Archive for April 16, 2013

Protecting Communications and Documents From IRS Summons Enforcement – Part II

tax shelter 1Posted in Parts I, II and III.

Executive Summary

Tax advisers may rely on the practitioner-client privilege of Sec. 7525 and the work product doctrine to protect certain communications and materials from IRS summons and discovery.

Exceptions

Despite careful measures to protect privileged communication, exceptions may override the practitioner privilege. Two exceptions that have long applied to the attorney-client privilege, the crime-fraud exception and the return preparation exception, also apply to the practitioner privilege. Two additional exceptions, the tax shelter exception and the criminal-proceeding exception, are unique to the practitioner privilege.

Crime-Fraud Exception

Neither the attorney-client privilege nor the practitioner privilege applies to communications between a client and adviser in furtherance of a crime or to perpetuate a fraud. 18 The Seventh Circuit has pointed out that advice relating to future wrongdoing rather than past wrongdoing does not come under the privilege. 19  This is true even if the tax practitioner is unaware of the client’s criminal or fraudulent intent. Read More

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CPA Firm Partner Goals Or Partner Wishes?

It’s April 16th. You are well into your performance year – for your team members and for your owners.

You probably have already scheduled counseling sessions for your team members to give them feedback on performance thus far for 2013.

What about your partner group? So many firms don’t even establish and document goals for their partners. More and more firms understand the importance and actually go through some sort of partner goal setting procedure. The trouble is, once set, there is little follow-up and few consequences if partners do not meet the goals.

I call this type of goal-setting – The Partner Wish List.

•  I wish I could bring in more business, that should be a goal.

•  I wish I Mary Manager and Mike Manager really understood the client service dynamics. I should work with them this year.

•  I wish I had more personal productivity (profit, charge hours, write-ups, etc.), I should work on that in the fall.

•  I wish we have done more with that new service line. I should spend more time on that.

Partner goal-setting is the managing partners job, responsibility, duty….. how is your MP performing? If you are the MP, set those goal check-up meetings with your partners for May, August and November. Pay for performance should apply to everyone inside the firm – poor performance means poor pay – or something worse.

Need help? Download a copy of my Sample Goals For Partners through my TaxConnections Profile. 

“Discipline is the bridge between goals and accomplishment.”

Jim Rohn

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A Collection… The Humorous Side of Tax… (#8)

♦  It’s tax time. I know this because I’m staring at documents that make no sense to me, no matter how many beers I drink. — Dave Barry

♦  On April 15th you count your blessings . . . and then send them to Washington.

♦  We picked the wrong day for April Fool. I would have chosen April 15.  Steve Maple 3-27-09

♦  “Tax day is the day that ordinary Americans send their money to Washington, D.C., and wealthy Americans send their money to the Cayman Islands.” –Jimmy Kimmel courtesy of Barbara D’Amato

♦  But one must take pride in paying up every April 15. Look at it this way: If you don’t spend your dollars on the IRS, you’d probably just squander it on foolish things, like food, rent . . Cindy Adams, NY Post, 3-29-09

♦  April 15 is lurking around the corner, so if you have yet to file your federal tax return, it’s time to set aside a few hours, gather together your financial records, and flee the country. Dave Barry

♦  The good news for taxpayers is that the smartest tax experts don’t work for the IRS. They were smart enough to realize that taxpayers will pay more to keep their money than the government will pay to collect it.

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Global Tax Audit and Controversy Risk Management Process – PART 1 OF 5

Global Tax Audit & Controversy Risk Management Process – PART 1 OF 5

Introduction

www.TaxRiskManagement.com (“TRM”) have maintained in our publications and workshops over the years that managing tax risk is one of the greatest challenges for tax departments around the world (creating the opportunities to build lasting world class relationships with Revenue Services), starting with the verification audit through to the resolution of tax controversies. A recent big 4 survey supports this contention. More than 540 companies from 18 countries took part in a fairly recent survey aimed to identify global trends in tax function priorities, time allocation and success measures.

Key aspects that emerged can be summarized as follows (key points are highlighted):

Tax risk is everywhere

… companies continue to face increased pressure on the tax function. As a result, tax functions are focused on addressing risks in every major area of the tax lifecycle – planning, provision, compliance and controversy. Improving the tax function is clearly more important than ever, with more than 90% of companies indicating this will be an important area for them over the next two years.

People are a tax risk

87% of respondents identified people issue as an important challenge facing the tax department. Companies are struggling to get enough people to staff their tax department. They are also challenged to train the people they have, with 77% of companies indicating that the lack of skilled resources is a contributing factor to tax risk.

The trend – proactive versus reactive

Today, companies report a significant increase in the time they’re spending identifying, managing, tracking and responding on tax risk. The number of companies who spend at least 20% of their time on tax risk increased over the last two years from 16% to 25%. Leading tax functions are responding by becoming more efficient and broadening their response to risk. Building linkages to other parts of the organization is becoming increasingly important.

Communication is key

According to our findings, companies that have regular communications with their board about tax risk are also more likely to report having specific measures in place to address those risks. The difference seems to be that they take a broad approach to tax risk assessment and work to efficiently leverage their people, processes and technology.

Throughout the world, any tax question or issue (before it becomes material) should be considered at a central division or consultation facility in order to determine what the approach should be to that question or issue – after being exposed to the proper factual analysis, and then to the applicable broad set of legal principles – tax and constitutional & administrative law. Without a central considering authority, one can never know in a large organization exactly where a tax review (potential or actual) may end up. Stated otherwise, group tax will not know exactly what is going on if each and every tax review is not reported to a centralized office that will then in turn decide how the matter should be dealt with.

