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A sweeping change in an accounting standard that requires companies to quantify the risk of an Internal Revenue Service challenge to many types of taxes reported on corporate tax returns and financial statements has companies running to tax lawyers. Companies are particularly eager for legal advice in light of court rulings overturning corporate tax shelters and aggressive IRS probes of a practice known as “transfer pricing,” which is how multinational corporations allocate income and expenses among their different companies for tax purposes. Tax shelters and transfer pricing are two types of reported taxes that now require more documentation under the new accounting standards, because the tax laws governing them are unclear or uncertain. Demand for corporate tax law advice ramped up this year as companies adopt the standard for their first fiscal year that started after Dec. 15, 2006. The standard comes from the Norwalk, Conn.-based Financial Accounting Standards Board, which previously had no uniform guidelines for how companies should reflect uncertainty in tax positions in their financial statements. The Standards Board sets standards for the accounting profession. A new dynamic The change adds another dynamic to almost any transaction, including mergers and acquisitions, financings and reorganizations, because there’s “a range of uncertainty that attaches to every tax position,” said Arthur Hazlitt, chair of the tax department at New York’s LeBoeuf, Lamb, Greene & MacRae. “It sort of permeates just about every aspect of tax practice,” Hazlitt said. “While it only applies to uncertain tax positions, how do you know it’s uncertain until it’s analyzed?” Companies are asking lawyers to help them assess the likelihood that they would prevail in each tax position that might be challenged by the IRS � a key requirement of the change. Whether any given tax position is uncertain depends on the tax law’s clarity in a particular jurisdiction, said Richard Paul, a practice fellow for the Standards Board. Key areas of corporate tax uncertainty include tax treatment of mergers and acquisitions, how a company qualifies for research and development tax credits and transfer pricing. Inquiries from clients have substantially increased since the accounting standards change because companies feel they need detailed legal analysis to back up their tax positions, said Michael Durst, a lawyer at Washington-based Steptoe & Johnson LLP. “There are now more inquires involving the assessment of uncertain positions than there have ever been,” Durst said. This year, two substantial projects and four other narrowly focused inquires have landed on Stuart Rosow’s desk because of the standard. Public-company clients are looking for opinions, said Rosow, a New York tax partner at Proskauer Rose. Previously, a public company’s tax director or vice president for tax would bounce ideas off a lawyer, but now they need much more help, Rosow said. “They’re being forced to seek legal advice to provide support for their positions,” Rosow said. The Standards Board calls the change an “interpretation” of its income tax accounting model, but Paul acknowledged that the impact of the change is significant. The standard was needed because the income tax accounting model is silent on how practitioners should deal with uncertainty in the tax laws, Paul said. Some companies were frequently basing reserves, which are liabilities on the balance sheet, on the likelihood of an audit, he added. A ‘different agenda’ The standard now calls for practitioners to assume that taxing authorities will examine every tax position, he said. “You’re assuming that the position would be getting reviewed and you’re assessing the technical merits of the position,” Paul said. In mergers and acquisitions, for example, tax lawyers are doing more due diligence on the target company’s possible uncertain tax positions, Hazlitt said. The upshot is that lawyers find themselves negotiating with their client’s accountants about how the transaction will be structured. “You’ve injected into the process an additional party that has a different agenda,” Hazlitt said. “The level of inquiry we’ve gotten from accountants has gone up dramatically. It can slow a transaction down.” Companies prefer to avoid booking reserves for a transaction’s tax consequences because high reserves can make a company less attractive to new investors and increase the cost of borrowing money, Hazlitt said. Meanwhile, the IRS’ increased oversight of tax reporting by multinational companies using transfer pricing only heightens corporate anxiety and advice seeking. In February, Merck & Co. Inc. agreed to a $2.3 billion settlement with the IRS for tax disputes that included the Whitehouse Station, N.J.-based drug company’s use of so-called “minority equity interest financing transactions,” which shifts income to an overseas subsidiary. The IRS announced a settlement with GlaxoSmithKline PLC of London concerning similar issues for $3.4 billion in cash and an agreement from the company that it would abandon a $1.8 billion refund claim. Neither company responded to inquiries about the settlements. Element of uncertainty Because transfer pricing used by multinationals is not an exact science, there’s always an element of uncertainty, Hazlitt said. The new standard means companies must analyze the tax positions in more transfer-pricing situations, he said. The standard reaffirms the need for companies to undertake a detailed analysis of the risks associated with their tax positions, but it doesn’t reduce uncertainty associated with the tax law, Durst said. “The IRS is more aggressive, and trying to be more systematic, in their transfer-pricing examinations,” Durst said The new accounting standard, coupled with IRS scrutiny of multinational transfer pricing, has heightened corporate demand for legal advice in this area, agreed Brian Andreoli, a partner in DLA Piper’s New York office. “New clients are saying, ‘Help us do it the right way,’ ” Andreoli said. “Senior executives have a heightened awareness that these type of transactions need to be properly thought out and documented.” Transfer pricing is a very visible issue at the IRS, said chief counsel Don Korb. About a year ago, the IRS created a new deputy commissioner position to oversee international compliance for international large and midsize businesses. “The idea was that under [former] commissioner [Mark] Everson’s tenure a decision was made that we need to focus more on the global economy and transactions across borders,” Korb said. Tax shelters are also under the microscope, following several years of aggressive IRS court action and victories in tax-shelter cases at the trial and appellate court level. Companies have long needed to worry about tax shelters, particularly those types of transactions labeled by the IRS as so-called listed transactions, which it considers tax-avoidance strategies, Durst said. The accounting standard has altered the way companies assess risks associated with tax shelters, and boosted their reliance on legal advice. “It requires a very systematic quantitative analysis and requires a more detailed legal analysis,” Durst said.

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