we have a dynamic panel here today to discuss these issues and others. I will introduce them in the order in which they will speak.
Fred Murray is an attorney and adjunct professor at Georgetown University Law Center who teaches, among other things, about FIN 48 issues.
Ray Groves is a former chair and CEO of Ernst and Young, and now a corporate board and audit committee member of several companies.
Bob Adams is a senior adviser to the Commissioner of the IRS Large and Midsize Business Division regarding the issues that we will discuss today.
A special thanks to you three for showing up. We really appreciate it, and it's a pleasure to have you.
After that, Fred, would you start us off?
MR. MURRAY: Thank you, Chris, and I appreciate the opportunity to add some remarks here at the beginning of the discussion to try to tee up some of the issues.
The promulgation of FIN 48 a year ago spawned a considerable amount of implementation activity, to say the least, and those enterprises that are subject to the new rules. The FASB and SEC hope that the new rules and the disclosures may decrease the abilities of some companies to manage earnings through the tax reserves and may increase investor awareness of tax risks that were previously unknown.
On the other hand, commentators predicted that FIN 48 will ultimately result in more volatile company effective tax rates. As a result, more volatile earnings reports and . . . reported tax liabilities interest in penalties will rise.
Many have expressed concern about the IRS use of the disclosures and possibly of the workpaper files that support them, the so-called roadmap, leading to a rise in adjustments and audits, litigation, and possibly increased tax payments.
These predictions assume no behavioral changes — that companies will not become more conservative in their tax filing positions. But given some predictable conservatism, the new transparency might cause some companies to pay more taxes whether or not they ultimately would have or should have owed them, either to avoid interactions between company managers and their board audit committees and auditors or to reduce the risk of asserted penalties and result in disclosures and regulatory reports and analysts reports in the financial press. The disclosures could affect projections of cash flows and market rights of return, investor demands, and the cost of capital.
Experience would suggest that many public company tax directors have historically taken a conservative approach under the methodologies allowed under FAS-5 that applied to tax matters before the adoption of FIN 48.
For example, an uncertain tax position might have been recognized in the financial statements as filed in the tax return, and if upon reevaluation it became probable that the position would be compromised upon audit, the estimated amount of the loss would be added to the reserves.
Detection risk, where in some cases factored into the analysis and the resulting estimates, recognized that some of the positions in the returns would be discovered by the related tax authorities and would be compromised or lost in administrative proceedings or litigation.
Conservatism, in some cases, led to the establishment of additional cushion amounts in the reserves to protect against uncertainties and surprises.
A tax [off mike] roundtable survey showed that 80 percent of companies that settled audits in the last two years released tax reserves. This would indicate a tendency towards conservatism and an over accrual for risks associated with uncertain tax positions.
The approach mandated by FIN 48 is very different. Among other things, the new rules do not allow for aggregation of tax positions or for general cushion amounts in the reserves. Liabilities for unrecognized tax benefits must be recognized for tax positions that previously would not have given rise to an increase in the reserves. The interpretation requires a position-by-position technical analysis of all tax positions of the enterprise.
FIN 48 contains a number of new disclosure requirements. Some of which have been criticized for vagueness, and others, because they're too clear, a fear that they will disclose tax exposures to the IRS.
How will the predictions fare on whether the criticisms are warranted? We don't know yet. Many of the effects will not be known until annual reports are filed early next year and perhaps, years from now. The public results of these implementation efforts are, however, just becoming evident, and we are learning some interesting things from them.
There was a recent report published in May by Credit Suisse Securities, LLP. They published a comprehensive analysis of initial reporting under FIN 48 that gives us some insights into information that may be available to stock analysts and to investors from the new data that's made public by these changes.
Part of the report states, "FIN 48 may highlight company-specific tax risks that investors were not previously aware of. If investors learned that a company actually bears more risk than was known before, that could have an impact on their estimates of future cash flows and the return that investors would demand."
That is, an increased tax risk should increase the cost of capital, which could affect evaluations.
So, how do we measure company-specific tax risk? With the new information provided by FIN 48, we focus on the unrecognized tax benefit. So, now you're wondering which companies might have more tax risk than others.
To get a rough idea, we took a look at 361 of the 368 companies in the S&P 500 with calendar yearends, and, in total, we found these companies had $141 billion in unrecognized tax benefits. That sound you just heard was cash registers ringing at tax authorities around the world. $141 billion is a nice chunk of change which any tax
authority would like to get a piece of.
Some industry groups seem to have more exposure to uncertain tax positions than others, with the 11 industry groups listed accounting for over 60 percent of the total unrecognized tax benefits.
At the company tax level, we found 62 companies with unrecognized tax benefits over $500 million and 36 over $1 billion at the date of adoption.
They go on to complete something they call a tax risk report card. Since the companies in Exhibit 3 have the largest unrecognized tax benefits, they have the most tax risk, right?
Not so fast. Just focusing on the absolute dollar amount of the unrecognized tax benefit is not enough. As one would expect, larger multinational companies tend to have larger uncertain tax positions. The key question is how significant the unrecognized tax benefits are to each individual company.
For a better measure of the risk, then they go on to look at four factors that they use to compile some tables that look at some of the companies involved.
The first is a ratio of unrecognized tax benefit to cash taxes paid. The median ratio in that metric was 0.7 years with a high of 260 years for Altera Corporation.
The next ratio was unrecognized tax benefit to market capitalization. The median ratio was 0.9 percent, ranging from a high of 14.9 percent for General Motors — I invited Roger Wheeler here today; I don't see him out here, thank heavens — To a low of 0 percent for 14 companies. The next metric was unrecognized tax benefit to cash flow from operations. The higher the ratio, the larger the claim on cash.
The median ratio was 12 percent with a high of 1,344 percent for PMC Sierra, Inc.
Unrecognized tax benefit to total liabilities. The median ratio was 1.5 percent with a high of 29 percent, again, for PMC Sierra, Inc.
On the other end of the spectrum, they looked at 14 companies that appeared to have the lowest or least exposure to these uncertain tax positions, disclosing either zero dollars or disclosing that the amount was immaterial.
Interestingly, one of the companies on that list is EOG Resources, which was a spin-off from Enron, which has been the poster-child for many of these reforms.
They go on to say that this is far from the perfect measure of tax risk, but it's not a bad starting point. And it is very revealing to look at some of the tables and to think about what they might say, and I'm sure our friend Bob Adams over here will have something to say about what the Service is going to do with some of this data.
And they conclude with an observation that as to FIN 48 disclosures, it's really not a roadmap for the IRS, but it's more of a compass for the IRS. But they go on in that paragraph to say, "The fear is that the disclosures required by FIN 48 will provide a roadmap for the IRS and other tax authorities."
As the SEC's chief economist Chester Spatt described in a speech back in March, besides the direct out-of-pocket costs associated with compliance for the new standard and the transition to it, there may be a much more fundamental concern about the cost of the standard. Providing the public more information about the
taxpayer's position on salient tax issues may provide a roadmap for the tax authority that may undercut the firm's marketing power in the associated tax disputes.
That gets us into an area that many of the companies have worried much about, the level of disclosure and its effects. One recent presentation by an SEC official highlights the environment well.
I would like to remind companies and their auditors of their documentation responsibilities. Tax contingencies is an area where some people may have been inclined to document less rather than more due to confidentiality concerns and a fear that tax workpapers will end up in the hands of the IRS.
We appreciate these concerns, but remind you of your responsibilities under Sections 404 and 202 of the Sarbanes-Oxley Act related to CFO and CEO certifications. It is equally important for auditors to recognize their responsibilities under the auditing standards. Audit documentation for taxes, including tax contingencies, should follow the same high standard as in other audit areas.
The staff believes that the auditor's obligation to report to shareholders on the company's financial statements takes precedent over any request from the company for confidentiality. Inherent in this obligation is the need to make sure the auditor's workpapers support the auditor's findings in each area, in particular, the accounting for income taxes.
The Public Company Accounting Oversight Board itself, an outgrowth of the recent financial scandals, has issued auditing standards that affect the environment. Auditing standard number three in particular is significant because of its emphasis on requiring a more comprehensive written record to support each of the auditor's
conclusions, and increase documentation of significant findings and issues, including copies of contracts and agreements and other relevant material in the auditors' files.
Following those requirements in its own role in these matters, the American Institute of Certified Public Accountants on April 9, 2003, amended its interpretation of auditing standard AU Section 9326, evidential matters. It pertains to the effect of an inability to obtain evidential matter relating to income tax accruals, and it says "If the client's support for the tax accrual or other matters affecting it, including tax contingencies, is based upon an opinion issued by an outside advisor with respect to potentially material matter, the auditor should obtain access to the opinion, notwithstanding potential concerns regarding attorney-client or other forms of privilege. The audit documentation should include either the actual advice or opinions rendered by an outside advisor," and so on.
In response to these standards, over the past several years, there's been a dramatic increase in the request for privileged materials, particularly legal opinions and litigation assessments relied upon by companies in formulating contingency reserves and for oral assessments of lost contingency ranges and other client
These queries are at odds with the standards developed by the American Bar Association and the AICPA 30 years ago and embodied in the ABA statement of policy regarding lawyers' response to auditors' response to auditors' request for information.
That policy was aimed at providing clients with appropriate advice concerning public disclosures on contingencies and providing responses to auditors in a form intended to preserve the client's ability to assert applicable privileges.
By requesting copies of the opinions and assessment themselves rather than seeking assurance that advice on appropriate disclosure has been given, the new practice by auditors raises risks that the attorney-client and other privileges may be waived to the substantial detriment of public companies and their shareholders.
There is a significant risk that such demands may actually be counterproductive to the goal of increasing the transparency of corporate financial statements. The serious threat over time is to the advice seeking process itself. If a discussion with a lawyer can not be conducted with the assurance of confidentiality provided by the attorney-client and other privileges, the risk is that consultation will be deferred or foregone altogether. And I'll note that the need is not unlike that, that you find on the other side in government with the deliberative process privilege.