The lessons learnt from the many clients TRM have consulted to show the following trends must be maintained:

§    up-to-date international best practice;

§    relationships with Revenue Services;

§    engagement with Revenue Services at various levels;

§    analysis and resolution of potential and actual tax reviews;

§    record keeping, filing and data securitization

The aim of this report

The aim of this report is to convince the head of group tax that the appropriate emphasis should be placed on the tax audit process through a tried and tested methodology, where this area of tax risk management can be streamlined and improved, in line with the lessons learnt by TRM in acting for multi-national corporations in reducing potential tax exposure on tax controversies from 100% to a mere 3%.

The focus is a pro-active engagement with Revenue Services, supported by a process (analyzing & strategizing the facts & law, through to a data securitization process) to deal with potential tax exposure issues before they become material risks. This precise methodology is currently not followed by most corporations as expounded in the textbook ‘Tax Intelligence’ written by Prof. D N Erasmus, the Chairman of TRM. It is a process that has significant merit in the correct circumstances.

These circumstances include a global environment where there is:

§         ‘country collusion’ between Revenue Services;

§          increased verification audits through Large Tax Units (LTU’s), and in the areas of indirect taxes, transfer pricing, and anti-avoidance;

§          more litigious Revenue Services; and

§          global tax administration.

The challenge in convincing the head of group tax is that this area of tax risk should be a high priority, and should be implemented on a broad scale across the group, region by region, in a staged manner. The urgency with which this must be done will become apparent from the results of the survey, that will justify the additional time and expense. It is also noteworthy that the benchmark case study recognizes this as a high priority and has commenced an implementation process.

Analysis of various sources to compile this report

This report has been compiled after analyzing various information sources.

The OECD Centre for Tax Policy and Administration released its first report dated 28 January 2009, prepared by the Forum on Tax Administration under the then leadership of Pravin Gordhan. The report is headed Tax Administration in OECD and selected non-OECD countries: Comparative information series.

In addition to this, and the analysis of various EU and Latin America Tax Reform and Development texts, numerous survey questions were prepared. Careful analysis was made of tax policies, processes and procedures to create a benchmark against which group tax information can be compared.

The OECD report covers 43 countries. We applied the information of that report to one of the top 50 taxpayers in South Africa, and established the following:

Of the 43 countries that participated in the report, 15 countries group operations in them. They are as follows:

EUROPE: Czech Republic, Germany, Hungary, Poland, Romania, Italy, Netherlands, Spain & UK

ASIA: Australia & China

AFRICA: South Africa

NORTH AMERICA: Canada, Mexico & USA

LATIN AMERICA: Non – although many Latin American countries are in a tax transition phase, and are in the process of following the tax reforms initiated in some of the former Eastern Bloc countries that have joined the EU.

In addition to the above, the Group Financial Statements make the following disclosure:

Company law requires the directors to prepare consolidated financial statements for each financial year. Under that law the directors have prepared the consolidated financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. The consolidated financial statements are required by law to give a true and fair view of the state of affairs of the group and of the profit or loss of the group for that year.

This requires comment – During February 2006 the FASB and the IASB concluded a Memorandum of Understanding stating their intention to seek a convergence of their standards and interpretations by 2008. FIN 48 is the FASB standard, requiring a two-step evaluation:

§          the business determines whether it is more likely than not (50% or greater likelihood) that a tax situation would be upheld in an examination, including resolution of any potential ensuing litigation process, based on the technical merits of the tax situation;

§          the tax situation that meets the more likely than not recognition threshold is measured to determine the amount to recognize on financial statements.

As a result, the advent of FIN 48, like SOX 404, underpins the requirement for businesses to embark upon a systematic TRM process to limit and expose, with the view to efficiently minimizing the incumbent tax risks. IFRS looks to do exactly the same.

The group has an extensive worldwide TRM process in place. The process works on a decentralized basis where each business unit reports to group tax risks when they become material.  The gap between the commencement of verification audits and the creation of a tax dispute (when it becomes material) is an area of TRM that we propose requires more careful attention, in each region, to ensure better risk management of any potential emerging tax risk exposure, before it becomes material.

TO BE CONTINUED…

Prof D N Erasmus is teaching the International Tax Risk Management class for the LLM in International Taxation at Thomas Jefferson School of Law, this summer semester. He is co-author of the IBFD Tax Risk Management textbook available from www.IBFD.org, and Tax Intelligence (on Tax Risk Management) available from www.Amazon.com.  Connect with him on TaxConnections.

 

Written by | Posted in Africa • Asia • Australia/Oceania • Europe, Middle East • South America • Tax Risk Management

Converting Into A Dutch Entity: An Overview

The Argentinian cancellation of the tax treaty with Spain followed by the financial crisis in Cyprus made companies aware of the pros and cons of their chosen holding company structure. Currently companies are looking into the options they have to strengthen their holding company structure within the EU. One of the jurisdictions which comes to mind is The Netherlands.

Introduction

Through domestic law changes and the EU jurisprudence, the international mobility of corporations is definitely increasing. One of the options EU/EEA body corporates have is to convert into the entity of another jurisdiction.
In The Netherlands domestic legislation is being prepared to ease a cross-border conversion. I will highlight the current practice of holding company restructuring and introduce the concept of conversion. Further the ECJ jurisprudence with regard to cross-border conversions as well as the draft Dutch domestic legislation is discussed. At the end I will provide some Dutch tax considerations regarding outbound and inbound conversions as well as my conclusions.

Current practice

Interposing a new holding company or a new holding company location within a group structure can be done many ways. Merely transferring the residency of a company by transferring the effective management and control is an option, however this may not always be practical. The body corporate is typically bound by law of its original home country and also needs to adapt to the host country rules. This increases the corporate compliance.

