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How to win a US tax dispute

International Tax Review, May 3, 2012
By Joe Dalton

A US report claims that taxpayers are likely to lose tax disputes at the Supreme Court. Read the advice taxpayers need to know if they are to avoid being on the losing side.

The report, entitled Corporate Shams, written by US tax law scholars Joshua Blank and Nancy Staudt, examines tax abuse cases at the US Supreme Court and says the odds are in the Internal Revenue Service’s (IRS) favour.

The study reviewed every Supreme Court case since 1909 in which the government alleged there had been abusive tax planning and found that the IRS won more than 60% of such cases, while it won 68% of cases where it argued that taxpayers misread the tax code rather than abused it.

Analysis was also carried out on which aspects of transactions would increase or reduce the probability of the taxpayer winning or losing the case, such as the use of a third party or multiple step transactions.

The report claims this analysis can offer practical advice to taxpayers and tax lawyers in tax planning and in prosecuting alleged tax abuse.

For instance, the study says: “Practitioners should be aware that the use of simpler transaction structures that involve only a third party or only multiple transaction steps [as opposed to both simultaneously] appear to best protect their corporate clients from judicial anti-abuse standards.

Douglas Stransky, of Sullivan & Worcester, said the study’s findings simply do not reflect the way business works today.

“In general, companies no longer engage in tax planning transactions unless such transactions have at least an 80% chance of being upheld by the courts upon challenge and such an assurance requires careful planning and analysis of the law, including business purpose, said Stransky.

Stransky said there is very little incentive for public companies to undertake risky tax planning because auditors would require a reserve – the amount of tax and penalties that would be due if the taxpayer lost in court – to be placed on the company’s financial statements, thus reducing the company’s reported earnings and impacting its stock price.

“In today’s world, tax planners and their clients simply do not engage in transactions that a court would find a corporate sham, said Stransky.

“I believe that the cases are skewed in the study and that looking at cases in years before 2000, which is most of the cases, there certainly were times in the past when companies engaged in such transactions, but I do not believe that it is the case today, he added.

Tax lawyers say the study has little practical merit because the world of tax planning has significantly changed and the only certainty in planning transactions comes from scrutiny of decisions in similar transactions which have gone before the high courts.

The report’s finding that the odds appear quite heavily stacked in the IRS’s favour when it alleges a misreading of the tax code by the taxpayers raises the questions of whether the tax code is too complex, or whether taxpayers and their advisers are not taking sufficient trouble to analyse what congress’s intention was when drafting a statute before acting on the basis of a particular statute.

Michael Kosnitzky, a tax partner at Boies, Schiller & Flexner, said tax laws are often written too broadly, especially when it comes to tax shelters or alleged tax shelters, or they give the treasury broad interpretive authority which creates further ambiguities.

“It isn’t always good for the treasury to tell the taxpayer exactly where the line is in any particular situation but rather to keep the line a bit blurry, said Kosnitzky.

“Legislative intent is often very difficult to discern and oftentimes cannot always be relied upon for guidance especially when applied to specific fact patterns not contemplated by the draftsmen of the legislation, he added.

The trends identified in the study offer little practical assistance to tax planners and litigators, according to Stransky and Hap Shashy, of King & Spalding.

Shashy said in litigating a case or planning a transaction advisers and taxpayers need to look in detail at similar cases which have been before the courts.

“Using trends regarding which factors can influence court decisions is not a substitute for understanding the specifics of previous similar transactions which have appeared before the courts, said Shashy.

And Shashy said it is possible that tax litigation moves in cycles and in some periods the courts appear more vigilant about tax avoidance schemes. However, Shashy said such cycles may be dictated by taxpayer behaviour rather than behaviour of the courts.

“When you have a period of aggressive tax planning like there was in the 1990s and early 2000s, it is followed by a number of these types of cases reaching the courts years down the line, said Shashy.

“The courts are possibly being fairly consistent in their treatment of cases but are just being presented with a rash of aggressive taxpayer behaviour. If rulings go in favour of the government it will have a disciplinary effect on the taxpayer and this will switch the cycle again, he added.

Related Lawyer: Michael Kosnitzky

Related Practice: Tax

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