The consequences of a disclosure of an opinion or litigation assessment to an auditor on the attorney-client privilege are uncertain under current case law. The broadest, most unfavorable outcome is that the disclosure to the auditor constitutes a subject matter waiver, not only of the document or documents disclosed to the auditors, but of all related communications and advice on the subject matter of the disclosure.
There have been efforts to deal with this outside the tax area. The SEC itself has adopted the position that waiver of privilege, in order to cooperate with the SEC, should not result in a broader waiver as to other parties.
This is the selective waiver concept. It's been rejected by a number of courts. Nevertheless, Congress responded with a bill in 2003, H.R. 2179, which would have codified or enacted this sort of approach. Similarly, efforts are underway, some of which I worked on while I was at the Justice Department, to amend the federal rules of civil procedure to include a new Rule 502 that would impose this concept of a limitation on the waiver of attorney-client work product privileges in certain circumstances.
Lastly, this brings us to the problem of tax accrual workpapers.
Even if, however, the consequence of disclosures to auditors can be limited to act as a waiver of the attorney-client privilege only as to the documents actually disclosed, the adverse consequences to
reporting companies and their shareholders will be severe. Disclosure of a company's internal assessment of its odds of prevailing in tax litigation, for example, affords its government opponents an advantage in the settlement process that will certainly not be reciprocated.
This advantage is magnified when it is realized that relatively few tax disputes are litigated and that the overwhelming majority are settled.
The Internal Revenue Service has shown increased interest in recent years in income tax accruals and the differences between income tax and tax accounts presented in the financial statements and those presented in tax returns.
Similarly, the Service has revised its policies in recent years with respect to requests for tax accrual workpapers in an effort to deal with a certain list of transactions, which I think Bob will talk about in his comments today.
LMSB Commissioner Deborah Nolan stated on February 1 that the IRS is now reevaluating its policies and positions in regard to FIN 48 disclosures and the workpapers containing FIN 48 information.
Given the new environment of increasing transparency, she believed IRS would be remiss not to reevaluate its policies irrespective of the promulgation of FIN 48.
And, in closing, I'll just note that a number of these issues are involved in the currently-pending Textron case up in Rhode Island, which involve not only expansions to this policy of restraint that the service has exercised since the Arthur Young case for a number of years now, the affects of the new section 7525 accountant-client privilege and whether or not it might in fact do something or affect the reasoning of the court in Arthur Young, and a number of issues about waiver of the privilege.
MR. BERGIN: Thank you, Fred. Ray, we'll turn to you to comment on our new world here.
MR. GROVES: Okay. I'm going to talk mainly about what the impact is on directors, or specifically, audit committees since they all have to do the most dealing with it.
I just might make a few personal observations.
First, you mentioned this is the one-year anniversary of FIN 48. This is my 50th anniversary in the accounting world this year, and in that 50 years, without assigning or having to disclose how I would assign weights to all the things that transpired, I put this in the top three.
I would say that when I started, we were just starting to clean up surplus. Many, if you don't remember, used to run debits and credits through surplus, not through the income statement. If you felt like it doing it, if you wanted to close a plant, you just ran it through the — or you sold some big securities, mostly debits, but some credits, too, that was a big change.
Then, a number of years ago, pensions and other post-employment benefits had to be finally recognized and disclosed and that type of thing. And I put this on number three. And I guess it's because, in one way, I think it's a pendulum type item.
The unrecognized tax benefits or the tax reserve — probably for any significant amount — the last vestige of the so-called secret reserves that were very popular a number of years ago. A number of decades ago, I should say. And the pendulum, no doubt, swung, I think, from one place where there was not much disclosed, if anything
disclosed, all the way to the other end where I think the disclosure has kind of gone overboard.
We'll see in the years ahead if that's really true or not, the latter part. The first part is certainly true. I think we've gone from minimum, again, or no disclosure to disclosure that, like a lot of things that come out today, I think there's a slightly false or overreliance on the accuracy. I don't think disclosure changes uncertainty. There's just as much uncertainty about the tax situation at company ABC or Wal-Mart or whoever before FIN 48 as after FIN 48.
But with FIN 48, you've got all kind of numbers, calculations, and it looks like everybody knows exactly what it is. They may have to disclose it now, but I don't think they knew anymore than they did before. They probably have better documentation.
At least my limited experience so far is that companies did not have that much documentation, and now they do, so I think that's a very positive aspect of FIN 48. That particular item is not disclosed that they have better documentation. At least I haven't seen anybody disclose that yet. They didn't want to say they didn't have any
before. So I think there is certainly more information. Investors will be better informed. Maybe some of the employees and directors will be better informed, too, but there's still plenty of uncertainty there.
And then just a third observation I would have is that the SEC, as well as the standard-setting bodies for accounting, have recently announced progress which seems to be really realistic for the first time in many decades, of having some convergence on international financial reporting standards in U.S. GAAP and maybe some other countries who had something else in between.
But I think as we recognize that most overseas and certainly the international financial standards are more principle-based and ours are more rule-based, and there's been a lot of pros and cons about both of the those — the advantages and disadvantages. I would say FIN 48 would not be an easy one to have convergence on if you were going to talk about somebody in China or in Italy or even in Germany. I think it'll make it tougher than what we had before. So this is one going the other way in that direction, but that's unrelated really to today.
As far as audit committees and directors since they are a committee of the board, this is a lot more work. That's not unusual. Everything that seems to come along these days is piled onto the audit committee.
Even audit committee members now get more money as directors than the other directors do because they have more meetings, they have to spend more time, and they have many more things to read. People give them piles of materials to look at before meetings, so this is just one more added on. I don't know where the time will come from, but they'll have to make time because I've probably been on a dozen audit committees since I retired from E&Y. Still on three. The amount of time we spend on taxes prior to FIN 48 was really pretty modest.
A few companies where they've had a lot of problems or they have very low effective tax rate, and that was depending on what country they were manufacturing in or some other tax situations that they were taking advantage of. But most companies, it's a modest discussion.
Now, already here in Q-1, it's become a significant discussion. Certainly, the tax director, at least for the first three or four quarters, maybe only annual thereafter, is going to have to be at the meeting.
Some people are hiring outside consultants, and they either give reports — and I don't know about the privilege side of that that Fred mentioned. We will probably ask to see or read reports or know about reports from people like that.
Certainly, if the independent audit firm has a senior tax partner sign, and they almost all do, we'll want to see him maybe more often, if we even saw him at all because there wasn't any need to before. So, there are going to be longer meetings, more time assigned, and more people showing up at those meetings.
And I think you have to keep in mind though that directors and audit committee members are not technicians. Their job is to provide oversight. It's not to set the policy.
It's not the arbitrator — sometimes they do end up arbitrating, but it's to provide — are things being implemented? Are there controls over them? Is there a reasonable approach to it, and are there pretty good professionals involved in it?
That's basically what you're doing, so that's what we would be doing, too, but, again, in this first go-around in implementing FIN 48, I think they'll be questions like, well, who does this work? Who's doing all of this new documentation that didn't exist before?
And, so, you'll probably get into more detail, and you don't really ask who's keeping the cash records, but you might be asking the first year, who's doing this FIN 48, and have you got enough staff to do it? I mean, have you been able to really make a crack at it since, as you know, there was an attempt to delay implementation
because it was a big job for a lot of companies, but that did not happen.
In addition, asking are you using any outside tax consultants, we're probably asking what are these major issues that are more likely than not going to be upheld, and how do you determine what's 50 percent? Are there some at 51 and 49? And did you start at 60 and drop to 40? Now, we probably aren't going to be getting into that
much granularity, but you kind of wonder where you've got this 50 percent. It's as if there was some magic thing. Oh, that's a 50 percent one and this is a 40 percent one, and then it comes out, as I said in a footnote, and it looks like it's all very accurate. And it comes out of a computer. Well, somebody still had to make judgments, and there's still all of that same uncertainty to it. So, I think we want to make sure that we're not kidding ourselves by the numbers we're looking at. Not that the company is not going to try to do that to us. I don't mean that. And how do you determine what the threshold measurement is, and how do you know it's an 80 percent or a 70 percent one, assuming that you have a good way of knowing whether it's a 50 percent one to start with.
Probably, as others will get into, we'll be asking, how does this affect your tax examination? Are you in the middle of one? Does it impact — probably early days, there won't be much here in these first couple of quarters, but, as years go on, as I said, the first year, there's a lot of startup time and everything, no matter what the particular chore is. And they'll get to be a pattern after the years go on. So we'll be asking about that.
At the same time, we'll be asking, if it's not disclosed already in the footnote, in the major countries, where do you stand on your tax exam? What's your status? How up to date are you? What are your open years? Again, which are the items that give rise to these unrecognized tax benefits?
Then we have the SEC. Joe here will tell us about that. I assume other than giving warnings, as they always do the first year, there's going to be more. Second and third year, they'll be asking in 2008 and 2009, well, why in 2007 didn't you tell us about this thing that was going to happen in the spring of 2008?
Because that had to be — you have to update this report. Not withstanding that there are many, many other items in your financial statements that you don't have this requirement for that could be just as or more important in terms of what's going to change on this asset carrying value or this liability, whether it's inventory or whether it's a loan loss reserve or what have you. That value, [off mike], like many things, they aren't consistent.
One particular standard has all kind of measurement aspects to it and another one doesn't have the same ones, so after you have 10 years of this, you've got to mishmash where you've got 75 pages of footnotes that are really inconsistent from one balance sheet item to another, and by the time you get 75 pages, people go click, they turn off, they're just going to stop reading because no matter how many pages of information you give people, there are still only 24 hours in every day and 7 days in every week. And there's no more time to read, even though it may be accumulated in a more efficient way, there's still only so much time to absorb. But that's another point, and that's one that I say more is not better.
But we'll be asking probably in 2008, 2009, has the SEC raised any questions? Most companies are always disclosing that to their audit committees anyway, but we're probably more curious on that.
Another thing we'll be asking about, just as we do in our strategic discussions, in director meetings, how do we compare in our industry to our competitors? What's going on in our industry? Where's the innovation? Who's doing what? How do we stack up with that? Where are we winning? Where are we losing?