Another option is to create a new holding company in another jurisdiction and transferring the assets of the obsolete holding company to the new holding company. If no unilateral succession is needed in the corporate structure, then the transfer can be done via an asset deal or via a liquidation/dissolution. This has a couple of draw-backs, such as the legal transfer of ownership of assets and triggering unrealized capital gains, because a legal transfer is generally regarded to be a recognition event.

The assets of a company can be transferred under unilateral succession (within the EU) by performing a cross-border legal merger. In The Netherlands it is in any case possible to perform a cross-border legal merger between Dutch companies which have a capital divided by shares (BV/NV) and specific EU companies. A merger between a non-EU company and a BV/NV is not facilitated in Dutch corporate law.[2] Within the EU cross-border mergers are becoming more and more common practice. Cross-border mergers benefit from EU legislation which instructed the member countries to not hinder an EU cross-border merger. These rules are laid down from a EU corporate law perspective in the Directive 2005/56/EC[3] and from tax perspective via the EU Merger directive[4].

Conversion via ECJ jurisprudence

The Vale case[5] was ruled on July 12th, 2012 by the ECJ. The ECJ ruled that article 49 Treaty on the Functioning of the European Union (further: ”TFEU”) and 54 TFEU regarding the freedom of establishment are infringed if the host Member State does not treat the domestic conversions the same as a foreign conversion. In summary this entails that a cross-border conversion by a host Member State within the EU/EEA should be allowed, if a domestic conversion by the host Member State is also allowed. The judgment states:

“However, the principles of equivalence and effectiveness, respectively, preclude the host Member State from refusing, in relation to cross-border conversions, to record the company which has applied to convert as the ‘predecessor in law’, if such a record is made of the predecessor company in the commercial register for domestic conversions, refusing to take due account, when examining a company’s application for registration, of documents obtained from the authorities of the Member State of origin.”

The TFEU upholds that if you can domestically convert one company into another, this should also be allowed by the host Member State for companies from other EU/EEA countries. In The Netherlands it is possible to convert a Dutch legal entity into another Dutch legal entity. Conversions can take place in The Netherlands between BVs, NVs, foundations, cooperatives and associations. Based on the Vale case it could be argued that companies from other EU/EEA countries are eligible to convert into a vast array of Dutch legal entities as well.

Conversion via Dutch domestic legislation

Currently there is no Dutch legislation which covers the conversion of EU/EEA companies with a capital divided by shares into a similar Dutch company.[6] However, based on the ECJ Cartesio[7] case the Commission Corporation law spontaneously issued advice on February 12th, 2012. It advised to incorporate Dutch legislation to facilitate cross-border conversion of Dutch companies into EU/EEA companies. The reasons to incorporate domestic legislation was that the position of employees, creditors and minority shareholders might be infringed if no domestic legislation was in place. Moreover, it indicated that European Parliament requested the European Commission to draw-up a new Directive, but the uncertainty when this directive would come into force, made the need to come with domestic legislation greater. Therefore, the Commission advised to legalize the conversion of Dutch companies which have a capital divided by shares (BV/NV) into other similar EU/EEA companies.

The Dutch Minister of Security and Justice is working on legislation to protect the position of employees, creditors and minority shareholders. His focus is on the Dutch outbound situation, whereby there are various protection mechanisms in place for the benefit of the stakeholders. One example is that in case of abusive situations the Dutch Minister of Security and Justice has the right to object. For every protection mechanism which doesn’t apply for a Dutch domestic conversion it can be questioned if the legislation is in line with the prevailing ECJ jurisprudence.
For Dutch inbound situations the new legislation prescribes that an EU/EEA company can only be converted in a Dutch BV or Dutch NV. The requirements to be fulfilled are (a.o.) a notarial deed, which is drawn up in Dutch as well as documentation that the procedure in the home country has been full-filled. In case a conversion takes place in a Dutch NV an audit certificate is necessary to prove that the minimum capital requirement is met. Currently it is unknown when this legislation will be finalized.

Because Dutch domestic legislation currently allows the conversion of a variety of Dutch legal entities which conversions are not limited to the BV or NV, the draft legislation regarding cross-border conversions would likely not be all-inclusive enough and therefore not be in line with ECJ jurisprudence. Therefore, if a conversion into another company than a BV or NV is contemplated, the direct application of ECJ jurisprudence would need to be employed.

Dutch tax legislation

From a Dutch tax perspective a conversion of a BV into an NV and vice versa is not regarded to be a liquidation of the company for corporate income tax (CIT) purposes (article 28b of the Dutch CITA). If other Dutch companies (such as a cooperative) are converted into another legal form, this is regarded to be a liquidation from a Dutch CIT, Dutch dividend withholding tax (DWT) and Dutch personal income tax (PIT) perspective. The question arises how the conversion into an EU/EEA company will be treated in Dutch outbound situations. Will the conversion be treated the same as a BV/NV conversion, not entailing a liquidation, or would it be treated as a liquidation.

A company is deemed to be a Dutch resident for Dutch CIT and Dutch DWT purposes, if it is incorporated under Dutch corporate law. The question arises how this would be applied by the home and host state after a conversion takes place. The practical hurdles would likely be solved over time, the tax technical discussions have not yet begun.

Conclusion

International corporate mobility is providing for additional flexibility with regard to international corporate restructurings within the EU/EEA. The ECJ’s position is broader than the subsequent Dutch reaction reflected in the draft legislation. This article is aimed at providing alternatives to companies which wish to strengthen their holding company structure in the current volatile environment. Updates regarding this topic will be twittered….

