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When the Financial Accounting Standards Board, the accounting industry’s quasi-public regulator, issued Financial Interpretation No. 48 at the beginning of this year, corporate tax specialists knew their work would soon be drawing more scrutiny. By requiring companies to calculate and disclose how much they estimate they would owe in back taxes and penalties if the government challenged their shakiest tax positions, the rule forces corporate accountants to reveal to investors what amounts to a rough sketch of how aggressively they claimed tax benefits. But what tax accountants and attorneys didn’t expect was to have Senate investigators on their case, as well. During Washington’s late-August slump, the Senate Permanent Subcommittee on Investigations, headed by Carl Levin (D-Mich.), mailed letters to dozens of blue-chip companies seeking information on how they were calculating their FIN 48 disclosures. The letters amounted to asking companies to explain specific tax shelters that they estimate face worse-than-even odds of holding up to an Internal Revenue Service challenge. Tim McCormally, director of the Tax Executives Institute, says six of his members have told him they received the letter. “Nobody knows where the [Investigations Subcommittee] is coming from,” he says, noting that “its other recent forays into the tax realm have not always produced good outcomes for the business community.” DRAWING THE �ROAD MAP’ Endorsed by the Securities and Exchange Commission, the rule aims to protect investors from being surprised by a large-scale tax judgment against a company. But, as a report issued earlier this year by financial analysts from investment bank Credit Suisse observes, it doesn’t take much of an imagination to see how authorities could use the same information as a “compass” to find which corporate money trees to shake. Truly digging into a company’s tax positions would require the IRS to demand the tax accrual papers used to calculate the FIN 48 disclosure — what Credit Suisse’s analysts deemed the “road map.” Although Supreme Court precedent entitles the IRS to demand such work product, the agency has usually refrained from doing so. Calvin Johnson, a University of Texas tax expert who just finished a year as the IRS’s professor in residence, says that lack of scrutiny allows corporations to claim ridiculous tax benefits by simply burying them deep within a morass of accounting figures. McCormally, however, believes privacy is essential for companies to be able to deliberate on their tax advice without worrying that those opinions could give away trade secrets or show up in tax court. “If you’re telling the government that a potential issue is out there, is that the tax equivalent of the Heisenberg principle?” he asks, referring to the theory popularly interpreted as saying that the very act of observing something changes it. Between 30 and 35 of the FIN 48 letters have been mailed out by the Senate subcommittee so far, according to two attorneys who requested anonymity to keep their clients out of the spotlight. (With only a limited number of firms running full-time congressional investigations practices, several of those that do have assisted multiple clients in preparing responses.) The letters seem to have been directed at “the list of clients you want to represent,” as one attorney puts it — the leaders in pharmaceutical, oil, financial, telecommunications, technology, and retail markets. But even if the targets are worried, they’re certainly not publicly fussing over it. Pharmaceutical giant Merck & Co., which was carrying the single largest unrecognized tax benefit at the time the Credit Suisse report was written in May — $7.4 billion — is the only company to acknowledge receiving a request and has no comment beyond that. The nine other companies listing the largest tax reserves — including such names as General Electric, Exxon, and AT&T — either declined to comment or did not respond to phone calls and e-mails asking about the letters. A generic copy of the letter, reported and published by trade specialist BNA Daily Tax Report almost as soon as letters were sent in late August, requests explanations and background documents on any shelter accounting that totals more than 5 percent of a company’s unrecognized tax benefits, as well as the names of outside entities that received more than $1 million for participating in their creation. Responses were requested by late September, though one attorney familiar with the process says that the subcommittee agreed to extensions and the last responses have just finished trickling in. If its recipients were uncertain about the level of detail requested, the letter suggests making special arrangements for document dumps consisting of five boxes or more. (The office of the subcommittee declined to address questions about or verify any aspect of any investigation, including the letter.) CORPORATE CONFESSORS McCormally and attorneys working on the issue say that, given the breadth of the subcommittee’s questions and the blue-chip nature of the letter’s recipients, they aren’t concerned that the subcommittee is probing allegations of specific misconduct. But that doesn’t mean there’s nothing to worry about. Devising procedures to comply with FIN 48′s requirement to quantify and properly disclose tax risk was difficult enough for accountants and tax attorneys, says McCormally. Adding a congressional review brings in yet another layer of complexity. One common suspicion, McCormally says, is that the subcommittee wants to use the FIN 48 documents to turn the risk appraisals of tax advisers against the corporations, creating tax disputes where there otherwise would have been none. The relationship between a corporation and its tax advisers is something like that between an attorney and a client or between a priest and a penitent, he argues — if the conversations are not confidential, they’re unlikely to be honest. An August federal court decision in Rhode Island, United States v. Textron Inc., provides some basis for a company’s claim that its internal attempts to handicap its odds of beating the IRS constitute privileged information. One of the attorneys familiar with the companies’ responses says that, while he’s unaware of any stonewalling, he believes “there are a handful of companies who decided to take a principled position and not waive every right they have” by simply turning over all their private work to the subcommittee. Claiming some privileged information isn’t necessarily a bad idea, says Raymond Shepherd, who was the subcommittee’s staff director and chief counsel before going downtown to launch Venable’s congressional investigations practice early this year. But although a credible claim of attorney-client privilege will often receive deference, he says, “if you don’t work with the committee, bad things happen.” Shepherd is not working with any clients on the investigation and has not spoken with his former colleagues about it. Given the obscure tax and accounting issues involved, he says, the subcommittee may well get IRS and Government Accountability Office staffers detailed to the investigation, and the work will take time. But the subcommittee has successfully handled similarly arcane issues in prior tax shelter investigations, Shepherd says, adding with evident pride that he believes the targets of the letter are giving his former colleagues’ work the respect it’s due. “Look at the fact [of] how tightly held those letters are,” Shepherd says. For its part, the investigations subcommittee refuses to confirm even that it has sent out letters on the subject of FIN 48, though the subcommittee staff may have given one clue about its interests: In mid-July, more than a month before the first letters are said to have been delivered, the subcommittee’s lead investigator attended a symposium on FIN 48 hosted by Tax Analysts, a nonprofit tax news publisher. Near the end of the discussion, chief investigator Bob Roach introduced himself to the lawyers, accountants, and IRS officials present and asked whether the IRS had been too reticent in demanding companies’ documentation of their tax positions and their risk. “Why shouldn’t people know that?” Roach asked, according to Tax Analysts’ transcript from the event. “[I]f 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 [ sic], the IRS says, �we won’t do it?’” That sort of access had been crucial to the subcommittee’s investigation of KPMG’s tax shelters, Roach observed, suggesting that there had been a link between the exposure of KPMG’s “sordid” practices and industrywide change. “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,” he said, according to the transcript. Roach declined to comment for this story except to say that his comments at the event should not be seen as indicative of the subcommittee’s views or intentions. But Jack Blum, a former veteran Senate investigator who is now of counsel in Baker & Hostetler’s D.C. office with a practice combining congressional investigations, white-collar crime, and finance, believes the scope of the subcommittee’s review is a sign that the review will expand into larger questions of equitable taxation. “I think the real objective here is to see how it is that the corporate world has managed to lower its tax burdens to the degree that it has,” Blum says. Without the ability to originate legislation itself, the subcommittee has traditionally produced reports and hearings that lit a fire underneath Finance and other committees. “I can commiserate with any company that has an information request,” he adds. “You can be sure that when the committee gets to hearings, somebody is going to have to defend an outrageous shelter.”
Jeff Horwitz can be contacted at [email protected].

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