Now we have FIN 48. Well, if you're in banking, if you're in retail, if you're in Wal-Mart, or if manufacturing a particular product and you have an SIC code, you'd say what about your competitors, what are they disclosing? They must have some of the same issues because they do the same things, so pharmaceuticals, are they making it in Puerto Rico? Are they making it in Ireland? What do they disclose on that? Are you this way or that? Are you right of them or left of them? So, the competitive type nature comes in just as it does in the strategic discussions.
Probably we might ask for the first time because we never thought about it before are there some tax jurisdictions that you don't file taxes in because you don't think you owe any for whatever reason, whether it be Internet or the situs or whatever it may be. I don't think I've ever heard that question asked. I think probably now
we'll probably ask it because they mentioned that in FIN 48.
So, I think there's a lot of things. Probably the other thing that we never talked about before in audit committee meetings that I've been in is interest in penalties. If you get through just trying to figure out what is the unrecognized tax benefits or the tax reserve and how much does it really cover? Try to make an estimate. Does it cover 60 percent or 40 percent of your exposure? Never, ever talked about interest or penalties. Now you have to, so that's disclosure that we haven't heard of before.
So, I would just say, to wrap up, Chris, there's a lot more, particularly in the first year, the start-up year, to be asking from an audit committee standpoint, part of which will be education for them to learn about, as I'm learning now about it.
I don't have to know all the technical. I have people telling me that, so that's a nice place to be sitting on the table.
But it does bring up a lot of issues that weren't thought about before. So, it is more work, more responsibility. I hope no more liability though. For the audit committee members.
MR. BERGIN: Thanks, Ray. Bob, this is a new world for the IRS, too.
MR. ADAMS: Oh, yes. It is. Let me just make a few points and then we can get on to some discussion. I wanted to comment on the Wal-Mart footnote. I had not actually seen that footnote before, but my guess is that since the footnote mentions the issue of worthless stock deductions, the IRS already knows about it.
MR. ADAMS: My point being that I think you'll see very little specificity of that type, unless the IRS is all over the issue already. Because from what I've seen so far from the disclosures, they're pretty opaque, and I think rightfully protective of the company's interest in not trying to provide a roadmap to us.
And I very much like the Credit Suisse's analogy of FIN 48 being a compass for the IRS rather than a roadmap. Clearly, FASB did not intend to create a roadmap for us. They didn't consult us on what to write in the interpretation, and I think that's fair.
So, let me talk as a little bit of a segue about roles as I see them.
First of all, and I just want to make sure everybody understands this, the FASB wrote the standard or the interpretation. The SEC is going to have to enforce how it's used. The IRS is very interested in what is going to be said. But those are the roles. So, we can't answer many questions about how to report.
In fact, any questions about how to report on the FIN 48, and we certainly would like to see what there is reported on the FIN 48 to see if it can help us more appropriately select returns that need examination, and more appropriately not examine returns that don't have potential high risk in them from a tax perspective. We just don't need to go down rabbit holes.
It is interesting to me that Credit Suisse compiled the conclusion that $141 billion is accruing interest on the P&Ls of 361 companies, all of which are owned by shareholders and pension funds and so forth, which I imagine would rather have those uncertainties taken off the books so that interest does not have to continue to pile onto the P&L.
I think and I'm hoping that FIN 48 will cause companies to reflect on what those uncertainties are doing to the financial statements and that they will seek certainty of those matters more quickly.
I'm very happy to tell you that we have programs to help gain that certainty more quickly and we're happy to exercise them whenever they're requested. As a matter of fact, we did institute an initiative late last year before FIN 48 kicked in before the actual adoption point, recognizing that some companies may prefer, in fact, to do away with the uncertainties before they had to adopt FIN 48 and they deal with it on the backside.
While very few takers came to the table, a lot of very large issues were dealt with, meaningful issues to those companies, and it was quite a successful program in terms of its result for those companies, certainly.
I do want to just mention one other thing coming back to you, Ray, that while more work, I'm sure, will fall on the audit committees, having spent 30 years myself in the private sector with large corporations, I really think that it is time that more attention is paid to an area of the company's activities that can involve 25, 30, 40 percent of its income and have an impact on its liabilities on its balance sheet and net worth.
It's a huge part of what companies need to focus on because it's a large expense. It needs to be done fairly and it needs to be given good attention.
So, I'm glad the audit committees are there, and I'm glad that they're going to be more attuned to what the decisions are made to do for tax and how they're reported, and, hopefully, they will also encourage their companies to deal with these uncertainties quickly and seek our help when we can provide that customer service.
MR. BERGIN: Thank you. Bob will hand out cards at the end.
Before we go to the audience, I'm real pleased to have somebody here from the SEC that I'm going to ask to react to what we've heard so far.
Joe Ucuzoglu. And I hope I didn't butcher your last name too badly.
So, Joe doesn't have to say it, he speaks for himself. He does not express necessarily the opinions of the SEC. But I wanted to see your reaction to what we've heard so far.
MR. UCUZOGLU: I'm happy to provide a few thoughts, Chris.
I think that all of the points that have been made thus far are absolutely fair ones. Ray, I think I'd agree with you that we seem to be — I think just human nature that you kind of swing on that pendulum to one direction and then, perhaps, as you swing in the other direction, it's always difficult to figure out whether you struck the balance in the middle or swung too far, but the SEC was in large part behind the recent changes to the tax reporting rules in
We were of the belief that the situation that existed prior to FIN 48 simply wasn't providing investors with the
information they needed to make informed decisions. In many cases, you had companies adopting drastically different accounting policies for the very same items.
In other words, company A has a particular type of tax transaction, particular view on the merits of ultimately having that tax position being sustained. Company B has the exact same position, the exact same view as to whether or not it will be sustained, yet, it's being reflected in the financial statements in a drastically different fashion, one of those companies may have set up a reserve against it and the other may not have simply because they took different views as to what the accounting model they ought to be applying should be.
And this difficulty for investors to understand was in many respects compounded by a lack of transparency in the disclosures. It's not as though companies were then laying out well, here's what the exposure is and here's how I accounted for it. I either did take the benefit in the financial statements or I didn't. Disclosures were
somewhat opaque. So, the combination of those two, the divergent accounting policies and the lack of disclosure led us to believe that there ought to be more consistency brought to bear both in the way in which companies accounted for these transactions, as well as the level of disclosure that would be provided.
But the one thing that I do want to make absolutely clear, and I think Bob touched on this, is that the objective of these rules was not to provide information to the taxing authority. That may well be one tangential outcome, but the objective of these rules was to provide information that investors need to make informed decisions.
And, so, in response to some of the remarks that Chris made in the introduction, will the SEC come out and force companies to be more transparent and more descriptive so as to facilitate more efficient tax administration? The answer to that question is absolutely no. No company in America will get a comment letter saying you need to disclose more because it will help the taxing authority. They may get a comment letter saying you need to disclose more because investors need more information to make informed decisions, but the objective of the disclosure and trying to figure out how much disclosure is needed will all be in the context of what information
do investors need.
And I don't think the average investor needs a multi-paragraph discussion on each particular tax issue, what the issue was, what the technical merits of the position were in terms of which code section they looked to, but they absolutely do need enough descriptiveness so that they understand the underlying risk that the company faces and the potential impact on the financial statements.
We don't want investors to be surprised and have a situation where the first time they heard about a particular tax exposure is the period in which it was settled, and they can see the check being cut and the cash leaving the organization and the hit to the P&L. We want some descriptiveness of exactly that uncertainty so investors know that, look, this is an uncertain world. As Ray said, uncertainty exists whether it's disclosed or not. The point is to make sure that that's clear to investors so that they know the possible outcomes down the road. And, hopefully, if FIN 48 is implemented correctly and investors read it correctly, it can actually play a role in what I might call an expectations gap as to the perceived precision of financial reporting.
I think, Ray, your point was excellent, that sometimes we put in all these numbers and all these tables and it might lead people to believe that we've got this thing boiled down to this precise number and the company has made exactly $3.12 per share this quarter when, in fact, the number of judgments and subjectivity that go into the
financial statements absolutely can't be boiled down to one number.
It would be nice if we could take the complex multinational operations of one of the largest 50 companies and boil it down to that one number, but you can't. In reality, there are hundreds of judgments that go into the numbers that are reported in financial statements, and investors need to understand that level of judgment and be sensitive to some of the ranges that exist as to how some of these items will ultimately play out, and, so we hope that FIN 48 can play a role in bringing that about.
The last area of discussion that I can perhaps provide a few thoughts on is this issue of waiver of privilege. This is a big issue that's been with us for some time. I think that it's only going to continue as a topic of discussion. Not only do we have FIN 48, but we have other financial reporting rules that are, in many respects, requiring more use of fair value information, more use of information that might require the input of attorneys, and we're only going to
see this issue continue to pop up more and more as to how do we balance these competing objectives of protecting the rights of companies to consult with counsel, while at the same time, ensuring transparency in financial reporting. And while I'm not an attorney and I can't comment on the details here, we've got to come to a medium where there's not a disincentive to share information with auditors.
In other words, auditors are out there trying to act in the public interest and ensure transparency in financial reporting, and we don't want there to ever be a situation where a company is actually disincentivized to be completely transparent with their auditors.
The auditor needs access to all of the information the company has that might have a bearing on the financial reporting, that might have a bearing on clear and complete disclosure, and we certainly don't want a situation where a company's put in the position of having to think should I be less transparent because I may potentially run up against these other competing objectives of protecting privilege.
MR. BERGIN: Thanks, Joe. I'm going to open it up for questions now. Please remember when I recognize you to state your name. Do you want to start?
MR. JAWORSKI: Tom Jaworski, Tax Analysts, Financial Reporting Watch.
MR. BERGIN: See, even if I know you, I'm going to ask that you state your name.
MR. JAWORSKI: So, it was mentioned prior that common practice in the initial phase of FIN 48 implementation has been for companies to hire outside consultants to help them prepare their FIN 48
disclosure, and this extra help could lead to additional costs, obviously, for companies of all sizes, large and small.