[1] Author is Hendrik van Duijn, Independent Dutch tax lawyer at DTS Duijn’s Tax Solutions BV (www.duijntax.com)

[2] An option is to relocate the non-EU company to a suitable EU location where it can be converted into an EU company and then perform the cross-border merger with the Dutch BV/NV.

[3] Directive 2005/56/EC Of The European Parliament and of The Council of 26 October 2005 on cross-border mergers of limited liability companies.

[4] Council Directive 2009/133/EC of 19 October 2009 on the common system of taxation applicable to mergers, divisions, partial divisions, transfer of assets and exchanges of shares concerning companies of different member States…

[5] ECJ 12 July 2012, nr. C-378-10 (Vale Építési kft).

[6] The SCE (European Cooperative Society, whereby SCE stands for Societas Cooperativa Europaea) has its own set of applicable rules, laid down in the Council Regulation (EC) No 1435/2003 of 22 July 2003 on the Statute for a European Cooperative Society. An SCE can be converted into a Dutch cooperative without losing its legal form.

[7] ECJ 16 December 2008, nr. C-210/06 (Cartesio).

 

Written by | Posted in Corporate • International

Protecting Communications and Documents From IRS Summons Enforcement – Part I

Posted in Parts I, II and III.

Executive Summary

Tax advisers may rely on the practitioner-client privilege of Sec. 7525 and the work product doctrine to protect certain communications and materials from IRS summons and discovery.

The Sec. 7525 privilege is similar to the attorney-client privilege but is limited to confidential communications on federal tax law matters not involving allegations of a crime or fraud. The privilege does not apply to written communications in connection with the promotion of, or participation in, a tax shelter. It is also limited to communications of tax advice, as opposed to tax return preparation.

Especially when a tax controversy is or may become a criminal proceeding, an attorney generally can better represent a client, although CPAs may still play a role through a Kovel arrangement.

The work product doctrine protects confidential materials that are collected or prepared in anticipation of litigation, unless an opposing party demonstrates the materials are essential to its case and can be obtained in no other way.

When performing services as a tax adviser, an accountant should understand when communications and work product are privileged and when they are not. The IRS is granted significant power to pursue information in examining a tax return or collecting a tax liability, and the courts have interpreted this summons power as broad authority to obtain confidential information in work product produced for, and communications with, a taxpayer. Some communications and work product, however, are considered privileged and not subject to summons enforcement under specific criteria. An accountant may assist in protecting a client’s confidential information by proactively taking steps to ensure these criteria are met.

Two privileges may apply to an accountant’s tax advice to a client: the practitioner-client privilege granted by Sec. 7525 and the work product privilege established by the Supreme Court in Hickman 1 and codified in the Federal Rules of Civil Procedure. 2 The application of each privilege is based on specific standards that are carefully weighed by the court when the privilege is claimed. If the practitioner and the client have maintained a defensive posture throughout the communication and documentation process, it is more likely that the privilege will be upheld and IRS access will be denied. This can be a vital protection for a client when tax advice contains opinions about gray areas in the tax law and speculation regarding potential litigation in those areas. This article examines the rules and definitions that form the basis for these privileges and identifies certain measures that can increase the protection of sensitive client information.

The Practitioner-Client Privilege

Sec. 7525 extends the common law protections of attorney-client privilege to a client who is communicating with a federally authorized tax practitioner regarding tax advice. The practitioner must be authorized under federal law to practice before the IRS, and such practice must be subject to federal regulation under 31 U.S.C. Section 330. Authorized tax practitioners include licensed attorneys, CPAs, enrolled agents, and enrolled actuaries.3  The practitioner must be rendering tax advice with respect to a matter that is within the scope of the individual’s authority to practice before the IRS. 4 Thus the privilege extends only to federal tax matters related to U.S. tax law. 5 It does not cover foreign tax advice or matters relating to state or local income tax. It also does not cover tax return preparation services.

The practitioner privilege applies to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney. However, it is more limited in scope than the attorney-client privilege, in that it applies only in noncriminal proceedings before the IRS and federal courts. 6 It does not apply to written communications in connection with the promotion of, or participation in, a tax shelter, nor does it protect against disclosure of communications to any regulatory body other than the IRS. 7

Basic Elements of Privileged Communication

To properly understand the practitioner-client privilege, one must analyze the rules and limitations of the attorney-client privilege. The attorney-client privilege is the most familiar protection of confidential communication in a legal setting and can be invoked in an IRS summons challenge. Certain elements of privileged communication must be present to preserve its protection: The communication must be for the purpose of legal advice, and it must be confidential. These requirements are also elements of the practitioner-client privilege.

The first element needed to successfully invoke attorney-client privilege is that the attorney must be acting in his or her capacity as a lawyer. Communication in which a client seeks or an attorney provides legal advice is protected. Legal advice is protected whether it comes from outside counsel or in-house counsel. 8  However, if an attorney is providing accounting services (including tax preparation), giving business advice, facilitating transactions, or receiving or disbursing money, he or she is not doing “lawyer’s work,” and these communications are not privileged. The distinction between legal advice and business advice is not always clear. The same concern exists for the tax practitioner in distinguishing tax advice from other client services, including tax return preparation (see below). Both the source and the content of the communication determine its privilege.

The second element that determines whether communication is protected is confidentiality. The privilege is essentially waived if the communication takes place in the presence of third parties. 9 The same is true if the information is intentionally disclosed to a third party. 10 Similarly, a client does not acquire protection of previously disclosed information by submitting it to an attorney. Information imparted to an attorney or federally authorized tax practitioner that is intended to be imparted to others is not protected, and information that is already in the public domain (e.g., SEC filings) cannot be considered privileged. In general, determining whether the communication satisfies these requirements requires asking “who, what, and when?” Carefully monitoring these factors may preserve the privilege.

Who?: Since only communication between the client and tax practitioner is privileged, the source and the addressee of any written communication is significant. For example, documents have been found to be unprotected when no recipient was specified, because, without recipients, the documents were not communications. 11 In addition, correspondence or emails with copies sent to third parties clearly imply a waiver of the privilege. This means that tax opinion letters and discussions of alternative strategies or hazards of litigation are all subject to disclosure unless they are directed to, or in discussion of, a specific client.

What?: The delineation between legal or tax advice and common business advice or services is not always a bright line. The Court of Federal Claims has noted that a court must “make close, factually-intensive distinctions…in which business planning, tax return preparation and legal advice tend to coalesce.” 12 The communication itself must evidence the request or delivery of legal advice between attorney and client.

In BDO Seidman, 13 the court determined that communication with counsel that sought guidance regarding various Code provisions and regulations was “classic attorney-client material.”14  In another case, discussion of Sec. 199 deductions, advance-pricing agreement calculations, and interpretation of a partnership agreement were considered advice and thus protected. 15 In some circumstances, names and numbers have been considered privileged when they revealed aspects of attorney-client communication 16  However, documents or communications that contain both privileged and nonprivileged content do not cause the nonprivileged information to become protected. While a communication may be privileged, the underlying facts are not. 17  Facts do not become protected because they have been included in a privileged communication. So while a taxpayer does not have to disclose what has been communicated, he or she can still be compelled to acknowledge facts that were part of the communication. For example, consider a situation in which a client seeks advice regarding a related-party transaction. Although the exchange between the client and tax practitioner is privileged, the fact that the transaction involves a related party does not become privileged simply because it was included in the practitioner-client communication.

Generally, when the government challenges the claim of privilege, the taxpayer is expected to provide a privilege log listing the documents or communications that have been summonsed and indicating the rationale for claiming the item is privileged. The court will often conduct an in camera review to judge the appropriateness of the claim for each item. Thus, both the addressee and content of the communication may be the first impression the court receives in deciding whether such items are privileged.

When?: The timing of the communication is also relevant. Because tax planning generally takes place before the fact, it is likely to be deemed tax advice. An adviser’s recommendation on how to structure a transaction to minimize taxes and comply with tax rules or estimation of the tax cost of various alternatives is likely to be viewed as advice. At this stage, the claim of privilege is often stronger than for communication after a transaction. An adviser’s subsequent analysis of the reporting of a completed transaction is less distinct from return preparation, and the claim of privilege may be weaker.

By:   Linda Burilovich, Ph.D., CPA The Tax Adviser Practice & Procedures, 04/01/13

Edited and posted by Harold Goedde CPA, CMA, Ph.D.

Footnotes

1 Hickman v. Taylor, 329 U.S. 495 (1947).
2 Fed. R. Civ. P. 26(b)(3).
3 S. Rep’t No. 105-174, 105th Cong., 2d Sess. 70 (1998).
4 Sec. 7525(a)(3).
5 S. Rep’t No. 105-174 at 70.
6 Sec. 7525(a).
7 S. Rep’t No. 105-174 at 71.
8 Upjohn Co., 449 U.S. 383 (1981).
9 Some exceptions allow the presence of a party with a common legal interest (e.g., a co-defendant) or certain agents of the attorney (e.g., secretary or unlicensed associate).
10 Santander Holdings USA, Inc., No. 09-11043-GAO (D. Mass. 8/6/12).
11 Pasadena Refining System, Inc., No. 3:10-CV-0785-K (BF) (N.D. Tex. 4/26/11).
12 Evergreen Trading, LLC, 80 Fed. Cl. 122 (2007).
13 BDO Seidman, LLP, No. 02 C 4822 (N.D. Ill. 6/29/04), aff’d in part, 492 F.3d 806 (7th Cir. 2007).
14 Id., slip op. at 4.
15 Pasadena Refining System, Inc., No. 3:10-CV-0785-K (BF) (N.D. Tex. 4/26/11).
16 For example, in Evergreen Trading, LLC, 80 Fed. Cl. 122 (2007), certain page numbers were redacted since the “numbering system itself could reveal aspects of plaintiffs’ counsel’s understanding of the case” (slip op. at 18).
17 Upjohn Co., 449 U.S. 383 (1981).
Written by | Posted in Federal • Individual

www.TaxRiskManagement.com Announces The Formation Of The Africa Tax Desk

www.TaxRiskManagement.com announces the formation of the Africa Tax Desk association with experienced multi-disciplinary tax and legal experts available in Southern Africa, East Africa and West Africa to help American businesses with their Transfer Pricing documentation, compliance and dispute issues.

As Africa has become an attractive continent for large American corporations to invest in (mining sector, oil and gas, and support industries), so have African Tax Authorities become aware of the loss of revenues to OECD countries through clever transfer pricing techniques. As a result 35 African countries are now members of ATAF – the African Tax Administration Forum – formed to educate and ultimately help African Tax Authorities to embark upon Transfer Pricing audits without borders.

Our panel of African and American based specialists, who have successfully trained members of the Tax Authorities, are well-connected with their leaders, act for major MNE’s in Africa and have successfully concluded a number of major Transfer Pricing disputes for clients in Malawi, Uganda and South Africa.

As an association of multi-disciplinary specialists, with direct African experience, we are well positioned to help American corporations overcome some of the practical difficulties they will face on Transfer Pricing issues with African Tax Authorities – many of whom lack training and experience comparable to what Americans will be used to in dealings with first world Tax Authorities. This leads to much frustration, and often a misunderstanding between the parties who, due to simple miscommunication, start to distrust each other. This in turn leads to complications that can easily be avoided.