And I was wondering is the SEC or the IRS concerned about a potential backlash, so to speak, from these companies over the costs associated with complying with FIN 48, similar to the controversy over the additional costs for SOX 404 compliance?
MR. UCUZOGLU: Certainly, we always need to be cognizant when putting out new rules of the cost-benefit relationship, and I think implicit in the FASB issuing FIN 48 was their judgment that the cost benefit relationship was a positive one.
That said, we have gone out of our way, along with the FASB, over the past six or eight months to make sure that companies are adopting this in what I might call a practical manner.
Initially, there was some level of fear that this would become another massive paperwork exercise and that companies would have to put together reams of binders and get outside opinions for each and every tax position that they have, even though the vast majority of positions that companies claim are in fact subject to little or no
So, we have tried to spread the message that companies and auditors ought to be spending their time on that subset of issues that really have the subjectiveness and judgment and are right around that 50 percent borderline where you may — if you're just above, you recognize it, if you're just below, you don't. That subset of positions, and I think by and large, companies have a pretty good understanding of which of those really sensitive positions, more so in the U.S. jurisdiction- I think companies have had to spend some additional time getting their minds around what the significant exposures are in foreign jurisdictions, but by and large, companies have had an understanding of what those truly judgmental subset of issues are, and that's where they have to focus the effort, not a paperwork exercise to come up with a binder for each and every obvious tax position.
MS. HARRIS: Christi — oh, I'm sorry.
MR. ADAMS: I'm sorry. I don't think the service would view what's been required for FIN 48 purposes to be that much more of a resource drain on companies in this respect. They've had to do tax accrual workpapers; they've had to make the accruals.
There's a bit more specificity, perhaps, in terms of the system employed.
But my sense is that it's tweaking what would have been required by Sarbanes, and, prior to that, had it not been done at quite such a finite level, perhaps, it should have been. I mean, the opportunity to have a big cushion to draw from, to manage profits, and that sort of thing probably was borne of a lack of specificity in the system.
So, in a way, you could say to the extent that there's more refinement required now in that system, there was a large resource savings in the past.
Now, having said all of that, TEI, I'm pretty sure I read, has surveyed their members, and basically concluded that within that organization, their membership is in pretty good shape to manage the process and deal with and without having to go out and hire new people or otherwise employ huge extra efforts, that it's going to be part of the annual process and while initially there's a short timeframe in which there will be some modifications to the basic
process, the basic process is still the same.
So, having been that long in the private sector, I don't see that that would have actually increased costs that much, just in terms of doing the tax accrual.
MR. GROVES: My sense is that it's a modest additional effort. It's a lot by a few people, but it's modest overall, and it's not in the same league with 404. I mean, they're playing in a different ballgame there.
MR. BERGIN: Fred?
MR. MURRAY: Just to I guess raise one question though, Bob, which kind of keys us into a different area. All of us so far have been talking about public companies, and private companies are also subject to these new standards. Anybody who's basically got GAAP basis financial statements has got to comply with these results, and I wonder if anybody's got some observations on where the burdens are there.
MR. BERGIN: Too early?
MR. GROVES: I would guess that the documentation burden is percentage-wise greater for the private company than it is for the public company who had to have some documentation and have some accountability beyond what a private company — so, some of them may have very little.
But, again, it should not be a big effort. But, percentage-wise, would be a bigger effort for a smaller company that's private than for a big company because a small percentage of what they have to do, but it's still primarily a one-time item for them, I think, and then a update each year would be modest, I think.
But they would have more costs percentage-wise. It would hurt them more than it would hurt Exxon.
MR. MURRAY: I guess just to pick up that thought, Ray, my own experience with some of the smaller companies has been, at least in the past, with respect to tax reserves is that there was not a lot of documentation at all, and this may have actually forced a first-time effort for a lot of those companies to actually deal with a lot of
these things that they might not have been perhaps as careful about in the past, or at least spend as much time and attention on.
MR. BERGIN: Which may not be a bad thing.
MR. OCHSENSHLAGER: If I could just tag on to that, too. Where the smaller companies may have not the skills, actually.
Typically, with a larger company, the SEC registrant probably does have a very skilled financial team, but with the smaller companies, in a lot of cases, they don't have the same sort of skill levels, and they're going to be relying a lot more on their auditor to be helping them with the FIN 48 analysis, and then you have to be careful that you're not crossing the line in breaching the independence that's required of the CPA.
So, I think with the smaller companies, it is a much bigger issue, not just a percentage sense, but also even a —
MR. BERGIN: Right.
MR. CAPLIN: I'm Mortimer Caplin, an ex-tax collector, and —
MR. CAPLIN: And now I'm representing private interest.
As I look at these two 10-Qs, I'm wondering what standards the SEC will require or establish so far as specificity on different issues. I mean, one is a number, the other is great detail. We know something about why there's so much detail, but what about generally? I think companies are really concerned about this.
MR. UCUZOGLU: I think at this point where we've only had one 10-Q filed thus far and the SEC hasn't had the opportunity to actually go through and process many of these, and, certainly not draw broad conclusions. It's a little premature to make any comments as to whether practice as it exists today is specific enough, not specific
enough, but I think that the standard we'll be looking to is the words and principles in FIN 48. FIN 48 drives the disclosure at a level that is sufficient for an investor to understand what may transpire in the future, but, at the same time, there's no expectation that there's going to be a laundry list naming position by position.
Now, I'm not sure it would be sufficient to just have one number and say in total, in the future, we've got tax exposures of $1.3 billion because those positions are subject to different levels of risk, different timing in terms of when they may play out and may be, in fact, a drain on the company's cash or have an impact on the P&L.
But to the extent the company is able to aggregate meaningful buckets in a way that is compliant with the requirements of FIN 48, those disclosures can articulate what an investor would need to understand in a matter other than providing a laundry list of each and every issue. We're certainly going to be open to that approach.
MR. CAPLIN: I think in the past, many audit committees get reports that the director of taxes will come into the meeting and say here is our total reserve and break it down by specific issues just identified and they talk about the bridge issue and the depreciation issue here with a number on the side and then — I don't know whether you are thinking along those lines of having identification of large issues, which could have an impact on whatever the tax rate is.
MR. UCUZOGLU: We certainly don't have the expectation that a company's actually going to publish that schedule. But, again, depending upon the particular type of tax position, how significant it is, what type of an impact? I mean, is this a deal-breaker that's a multi-billion dollar issue depending on how it turns?
In that extreme circumstance, maybe the company would need to highlight more of the specific attributes of that particular position, just given its significance as well. For certain other issues with other attributes there may not be a need to go into the details of each and every one. It's going to be fact-specific. People are going to have to
apply judgment, and I don't think this is an issue that is unique to income taxes. I mean, these same issues in terms of not wanting to tip one's hand to the counter party while being transparent to investors come up in any number of litigation contexts, companies and their outside advisers and auditors have to make these judgments
about that balancing act everyday.
MR. ADAMS: Chris, if I can?
MR. BERGIN: Yes, please.
MR. ADAMS: Let me just make an observation along these lines in terms of transparency, and what's really being told to shareholders, and you get a good view. And I know it's only quarter one, but this is an interesting example.
This company, which I won't name, has its footnote out on the 10-Q, and it says, "Including the cumulative effect increase at the beginning of 2007," which is the transition adjustment to retain earnings, "the company had approximately $6 million of gross, unrecognized tax benefits, all of which would favorably affect our effective tax rate, if recognized."
So, that was out, let's say, some time before April 15.
June 29 from Reuters, so and so company said "The U.S. Internal Revenue Service has claimed that the company owes additional income taxes of about $122 million, plus penalties of $49 million for 2003 and 2004 tax years."
Now, this relates to an intercompany pricing matter, and I can imagine scenarios where the amount of cumulative cushion is sufficient in that circumstance. But a reader reading this, reading the footnote, juxtaposed to what happened next wonders why didn't I know about this?
MR. BERGIN: Right.
MR. ADAMS: The potential sounds very large. So, this example, to me, is a good example of not having to be specific in terms of tax issues, but having to protect your shareholders who currently own the stock from being able to dump it soon enough.
MR. BERGIN: Good point. Let me drift back to the tax side and go away from the investor side for a quick second, Bob, and ask you a question.
If I remember correctly, the Credit Suisse Report talked about the FIN 48 disclosures as being the compass, but the tax accrual workpapers as being the road map.
For the last several months, I guess, since LMSB announced that is was reconsidering the position on tax accrual workpapers, which is a completely reasonable thing to do, a lot of people I talked to have been on total pins and needles.
By the way, you don't have any news for us today, do you?
MR. ADAMS: Unfortunately, no.
MR. BERGIN: Okay. So, the policy of restraint remains the same as it was.
In May, LMSB issued some language that said that FIN 48 workpapers are tax accrual workpapers and they are, therefore, subject to our current policy of restraint.
MR. ADAMS: Correct.
MR. BERGIN: In June, counsel issued a notice that stated, and I quote, "We have concluded that effective tax rate reconciliation workpapers are neither tax accrual workpapers nor audit workpapers."
Now, again, remember, I'm a novice in this area, but they don't seem to make sense to me.
Can you explain the difference of why one is subject to restraint and one is not subject to the policy of restraint?
MR. ADAMS: Yes. First of all, let me reconfirm, because I want to make sure it's emphasized that the policy of restraint that we've had in our tax accrual workpaper policy as a whole was last revised in 2002. So, the way it was before the announcement by Debbie Nolan in February is still the same. Current policy applies.
And as a result of counsel's determination that FIN 48 workpapers are tax accrual workpapers, they're also subject to the policy of restraint, so I just want to emphasize that.
The recent announcement or notice refers to a required footnote or footnote that's required by FAS 109 for public companies, and private companies are also required to explain material differences between a sort of notional tax expense in contrast to its reported tax expense. And the footnote requirement is that assuming the
statutory rate of a major jurisdiction at 35 percent, for example, in the U.S. times pre-taxed net income would give you X. Y is your reported tax expense Y. The difference is always comprised of permanent differences, and that's important in terms of what it says about the effective tax rate in the sense that timing differences produced deferred tax compliments or offsets to the reduction in current tax.
The importance of that footnote is that it includes all permanent differences that we also require on Schedule M-3 to be reported to us. So, a little different formulation of how it's done, a little different nomenclature, but basically they're the same.
In finding that some of our Schedules M-3 were not being done very well. In fact, a significant portion of them, we asked how do we verify what's coming in on the M-3? And that's important for purposes of assessing risk and returns.
Well, for years, the tax rate reconciliation footnote data has been used as an audit technique to do audits. But it hasn't been used a lot. So, it was something not known or the technique was not known to a lot of taxpayers.
Consequently, when we started thinking about the M-3 and we started thinking about that footnote, the question was, why is that not a good technique to use to validate Schedule M-3 requirements?
And then, because of the conversation about tax accrual workpapers and the heightened interest in that area, questions surfaced about, well, are we going to get pushback in terms of is that a tax accrual workpaper, and counsel answered the question no, it's not, because it's neither of the two things defined in our IRM that is covered by the policy of restraint.
The important thing to me, in addition to counsel's opinion, is that Schedule M-3 requires the reporting in a return of the permanent differences, so we're not asking for anything that we shouldn't already be getting in terms of requirement on a return, but having the details to that footnote that's required by FASB. Those allow us to verify that what we're getting is the same thing that's being
essentially underlined, what's told to the public.
MR. BUSEY: Ken Busey, PricewaterhouseCoopers. I'm glad we're talking about this particular topic as it has raised a lot of questions in recent weeks; the effect of rate reconciliation notice. As you mentioned, the main items in that schedule are permanent book tax differences. That's what reconciles the statutory rate to the effective rate.
There's another reconciling item though and that is changes in tax reserve, also run through that schedule. And so the question that's been raised in more than one forum is, is this a — and these aren't my words, are their words — a backdoor attempt by the Service to gain access to tax accrual workpapers; that is that portion of the reconciliation that related to reserves as opposed to plain old book tax difference. I wonder if you can make any comments with respect to that.
MR. ADAMS: Okay, the question was, is it a backdoor approach, the tax accrual workpapers? The answer is no. Now let me take another —
SPEAKER: Side door?
MR. ADAMS: Sorry?
SPEAKER: Side Door?
SPEAKER: Side door.
MR. ADAMS: No, not side door.
MR. ADAMS: It's a good thought; I'll work on that one.
MR. BUSEY: Any point of egress or — no.
MR. ADAMS: Let's think about what FIN 48 requires annually in the tabulation. It asks what is a reserve and what is the change in certain strata, if you will. So the answer about changes in reserve is — whether it's in that tax rate reconciliation footnote or not — it's already going to be in a FIN 48 disclosure. So we know those numbers already.
We're going to know them at the end of each year.
So we're not learning anything new about that. Depending on how that — the underlying detail to that footnote is constructed, you might have a number that says change to reserve for the year. You might also have something else as the delineator, which is a number different than it was in a prior year, or it's — if it's a current year item, it's different from what's on the return.
So it doesn't refer to the word reserve or cushion, it's only an amount in the financial statements, then it's different on the Schedule M-3. And we're interested in that, and that's why we applied the technique. But in my mind if there's anything referencing in the underlying workpapers to the reserves, then it's referencing to the tax accrual workpapers and the tax accrual workpapers are — is — the information we don't go after.
What's in the tax reconciliation footnote workpapers can be compartmentalized if it's properly done, if there's a concern about us looking at underlying workpapers referring to the reserve. So the point I'm making is that taxpayers and registrants have control over what they — how they — construct that footnote. And while it may
have to list all the prominent differences, it can be constructed in a way where it can cordon off what would otherwise be tax accrual workpapers.
So it's not an effort to get to them through the back door. It's just an effort to use what's basically publicly available and have significant enough detail to verify what we already have coming to us. I hope that's responsive?
MR. BERGIN: Yeah it is.
MR. ADAMS: Yeah.
MR. BERGIN: And to be clear, the IRS has the right to tax
MR. ADAMS: That's true too.
MR. BERGIN: The policy of restraint is self-imposed. Having said that, just to get the question out there, these two types of papers are separated. The ruling from counsel regarding what is not tax accrual workpapers is not an indication on where you're going with the decision on whether to change restraint or not?
MR. ADAMS: That's correct.
MR. BERGIN: Okay.
MR. ADAMS: I mean, bottom line, our evaluation is still under process. The question about tax accrual workpapers, whether or not FIN 48 are tax accrual workpapers was actually a response that we drove because it was being asked so much from taxpayers. And while we always said, well, we surely think they are, but we had never seen them, we don't know what's going to be in them, and so we said, counsel, what do you think?
And so we got an answer that, I think, is the right answer. It's always been the right answer in my mind, but I think we just wanted something that we can latch on to it to make public. So that doesn't signal anything about what we intend to do with the policy of restraint. Other than that those FIN 48 papers are just as protected as other tax accrual workpapers.
MS. HARRIS: Christine Harris, Tax Analysts. But in the context of at the end of the year, these end of the year disclosures, annual disclosures, is it plausible, if not absolute, that the IRS, once it receives more information from companies and starts to look at the financial statements, won't begin — or at least basically revise its policy once again. Is it plausible? You're evaluating it now, so —
MR. ADAMS: Nothing set in stone. That's true, and we are evaluating our current policy for a purpose. I don't know where that's going to end up, but it is being looked at.
MS. REEDER: Barbara Reeder, PricewaterhouseCoopers. Bob, do you have any idea of the timing of your decision making process with respect to your policy of restraint for tax accrual workpapers.
MR. ADAMS: You know, I'd rather not suggest a time because as soon as I say a time it will be three months later or five months later or two months later. So I'd rather not create any expectations. And frankly, it's a long and windy road to get to what you want to do and to make sure you've touched all the bases and done it reasonably
and thoughtfully, and that's what we've promised to do. So I'd rather just stick to the promise — just going to be reasonable and thoughtful — and not on the timing.
MR. BERGIN: Martin.
MR. LOBEL: Marty Lobel from Lobel, Novins and Lamont. I'd like to pick up on a point Ray, sort of, dropped into the conversation, the international aspects of this and reporting. Admittedly investors need more information; I think that's a wonderful purpose. But it appears to me that the largest single items would be the uncertainty
about some of our transfer pricing things that go on that the IRS seems not to have noticed in large measure.
Some of the offshore tax shelters. I find it hard to believe that the Cayman Islands is the fifth largest banking center in the world. I find it hard to believe that most of the hedge funds are located in Bermuda. I've been there, and there's not enough room on the golf courses for all those guys from Greenwich.
You also have political instability, for example, in Russia, which seems to be devising tax programs in American companies over there.
And these all seem to pose substantial tax risks for the companies. Now, how do you do that under FIN 48?
MR. UCUZOGLU: Very carefully, is not sufficient?
MR. LOBEL: I mean, if I were sitting in Ray Groves' position on an audit committee, and I see all these, you know — well, the one that's real public is Microsoft, according to Glenn Simpson of The Wall Street Journal, saving $300 million by renting a desk in a solicited office in Ireland. And you're sitting on the audit committee and saying, well, you know, Congress is likely to do something about this; do I have to take that into consideration. You know, the EU is now trying to close some of these loopholes and the administration is still opposing the closing of the loopholes. What do I do?
MR. UCUZOGLU: Well, the one thing I can say with certainty is that the entire income tax model, that is the model for reflecting income taxes for financial reporting purposes, is built off of currently enacted law. So we don't expect people to have a crystal ball. To the extent that there is a possibility, a jurisdiction might put out a new ruling or change the law, that doesn't have to get taken into account.
But I can still appreciate that it's a significant challenge to analyze the merits of these positions under the current law even assuming no change. And, I mean, these are all, kind of, degrees of severity. Obviously, we have a much more formalized and robust process here at home with respect to U.S. taxation issues.
My understanding is that attorneys are very familiar with some of these thresholds. The type of opinions we're talking about, you know, more likely than not, opinions, have a well established place within the infrastructure of the U.S. taxation system and the legal advice that companies get.
And I think as you get outside of the U.S. jurisdiction, whether you have the same infrastructure in place, it's something I'm not qualified to speak on. But the company certainly would need to look to whatever expertise was available to them in some of these foreign jurisdictions to make these very same cuts.
In other words, is this position more likely than not, being sustained in whatever jurisdiction it is that we're talking about based solely on the technical merits of the law in those jurisdictions. And when you have jurisdictions that perhaps aren't quite as stable as our own, I think we can certainly appreciate that it becomes incrementally more difficult.
And I would say that in response, the company ought to be that much more transparent and disclose that much more so that somebody can understand it was even more difficult to reach those judgments in certain foreign jurisdictions.
MR. BERGIN: Go ahead.
MR. MURRAY: Just kind of a follow on point to some of that conversation. Joe, as you know, the commission announced in its open meeting several weeks ago and gave the staff permission to go forward with the proposal to look at IFRS and whether or not those best statements would be acceptable for filings here with the SEC.
And as I recall, those standards don't include a FIN 48 type standard, and I wonder if that's going to have some impact on whether or not that kind of process — you know, how that process will work. And particularly, if it becomes elective whether you're in GAAP or IFRS, can companies opt out of FIN 48 by whatever. I appreciate your observations, but how that process is going to move in this regard.
MR. UCUZOGLU: Well, let me —
MR. MURRAY: Is this a convergence item, I guess, I should say.
MR. UCUZOGLU: Let me provide a broad observation and then one specific to income taxes. There is no illusion that U.S. GAAP and IFRS are currently the same. I mean, there are differences. The proposal to potentially allow foreign private issuers to file financial statements under IFRS without reconciliation to U.S. GAAP, isn't predicated on the assumption that the two sets of standards are the same.
It is predicated on the assumption that both sets of standards are a high-quality comprehensive basis of accounting such that an investor would be able to make an informed decision, using a set of financial statements prepared under either. Now, that would be underlying logic if the commission were to go forward.