Working with a practical hands on team in Africa, with representatives in America as well, gives these American corporations an edge over those that simply continue to use the usual large accounting and legal firms, thinking they have the hands on experience in Africa. Often they do not. Many offer their expertise out of offices based in Europe, also removed from the African continent, and without the proper connectivity to Tax Authority leaders.

As a result of a focus on education around Transfer Pricing in Africa, our association specialists are well-respected by their Tax Authority counterparts, and will oftentimes listen carefully to representations made by them, when acting for clients. It must be remembered that Africa is going through a fast learning curve. This must be respected from an African perspective, and approached with sensitivity to the various African cultures throughout Africa. An overhanded, first world approach will not necessarily result in success.

An educated, practical approach, with a clear understanding of the domestic laws, and an audience with the right leaders in the Tax Authorities, will ultimately achieve greater success.

For more information please connect with me on TaxConnections: Daniel Erasmus

Written by | Posted in Africa • International • North America • TaxConnections • Transfer Pricing

Incorrect Expert Advice About Estate Return Filing Deadline Does Not Excuse Penalty

An executor of an estate who relied on his accountant’s mistaken advice that he had obtained a one-year extension of the filing due date for Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, was nonetheless liable for a large late-filing penalty [Knappe, No. 10-56904 (9th Cir. 4/4/13)].

Knappe’s accountant believed the estate tax extension form (Form 4768, Application for Extension of Time to File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes), which is used to request both an extension to file and an extension to pay, permitted a one-year filing extension and a one-year payment extension, whereas it actually permits a one-year extension to pay the tax and only a six-month filing extension (unless the executor is out of the country).

When the IRS approved the extension request on January 11, 2007, the IRS agent hand-wrote on the Form 4768 “2/28/07” next to the box that the accountant had checked to apply for the filing extension and wrote on another form that the payment extension was until “8/30/2007 only.” Neither the executor not his accountant realized their mistake, so they filed the return on May 29, 2007, both thinking the due date was August 30, 2007. The IRS assessed penalties for late filing, which, since the estate tax was $1.1 million, were significant (the penalty and interest amounted to $185,626.71 by the time the case reached the appeals court).

The executor argued that he had reasonable cause for the late filing because it was reasonable for him to rely on his accountant’s expert advice. By relying on this advice, he had “exercised ordinary business care and prudence.” He also argued that whether his actions were reasonable was a factual issue that could not be determined on summary judgment.

The Ninth Circuit, however, in its decision affirming the District Court (No. 2:09-cv-07328-DMG-PJW (C.D. Cal. 10/22/10)), upheld the government’s request for summary judgment that the late-filing penalty applied as a matter of law. Quoting the Supreme Court, this court explained that “[w]hether the elements that constitute ‘reasonable cause’ are present in a given situation is a question of fact, but what elements must be present to constitute ‘reasonable cause’ is a question of law” (quoting Boyle, 469 U.S. 241, 249 n.8 (1985) (emphases in original)).

The Court explained that there is a distinction between cases in which a taxpayer relies on the erroneous advice of an expert about when a return is due and cases in which a taxpayer relies on an expert’s erroneous advice about whether a return is due. Because the latter requires advice on a matter of law, it is reasonable for a taxpayer to rely on an expert in that situation. In the other situation, it is not reasonable for a taxpayer to fail to ascertain when a return is due and rely instead on an expert’s opinion.

Therefore, the Court will distinguish between substantive issues and nonsubstantive issues in determining whether taxpayers may rely on expert advice about filing deadlines.  The Court acknowledged that its holding imposes a heavy burden on executors, who have to ensure that they are receiving the correct advice. Nonetheless, the government’s interest in timely filed returns justifies this burden. A further rationale behind imposing the duty to ensure the advice on filing deadlines they receive is correct is that holding otherwise would encourage collusion between taxpayers and their expert advisers because the advisers would have nothing to lose by lying about the advice they gave taxpayers to avoid any further liability.

by Sally P. Schreiber, J. D. Journal of Accountancy, senior editor – April 8, 2013

Edited and posted by Harold Goedde CPA, CMA, Ph.D.

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A Collection… The Humorous Side of Tax… (#7)

♦  What can we, as citizens, do to reform our tax system? As you know, under our three-branch system of government, the tax laws are created by: Satan. But he works through the Congress, so that’s where we must focus our efforts. Dave Barry, Column, April 6, 2003

♦  I think that one of the scariest letters one can receive is the one from the Internal Revenue Service. Greg Roberts, Aiken Standard, 3-3-13

♦  The chaplains who pray for the United States Senate and the House of Representatives might speak a word now and then on behalf of the taxpayers.

♦  When the time comes for the meek to inherit the earth, taxes will most likely be so high that they won’t want it.

♦  A man dies and goes to hell and is shocked to see his former tax lawyer entwined with a beautiful woman while everyone else roasts in eternal flames. So he calls over the nearest demon and asks how come the tax lawyer gets a girl while he just gets fried. The demon glances over and shouts “Who are you to question that woman’s punishment?”

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Ever Changing MN Budget Proposal

So not too long after I posted about the sales tax expansion on service businesses, Governor Dayton dropped that part of the proposal.  Coincidence?  Not really, as I said then the business community and most of the politicians were actually against that part of the proposal.  Dayton realized it was an unpopular provision and took it out. 

If he took out the increased revenue from a service sales tax, then there must have been some tax breaks taken out of the proposal.  Not surprisingly, the thing to go was the strange $500 property tax refund.  As I said, that part didn’t really make much sense and by cancelling it out, the budget proposal is back to even.