That said, the IASB actually is working on, I won't call it a FIN 48 equivalent because I don't know that it's covering the exact same stuff, but they are working on their own piece of guidance that does deal with tax uncertainties and how they are to be reported.
Now, it's not exactly the same as FIN 48 and there are some reasons why this one wasn't done in a joint fashion as some of the other projects that the two boards are working on are being done in a joint fashion to come up with a consistent standard. But they are working on their own version.
MR. PETERS: That was basically the question that I was going to have on the convergence issue because there is at present significant differences. And while they may be working on something principle based, there's certainly going to be significant differences between that and how it's applied and what we have here.
So from a competitive perspective when you look at Shell, BP and Exxon, you know, they are going to have significant disclosure and perhaps significantly different numbers on the same issues. And there's — as far as oil companies are concerned, that's probably among the most complex of tax situations.
MR. UCUZOGLU: Well, this is certainly not an issue that's in any way unique to income taxes. If there are in fact two sets of standards that companies may have the opportunity to use, and there are differences between the two, in the income taxation area some companies may prefer the U.S. standard over the foreign one or vice versa and there's going to be other areas where the dynamic is in reverse, where a company would prefer one over the other. And — I don't think that's in any respect an issue that's unique to income taxes.
That's a broader issue with respect to having two sets of accounting principles that aren't the same.
MR. BRUNORI: David Brunori, Tax Analysts. I had a question for Fred. Fred, did you mention before that in your experience companies are being more conservative in their tax positions or will be more — your prediction was they will be more conservative in their tax positions in general because of FIN 48?
MR. MURRAY: I guess, I was really raising a speculative question in some respects because I know in my own experience so far with respect to some of the issues that had been raised talking to some companies about some of the issues that they were trying to wrestle with have gone into this mix. Just from a corporate culture
standpoint there are certain things that are important internally and in the management of companies that sometimes affects behavior.
And among other things our companies have always been abhorrent of — you know, they've never been in a position where they wanted to see a penalty applied by IRS because that sometimes had more of an effect that just paying the additional tax, for example, just because it sets off a lot of alarm bells internally inside the company.
Now, in this context I've seen — placed one situation where management was really reluctant to take this to the audit committee because it's just not something they — the tax department typically wants to do, go out and give bad news to the audit committee that there's an issue there that needs to be looked at. And I just wonder, over time, whether this, and the fact that some of these things are going to show up in the credit reports and other things like that, may force companies to say —
I mean, obviously from a regulator's perspective or from Bob's perspective, it may be a great thing because maybe companies won't get into some other kinds of, for example, shelters that we've looked at in some of the situation in recent years. On the other hand, I just wonder if it might effect, you know, sort of a garden variety
behavior and a lot of — a range of other issues where companies just say, you know, if we do this, we'll increase our exposure; we'll have to go talk to the audit — you know, we'll have these kinds of things to deal with. And in some cases may well just pay the tax so we don't have to go upstairs and talk about it.
MR. BRUNORI: Yeah, my question — yeah, that's what I thought you had said.
MR. MURRAY: Yeah.
MR. BRUNORI: And isn't that kind of a net good for society?
MR. BRUNORI: I mean, you'll have companies taking less aggressive positions, right, and instead of going out on a limb, they'll be a little bit more conventional in their thinking? Isn't that — that's not necessarily a bad thing, is it?
MR. MURRAY: Well, I — you know, you can certainly make that argument. On the other hand you can — from a shareholder perspective, if I'm paying a lot more tax now than I might've been paying before, maybe I'm not as happy about that. Maybe from an investor perspective if I look at some of these numbers as Credit Suisse eluded, some investors are going to look at those companies that have the highest tax risk and say, you know, I don't want to invest there or they're going to look at — look for something in the share price to give them the comfort they need to figure that they're going to get the return that they would want over time.
And in some cases if we just pay the tax just because we don't want to have to deal with some of these issues, even if we didn't owe the tax, I'm not sure that's necessarily good for society. You know, it's a mixed bag. There are good things here, but there maybe some follow-up.
MR. CAPLIN: I'd like to add a word there. I think part of this conservatism may grow out of the sea change that's occurred to the IRS. I mean, when Commissioner Rossotti was in there, he was at the time of the, sort of, the whole restructuring of the IRS administration. And the emphasis was on coffee and donuts, customer service, and I hate that word.
MR. CAPLIN: Yeah, right. But I think with Commissioner Everson
coming in, I think you've seen a big shift in the pendulum.
I think that you see a lot more sophistication on enforcement. You know, the great formula service plus enforcement gives you compliance. But I think that's really put a big restraint on some of the activities. Bob has something to say.
MR. ADAMS: Yeah, I was going to jump in too. And thanks for that comment; I appreciate it. We do less coffee and donuts than we used to, and we always pay for them ourselves.
MR. CAPLIN: That's right, I remember the coin box.
MR. BERGIN: Of course, the question is who's pushing that pendulum.
MR. ADAMS: Well, here was — I wanted to respond to your point in this way. Even Credit Suisse says it could cause companies to relax its aggressiveness a little bit and maybe not take as many chances, and yes, that could benefit a lot of coffers of a lot of treasuries, but in point of fact, I think there are mechanisms in every taxing jurisdiction to help get taxpayers, to help them minimize their taxes and know beforehand that they're not walking
into an uncertainty. It's not always available because of the circumstances and the transactions being done.
But when you think about our own jurisdiction, we have private letter rulings, we have pre-filing agreements, we have many ways to gain some certainty, not before the transaction is done, but at least before the return is filed and hopefully before the financial statements are presented — prepared and presented.
On the back side of that, if you have any issue that's going to keep the certainty going, we have avenues, and most jurisdiction avenues to deal with those uncertainties sooner rather than later when taxpayers are willing to do so and when they want that certainty. And again it doesn't stop people from doing transactions. What it does do is, say, if you have an uncertain situation and you have to sit here and keep accruing interest, that's not so good for
your shareholders to write actions to go get an answer.
MR. CAPLIN: The question you raised, and who is pushing the
pendulum? Part of it is the pressure from the Hill.
MR. BERGIN: Yeah, that was my point.
MR. CAPLIN: The whole question of tax gap —
MR. ADAMS: Tax gap.
MR. CAPLIN: — and there's greater and greater support at least on the Senate side right now — and perhaps it will happen in the House as well — for the IRS to try to close that gap. They don't have to amend the law, amend them saying to get rid of this preference; let's get that other money first that's sitting on the table. And I think this whole pressure on tax accrual workpapers you mentioned.
MR. BERGIN: Yes.
MR. CAPLIN: You may hear from the Hill on that before long.
MR. BERGIN: Yeah, that was my point —
MR. CAPLIN: Yeah.
MR. BERGIN: — that the pendulum is being pushed not necessarily or at all by the IRS.
MR. CAPLIN: That's right.
MR. BERGIN: That's from our friends on the Hill.
MR. MURRAY: I just want to add, going back to the point that was discussed a little earlier about some of the international effects of some of this as well. There are some problem areas here that are not easy to wrestle with. For example, the nexus issue that you have with the states, but also the PE issue that you have with respect to a lot of foreign jurisdictions. And then when you look at cases like the Phillip Morris decision in Italy a few years ago and some of the discussion around what the Italian court did there in trying to fashion its view of how profits ought to be attributed to a permanent establishment in Italy. A lot of U.S. multinationals that have operations in Europe were concerned about some of the concepts that were raised there.
And then if you look at the analysis that's going on here, and particularly if you try to speculate about what the Service might do with respect to tax accrual workpaper policy, and the information that's available and all those sorts of thing.
One question that Bob and I have talked about, and I have still haven't got an answer as far as what the Service is going to do, is what are we going to do under treaty information exchange agreements, and other kinds of situations like that where other tax authorities may want some of this information as well.
So we are not only talking about our own tax situation here, but that might be applicable in a number of other jurisdictions, and some of which the standards are much more difficult to apply than they are here, and much more problematic.
MR. ADAMS: Is that a question?
MR. MURRAY: Yes, sir.
MR. ADAMS: Elvin Hedgpeth and I spoke at the Tax Council Policy Institute and the panel that addressed this matter in February. I think it was February, and obviously I am not in the international section, and clearly this is their domain, but anticipating the question might arise, I did check with them before I came.
And basically we do — I think everyone knows we have mutual exchange agreements. We also have treaties that require a certain amount of exchange of information. It's interesting to note that in the history of tax accrual workpapers since 1980, we've had overall about, a look at about a 130 tax accrual workpapers. Only less than — let's say less than 10 — occurred, but we got a little bit before 2002.
So when you realize that we have had possession of very few, the opportunity or the circumstance where they have been requested, had been virtually nil. They are in fact nil — they've never been requested from us.
And we've never requested tax accrual workpapers from anybody else in terms of a mutual exchange.
Will that change? I don't know, but it's based on whatever happens in that domain, and I think the touchstone is that we are always conscious of not doing things that would be against public policy, number one, which is very important. But number two, unless there is an absolute quid pro quo it is unlikely that we would divulge, even if we had them, tax accrual workpapers without tax accrual workpapers from the other direction in the same circumstance.
Now, you know, we have joint audits in some jurisdictions. So there is a potential there that as auditors work with each other, there might be some information they could share. I guess it depends on whether or not there are tax accrual workpapers at hand. But circumstances are limited in which we get them, and I don't know in the future what will hold, but we'll just have to see.
MR. GROVES: Chris, I think Fred brings up a good point, the measurements — the kind of measurements and disclosures — do affect in some cases actions that management, shareholders, employees, whoever may take.
Certainly when pension disclosures and measurements were changed, there was a prediction that's certainly come true. It said people won't grant the benefits they are granting, that it won't take place for 20 or 30 years, on somebody else's watch if they had to be measured currently, and the number of defined benefit plans in this
country has probably dropped in half.