As a reminder, the rest of the proposal included raising the individual rates from 7.85% to 9.85% for single taxpayers with taxable income over $150k and married taxpayers over $250k.  There is sure to be plenty of heated discussions about that part but I don’t see that going away quite as easily as the sales tax on services. 

There hasn’t been much other important tax news lately for MN, but the best is yet to come for the budget proposal.

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Tax Considerations-Dividing Divorce Property-Part III

Marital Estate Division Offers Challenges and Opportunities For Advisors

The emotional aspects of a divorce often interfere with planning for the efficient distribution of the marital estate. The shock and ill feelings may create a barrier between spouses that prevents even discussing issues. Tax practitioners need to know how to explain to a divorcing client the tax realities, to avoid any post-divorce tax surprises. Mistakes in property division or fraud can produce consequences that the tax practitioner may be unable to reverse.

This is Part III in a three part series.  See Part I and Part II.

Alimony:

Sec. 71(b)(1) defines alimony as a transfer of cash made under a divorce or separation instrument to a spouse or former spouse under the following conditions:

1.  The divorce or separation instrument does not designate the payment as anything other than alimony (not for child support).
2.  The payments do not continue after the death of the recipient.
3.  The provisions of the instrument do not preclude a deduction by the payor spouse and the recognition of income by the payee spouse.
4.  Spouses who are legally separated under a decree of divorce or separate maintenance do not live in the same household when the transfer is made.
 

Certain payments to third parties on behalf of the spouse—for example, mortgage payments—qualify as payments in cash. Alimony does not include: child support payments (which are generally nondeductible by the payer and not included in the recipient’s gross income), non-cash property settlements, payments that are part of the community income of the payee, payments to maintain the payer’s property for use by the payee, or the value of such use. If the parties are married at the end of the tax year and file a joint return, payments made during the year do not qualify as alimony. Generally, alimony is deductible by the payer and included in the recipient’s gross income. Thus, there is inherent tension between property settlement and alimony. the payor may want a low property settlement and high alimony amounts for the tax deduction. The payee spouse, however, wants the reverse—that is, a property settlement not includible in income rather than taxable alimony.

To make property payments deductible, the payer spouse may try to disguise the payments as alimony. For example, the payer may make large “alimony” payments Sec. 71(f) prohibits excessive front-loading of alimony payments and requires the payer spouse to recharacterize (or “recapture”) part of the alimony payments as nondeductible property transfers if there is excessive front-loading. Tax advisers can help their divorcing clients by reviewing any nonuniform payment schedule to make sure it does not violate the anti-front-loading rules.

Ensuring Safety

In planning for the division of assets and the obligations of the parties, safeguards can be put into place to avoid failed expectations. For example, parties may contractually decide that new life insurance is needed to fulfill the payer’s alimony and child support payment obligations in the event of death. The parties may contract to leave the ex-spouse as beneficiary (hanging beneficiary) on life insurance policies and retirement plans to ensure that the ex-spouse receives his or her bargained-for interests. If the beneficiary is designated as “my current spouse” and the owner spouse remarries, the ex-spouse no longer receives his or her interest when death or retirement occurs.

Safeguards also may be needed when a payer spouse has cyclical income business interests or illiquid business interests; the spouses may agree that an alimony trust or maintenance trust (Sec. 682 trust) is the best solution. An alimony trust can protect the payee (ex-spouse) from the death or financial insolvency of the payer before all of the payments have been made.

Emerging Whole

Spouses in divorce situations must disclose all property, and this property must be distributed to the proper party. When fraud, errors, or omissions occur, a CPA needs to be capable of helping his or her client avoid the negative tax consequences of transfers or payments made in connection with the divorce. The client’s objective is to emerge from the divorce economically whole while minimizing taxes.

Divorce Issues Checklist

Among the many tax practice resources the AICPA makes available to Tax Section members (see Resources box at the end of this article) is an eight-page checklist of tax considerations for CPAs representing clients who are divorcing or recently divorced. Some of its points are:

1.  Determine which party to represent and prepare a new engagement letter, privacy disclosure notice, power of attorney, and similar documents.
2.  Consider obtaining conflict-of-interest releases where indicated.
3.  Review any prenuptial agreement.
4.  Consider the effect of joint liability for any taxes owed.
5.  Consider the need for (or, if completed, obtain a copy of) a qualified domestic relations order for any individual retirement accounts and other retirement plans.
6.  If there are children with investment income, reevaluate “kiddie tax” implications.
7.  For a property settlement, obtain or prepare a schedule of assets with tax considerations for each asset.
8.  Consider the effect of divorce on insurance coverage, beneficiary designations, mortgages and other debts, financial and estate planning, etc.

Source: Divorce Issues Checklist, AICPA Tax Section.

Executive Summary

CPAs can provide forensic services and/or tax advice concerning identification and division of marital property for a client going through a divorce. Since divorcing spouses are likely to have competing interests, however, CPAs providing these services should take care to avoid conflicts of interest.

In the nine community property states, property is owned concurrently between spouses. In the rest, referred to as common law states, courts must determine an equitable distribution of the spouses’ property between them.

Property transfers by a spouse during a period of marital strife may be subject to heightened judicial scrutiny in an equitable distribution of property. A court may invalidate transfers made to deprive the other spouse of assets by fraud or dissipation.