You know, if it was two-to-one defined contribution —
MR. GROVES: — it would benefit the — it's reserved by now or something of that magnitude. Part of which is the recognition this stuff comes home to roost. And all these state and local governments will have to put it on their balance sheets, you wonder would they be giving you know, retirement, 20 years, you know, at age 39.
MR. GROVES: If they had — if the current persons granting that had to actually pay a portion of that. So it does have an impact, and I think, there'll be some people, I am sure I don't know any.
MR. GROVES: But there will be some people that will be more aggressive on their tax, they'll say, "Gee, this is not a 60 percenter, this is a 95 percenter. So my unrecognized tax benefit is not $100 million it's only $10 million, because I am going to have to argue with the IRS anyway, why don't I argue from that position and say, I think I'm right 95 percent, and I've told my shareholders that."
I think there'll be people who do that. There'll be some of the conservative that will go the other way, just like you said it.
MR. BRUNORI: That's why Bob should have a small army of auditors reading every one of these disclosure reports, for people who take the billion dollars, or the — whatever it is. You do have a small army of auditors reading this stuff don't you?
MR. ADAMS: No, but I want your name.
MR. BERGIN: So we could make — your point is we could make some companies more aggressive, and some companies more conservative?
MR. GROVES: I would guess that, I don't have any, you know, any evidence of that, but I would guess it.
MR. BERGIN: That, I think, it's a good guess.
MR. STEUERLE: Gene Steuerle, from the Urban Institute. I am not that familiar with this particular issue, but I am familiar with the issue of how important accounting is to economics and to our market economy. And it's beyond just the issues that you raise with the SEC with terms of people just having the right amount of information so they can invest accurately.
But accurate economic accounting actually leads to allocating investments correctly. So, for instance you mentioned this, your example with the pensions, the fact that pensions were often not in my view accounted for accurately in the economic sense in terms of other future liabilities, led to all sorts of really bad allocations in terms of wages today, versus wages tomorrow, in terms of even survival in some companies.
And, so my question, so I've always very strongly believed that the accountant has this extraordinarily important role which is beyond the audit function, beyond the honesty function, it's actually making sure the accurate accounting gets us to allocate the resources that allows basically the modern, if you want to, industrial and post industrial economy to function well.
And so my broad, very broad question is do items like this, decisions like this, actually re-empower the accountant, so we move away from the day. For instance when I first came to town, when the AICPA was putting out proposals to increase IRA deductions for absolutely silly reasons, or when accountants within firms were
saying they had become a profit center, as opposed to reflecting accurately what's going on.
Do we actually now re-empower the accountant within the corporation and within the big four accounting firms to say, "Hey, my job is to really, accurately report this income," and the people, who are pushing to do otherwise, are weakened, or is this just too small of an item in terms of that?
I just consider that, it's just an extraordinarily important issue. I certainly think that's the direction as you see is going, but I am wondering more broadly, are we actually empowering the accountant to report accurately?
MR. UCUZOGLU: I think you are absolutely right, and while this may just be one little piece, it's kind of a continuing trend. Accountants have been extremely empowered in the post-Sarbanes age. But the point that you and Ray bring up is a critical one, and I think it highlights a distinction between the underlying purpose of financial reporting versus tax policy.
On the tax side, often times — obviously the purpose of taxation is to collect revenues — but there's also another purpose which is to incentivize certain behaviors. Congress wants to encourage this constituency to act in a certain way, or you know, more high-tech investment.
Financial reporting has a single goal, and it is absolutely not to encourage a certain type of behavior, or discourage a certain type of behavior. It's just to layout the truth as it is. To get the information out there, in a transparent accurate manner and that may in fact have real world economic consequences. And that's the intent.
If it wasn't important we wouldn't all be spending this much time on it. But sometimes we will be working on a new rule or a new proposal, and somebody will say, "Oh, if you enact that it will show how costly xyz benefits are." And then companies will give less of them. And that would be bad, because then workers will have less benefits, or something along that same theme.
And the response from the standards setter or from the SEC is always consistent. Our objective is not to try to incentivize or disincentivize a particular type of behavior, or encourage a certain societal trend. It is simply to lay out the truth. And if the truth is painful, well, then people ought to be confronted with it and ought to then make public policy decisions based upon having the full facts set at their disposal.
SPEAKER: This question is for the IRS and the SEC both, and you know, given the macro level that you've talked about, about good financial reporting, we are still interested in you know, as these disclosures come in, what is the relationship going to be between the IRS and the SEC, and you know, once the paper actually comes in, what's going to happen to it?
MR. UCUZOGLU: You know, as we've said, these rules were really written from the perspective of providing additional information to investors. I certainly don't contemplate a large level of interaction between the staffs of the SEC and the IRS.
Clearly, if there is a particular tax issue that comes up in a question as to how it ought to be reported in the financial statements, we certainly have the ability to call over to the IRS, and have — or any other taxing authority, for that matter, and try to gain a better understanding of the issue, so we can assess whether it is being appropriately reflected in the financial statements. But I wouldn't expect that the nature of interaction would be that
drastically different than whatever the interaction has been historically.
MR. ADAMS: You know, the IRS is a large consumer of information as you can imagine. We get information — good information — where we can get it. The SEC provides a lot of good information. But all that information is public record. It's all public documents, and we use that anyway we can to the best interest of the IRS.
On the other hand, we are duty bound not to disclose information that we acquire to anyone, basically, including the SEC. So, the relationship that we've always had has been one of mutual help in ways that we can be helpful, but there are very few ways in which information can be directed to the SEC from the IRS.
MR. ROACH: My name is Bob Roach, I am with the Permanent Subcommittee on Investigations. And I'd just like to remark on something on he said, which is that the purpose of these requirements, is to do one thing, and one thing alone, and that is to try to make sure that the truth as the financial situation is laid out.
From what I can see, no one here disagreed with that. And given that, I guess I am just wondering why there — at least what's expressed today, there's such a tremendous defensiveness on the part of the regulatory agencies, and so much apoplexy in the part of the practitioners that have spoken today about FIN 48 or anything else,
serving as a roadmap to what companies are doing with respect to their tax positions?
Why shouldn't people know that? I mean, if they've done something properly then the empirical evidence will show that. And if they've done something wrong, they probably shouldn't have done it, and it's good they get caught. So, why is it that even though the Supreme Court said that the IRS can look at the tax accrual workpapers, the IRS says, "we won't do it?"
Why is it that companies are so afraid, with the IRS looking at it, if they really believe the position they took is a good one? And I'd just like to hear some comments on that.
MR. CADLEY: Jim Cadley. For many years I was at the Internal Revenue Service. I was the associate chief counsel for litigation for a period of time, and I was also special counsel for a large case. I tend to fully agree with your comments saying, "What's wrong with everybody knowing all the facts?"
And as a litigator it was like, "Well, just give me all the facts, and we'll make a decision." But on point of the tax accrual workpapers, having lived through that debate many number of times, and it continues to be debated, I think the agency exercised more restraint than I would have as a litigator, because they were clearly concerned with reaction you would get on the Hill.
That if they took the full position saying "we want them in every case" that they would have a very adverse reaction, and something worse would come out of it, when they thought most cases they were getting sufficient information to be able to operate the way they were operating. And they were worried — they were concerned
with the Hill reaction.
If I remember the Hill was all — created the accountant privilege to whatever extent that exists, so you see that came out of the Hill. So you have to — I mean, that was my reaction why the restraint was taken, and continues to be followed to this day. To be honest, they spin it; they toss around with it, but basically that's what's going on. So from a historical perspective, that's my point.
But on the other hand, I agree this whole debate is about not telling all the facts to the IRS. And again as a litigator it was like, if you tell me all the facts, we can all asses the risks and the hazards of litigation, we'll be able to come with a position of settlement position because you can't come with a settlement position if you don't have all the facts — it's just impossible.
SPEAKER: But then to a couple of — a couple of important facts.
MR. CADLEY: Sure, the whole truth is a piece I didn't hear. Out of the SEC it's like you know, the facts, but it's not all of the facts.
MR. BUSEY: But let's talk about facts because Ray brought it up early in his comments. FIN 48 is about judgment. And as a matter of fact there are elements of FIN 48 that require judgments on top of judgments. Paragraph 21(d) requires a prediction about the future.
And so, it's not so much the facts as it judgments. And I think, as Fred mentioned earlier, the government itself has a deliberative process type privilege, in which the government doesn't reveal its thinking on a lot of technical issues in the same way that taxpayers weren't obliged to reveal their technical thinking.
And so, before we, you know, kind of talk about the "truth will set you free," it's also a two-way street. And, so I would just respectfully submit that it's not the facts here, it's really about judgment. That's what's missing I guess from this most recent exchange here.
MR. CADLEY: I would respond to that one there, I mean, it lives through disclosure on the IRS side as Tax Analysts knows. The governmental privilege protects kinds of conclusory comments, evaluation comments. It does not protect the underlying facts, which is, you know, a very different situation.
If the agency has all the facts, they will be glad to bring you their own conclusion as to what the facts add up to. So it's not the assessment, or the hazards of litigation assessment that is that important, I think, to the agency. It's what the facts are, what's going on, how the transaction was structured. And then they can make a judgment whether they want to litigate the case or not.
MR. MURRAY: Yeah, I just want to pick up on several of those points, and I particularly agree with yours that, and Jim yours as well in this last round. There are a lot of different things that are in the tax accrual workpapers.
I mean, we talk about them as if there's some amorphous you know, there is a file folder that is on the desk, that's got six or eight pages in it. It's got a lot of factual data that the Service ought to know about. In some cases it maybe a truck load of stuff.
And it may contain reams of attorney opinions. It may contain reams of all kinds of risk analysis, and other kinds of judgmental thinking, as well as a lot of factual data, upon which some of those opinions are based.
And, so, I think, the real concern that your question raises is not so much about giving up facts — I don't think anybody in the room can testify that the Service ought to have access to whatever factual data it needs to do its job.
I think the concern on both sides, whether you are in the government and you are trying to decide your litigating position on how you are going to handle an issue, or whether you are going to litigate this issue, or not litigate that issue, or whether you are going to litigate it in the fourth circuit, to the third circuit.
Or what some of the analysis that may be implicated by that, or whether you and the taxpayers making the same judgments with your counsel or for that matter with others that you consult in that respect. You don't want to give up that part of the analysis. And, I think, the sensitivity is not so much — I don't think there's any sensitivity around giving up the facts. It's the timing I would think raise the facts.
MR. GROVES: I would just say that there needs to be a little perspective. I think your question is a good one, and if everything in life were black or white, and you just had a checker box, we wouldn't be sitting around this table today. In fact most of the tax items — you pay your rent bill, that's deductible, you buy a pencil, it's deductible.
Most of the things in the tax world or accounting world are black and white.
We are talking here about the grey issues. The issues that you know there is uncertainty about. We have uncertainty in our lives, that's why we have a big court system that deals with uncertainties. So, we are talking about the uncertain things because you read — person A reads something, in a tax code, and person B, and person C. They may all have a difference — I mean, 10 people may have different views in terms of the ways they put it. We are talking about the very small percentage, some of which are very large numbers.
SPEAKER: Yeah, that's right.
MR. GROVES: Very large numbers, but we are talking about the small percentage of the items that affect the tax return that are in the grey area where there is uncertainty involved.
And there is always going to be uncertainty involved. You know, life just isn't full of everything, 100 percent black and white, it doesn't work that way.
MR. ROACH: I mean, well, isn't the value there to try to resolve that uncertainty, and you resolve that uncertainty by playing those issues out in a public forum where people can decide, A, you know, have we reached a proper conclusion — get some consistency on that.
And if from a public policy perspective people determine that the way the code is certainly written or interpreted does not achieve the policy objectives intended, it can be corrected.
I will tell you from experience in dealing with the KPMG case, had we not seen some of what you call people's opinions and people's judgments on this stuff, I don't think people would have realized what was going on, and how sordid that activity was associated with some of those shelters, because the opinions didn't show that. They
were all the same opinions 300 times.
MR. MURRAY: Well, of course you are dealing there with a somewhat different context than I think, we are dealing with in a tax — in a situation where you've got a taxpayer, who is trying to resolve his or her or its liability with the Internal Revenue Service.
You've got a somewhat different situation than where you perhaps may have marketed opinions where those opinions are shared publicly amongst them, a number of people, or whatever, and the laws that the members have put together in that respect.
And particularly a lot of the amendments in the last few years have tried to deal with a lot of that and tried to make more of that public, or more of that available, and strike a balance amongst some of these different factors.
But I think the — I'm not sure that most taxpayers would agree that they would want their liability to be decided in a public forum. I think they would still want to have a one-on-one relationship with their tax collector over here and not necessarily make it a, you know, a public debate.
MR. ROACH: Well, given the tax accrual workpapers are giving a roadmap to the IRS it's not making it public. But it is a debate between the policy setter in this instance, which is the IRS, and the taxpayer.
And if the IRS sees what a particular company or corporation is doing with respect to the approach it is taking on a particular issue, and sees a discrepancy with respect to another corporation in that matter, then it can begin to normalize the process, and it can normalize between the two, as you mentioned companies do. Because
they try to — will look at the FIN 48 and see what their competitors are doing. And so there is some value to that even in what might be called a nonpublic setting, but at least a setting that makes this available to certain government actors.
MR. BERGIN: Let me go to one of our tax collectors here.
MR. STEUERLE: Do any corporations actually voluntarily make the tax accrual papers available?
MR. ADAMS: In a way, yes. Let — if I can, let me answer that question, a second, I just wanted to — well, on this topic, I wanted to throw a comment out. And there is a history to why we have this policy of restraint, and I think the current evaluation that we're doing asks essentially, is it still the right position to be in given where we are today.
I mean one could always ask was it the right position to adopt in the first place.
But it's kind of like we're already in Iraq, so what do we do. But in point of fact, we have the circumstance . . . we'll do something with it on this evaluation. But historically, the policy, the reason — the policy reason behind adopting that policy of restraint was that it was seen or expected — or the concern was that companies would be less candid with their independent auditors about the risks that they might have undertaken in terms of tax transactions had it provided a roadmap to the IRS.
And thus it might allow for or result in less liabilities that were possible, being reflected on balance sheets, thus undermining perhaps the financial markets — long story short.
So in order to avoid that, while the Supreme Court did say we have an absolute right to get those workpapers, they're relevant to what we do for a living, the IRS backed off of that to make sure that it only acquired those tax accrual workpapers in unusual circumstances.
So that was the foundation for adopting the policy. And I think, clearly, so much has happened between then and today that one has to evaluate where we are in light of where we ought to be. And that's really what's going on. I mean you think about globalization. You think about globalization inbound. You think about the complexity of
You think about the use of foreign banks and financial institutions for God knows what, and a lot of tax haven
jurisdictions, you just don't see as much from our perspective, in any taxing authority's perspective, as it used to. There's just too many nooks and crannies to hide in.
So the question is: should these contingent liabilities that are established and confessed in bulk to shareholders in some fashion be available to taxing authorities to make sure that they are collecting the right dollars?
MR. MURRAY: I just wanted to add a comment — sort of some gloss on some of the discussion. Again what we are talking about in large part are some of the judgments formed by counsel to the respected parties and the Service is not as — I used to work for the Office of Chief Counsel at the IRS, and they're not exactly at a loss. There
are a lot of — in fact it is the largest tax law firm in the world.
They're not exactly at a loss to be able to make their own judgment, so about some of these very same technical issues that are present and some of these returned. So again, I think, there is a big distinction being made between having ready access to some of the factual information that is there that needs to be there versus some of the judgmental aspects of these analyses that we're talking about for the same — you've got the same issues with the auditors.
I mean a lot of the audit firms have technical staffs that are much deeper in fact than the company tax departments that they are dealing with. And part of what's been a subject of some discussion at the SEC and the Public Company Accounting Oversight Board in recent years is the provision and — that's there under Sarbanes-Oxley, it's the provision of tax services.
And trying to find the right line between whether or not audit firms ought to be engaged in various types of consultations with their audit clients in the same context. It's a hard — I guess what I'm saying is it's a much harder question than it might seem to be on the surface once you really think about some of these —
MR. BRUNORI: Chris, I had a question. FIN 48 seems to have unleashed this firestorm of debate over the last year. One year, in fact, the last year, and we've heard from Ray and Bob and Fred about the effect on directors and management and shareholders and the Service and everything else. And I think Joe very articulately pointed out that this is all about protecting the investors.
How do we know if it works? Like how do you know if FIN 48 at the end of the day actually helps the investors or not? I mean, does that footnote matter and how do you determine whether it matters or not, and whether all of this time and money we're spending even right here is worth it.
MR. UCUZOGLU: Well, that's a fair question. It's one of the great difficulties in coming up with new accounting rules — trying to forecast whether the information will or won't be useful to its intended audience, investors, before you've actually put out the rule that solicits the information.
One piece of evidence we do have is that investors were asking for it before they had it. In other words, under the old regime we did hear on frequent occasion, "hey, we can't figure out what's going on here, we don't understand the underlying tax risks of the company. We're getting surprised in either direction, either favorable reserve releases or unfavorable additions. We need more information.”
So we've been told historically that the old reporting infrastructure wasn't providing sufficient information, and I think time will tell whether feedback from investors is that they're being well served by the new regime.
MR. BRUNORI: So it could be 10 years down the road.
MR. UCUZOGLU: Not that there is a process in place to actually explicitly solicit that information, but I would imagine that those who use the information will share with us whether they think they're getting sufficient information or not, people normally aren't shy about telling us when they think that the rules either have or haven't worked. So I think we'll hear —
MR. CAPLIN: I have — sort of — your comment almost specifically. I was deeply involved in the tax accrual issue. My firm represented Amerada Hess, which was Artie Young's client whose papers were being protected, and we had been representing Amerada Hess for some time, and we were involved with the case from the very
beginning, the lower courts.
We won in the Court of Appeals two- to-one in the Second Circuit based on the question that making these tax accrual workpapers available would really just — really limit the quality of the financial statements in terms of protecting the public at large that the — again, the candid issue that the client wouldn't be as candid with the auditors and the financial statements wouldn't really accurately reflect the true situation.
As I said the Second Circuit bought that argument. I had written extensively about it, a whole series of articles, and the Supreme Court didn't buy the argument.
MR. CAPLIN: There are only eight judges who sat. They voted eight to nothing about making it happen.
MR. MURRAY: I might add though that a lot of it had to do with whether or not there was an accountant-client privilege —
MR. MURRAY: Not the merits of your argument —
MR. CAPLIN: But then the IRS of course is geared to move forward to take advantage of that opinion, but the commissioner of that time was a — had been a partner of, I think it was PriceWaterhouse, and he just wanted to — he assured the accounting profession and the world that they were not going to go all the way and they drew the
lines. And they were going to follow the policy they had pre-Arthur Young case.
But now the accounting profession reacted to this nevertheless. They started paring down what they put in their tax accrual workpapers. I happened to be on the public review board later on of Arthur Andersen & Company which is the only one of the Big Eight that had a public review board.
And there was a whole change in policy within the accounting profession, and maybe you can confirm this or disagree with me about what you put in these tax accrual workpapers. The opinion of that might be in file B and the more factual type information in file A and —
MR. GROVES: That sure was a lot of talk about it.
MR. CAPLIN: Yeah.
MR. CAPLIN: It was more than talk, but I think that was the picture as to why there was this restraint, but I think things have changed. Sarbanes-Oxley was a big impact on the situation and FIN 48.
MR. BERGIN: Yeah, you know, I started this by saying that I was a novice on FIN 48, which was a true statement. I'm not quite that much of a novice when it comes to transparency issues, and those issues are hard whether you're the private sector, you're a regulatory agency, or you're the United States Congress; how
transparent to be is a hard question a lot of times.
Let me thank you all for being here, especially our panelists, especially our friend from the SEC. It was a really
nice discussion, I appreciate your participation.
(Whereupon, at 10:58 a.m., the PROCEEDINGS were adjourned.)
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