A transfer incident to divorce from one spouse to the other generally will not result in taxable gain or loss. However, divorcing couples should be made aware of requirements in the Code and regulations for a transfer to be considered incident to divorce. Similarly, alimony typically entails tax planning.

by Ray A. Knight, CPA, J.D. and Lee G. Knight, Ph.D. (April 2013)

and posted by Harold Goedde CPA, CMA, Ph.D. (taxation and accounting)

Written by | Posted in Federal • Individual • North America • Real Estate

Tax Considerations-Dividing Divorce Property-Part II

Marital Estate Division Offers Challenges and Opportunities For Advisors

The emotional aspects of a divorce often interfere with planning for the efficient distribution of the marital estate. The shock and ill feelings may create a barrier between spouses that prevents even discussing issues. Tax practitioners need to know how to explain to a divorcing client the tax realities, to avoid any post-divorce tax surprises. Mistakes in property division or fraud can produce consequences that the tax practitioner may be unable to reverse.

This is Part II in a three part series.  See Part I and Part III.

Separation Agreement and Divorce Decree

If the parties present their separation agreement to the court and the court issues a decree dissolving the marriage, the court may incorporate the agreement in the divorce decree, usually referred to as a merger. According to Section 306(d)(1) of the Uniform Marriage and Divorce Act (UMDA), merger occurs when the decree sets forth the terms of the separation agreement and orders the parties to perform its terms as an enforceable contract with enforcement as a judgment. Section 306(e) of UMDA provides for enforcement as a judgment, as well as contract remedies, if the separation agreement is in the divorce decree. A court order that specifically modifies an original divorce or separation instrument relates to the ending of the marriage and thus is incident to the divorce (with tax implications described later), even if it is issued many years after the divorce.

Transfers During Marital Difficulties

A transfer of property by one spouse during a period of marital strife, whether or not divorce is imminent, might not be considered made unconditionally and is subject to additional scrutiny. All states give each spouse certain legal rights to share in the family’s assets if there is a divorce, but the scope of those rights varies significantly from state to state. In most states, the non-donor spouse may have set aside—as a fraudulent transfer—a gratuitous transfer of property made after the marriage has begun to deteriorate. Any unwritten custody arrangements where one spouse transfers property to a custodian for safekeeping with the understanding of a future repossession is highly suspect when the other spouse has no knowledge of the transfer.

Transfers of Property: Asset Dissipation

The judicial doctrine of fraud on marital rights or dissipation of marital assets is an attempt to balance the transferor’s right to freely transfer his or her own property against the need to protect the legal entitlement of the transferor’s spouse to property. In most states, the law invalidates lifetime transfers if they are made with intent to deprive the transferor’s spouse of marital property rights, or if the transfers are made under circumstances where it would be unfair to permit them to stand. To determine whether a spouse has attempted in a divorce situation to remove assets from the claims of the other spouse, courts look at all the relevant factors including:

1.  Other consideration is involved;
2.  Size of the property transferred versus the transferring spouse’s total wealth;
3.  Time elapsing between the transfer of property and the divorce;
4.  Relations between the spouses at the time of transfer;
5.  The source of the property transferred.
6.  Whether the transfer is revocable or illusory (i.e., the transferring spouse retains rights in or powers over the transferred property).

Tax Considerations

It is usually important that any property transfers between the divorcing spouses occur under circumstances that do not produce taxable gain or gift tax liability. Since no estate tax marital deduction is allowed for transfers to a former spouse, the transferor also will not want the transfer to be includible in his or her taxable estate.

Taxable gain:

Under the general rule of Sec. 1041(a), a transfer of property to a former spouse incident to divorce will not cause the recognition of gain or loss. A transfer of property is incident to a divorce if the transfer occurs within one year after the date on which the marriage  transfer ceases or is “related to the cessation of the marriage,” which requires that the transfer is pursuant to a divorce or separation instrument, and occurs not more than six years after the date on which the marriage ceases. A divorce or separation instrument includes a modification or an amendment to the decree or instrument (Temp. Regs. Sec. 1.1041-1T(b), Q&A-7).

Transfer taxes:

A transfer of marital property rights under a property settlement agreement that was incorporated into a divorce decree is not subject to gift tax. In Harris, 340 U.S. 106 (1950), the Supreme Court held that in such a case, the transfer would be pursuant to a court decree, not a “promise or agreement” between the spouses as required under gift tax law. However, subsequent decisions have limited the application of this rule to transfers that occur after the entry of a divorce decree.

If a transfer is not made under a property settlement agreement incorporated into a divorce decree, it may still not be subject to gift tax under Sec. 2516. Sec. 2516 provides that transfers of property or interests in property in settlement of marital property rights are treated as made for full and adequate consideration if the transfers are made pursuant to a written agreement and the divorce occurs within a three-year period beginning one year before the spouses enter into the agreement. Note that under Sec. 2516, the property transfer does not have to occur during the three-year period; the transfer may be made any time later, as long as it is “pursuant” to an agreement entered into during the three-year period.

Example. On Jan. 19, 2006, Mr. and Ms. Smith signed a separation and property settlement agreement to address contractual issues arising from the cessation of their marriage. The Smiths divorced in 2007. As part of the agreement, Mr. Smith transferred certain property to Ms. Smith. The agreement also provided:

Each party accepts the provisions herein made for him or her in lieu of and in full and final settlement and satisfaction of any and all claims or rights that either party may now or hereafter have against the other party for support or maintenance or for the distribution of property. However, each party has relied upon the representations of the other party concerning a complete and full disclosure of all marital assets in accepting the property settlement, and it is understood and agreed that this provision shall not constitute a waiver of any marital interest either party may have in any property owned but not fully disclosed by the other party as to existence or fair market value at the time this agreement is executed. Moreover, the failure of either party to disclose property shall constitute a material breach of this agreement, which shall give rise to whatever remedies at law or in equity may be available to the other party.

At some time after the parties signed the agreement, Ms. Smith began asking Mr. Smith whether all assets had been disclosed. She also hired an attorney to pursue claims arising from nondisclosure of assets. In 2011, Mr. Smith realized that he had inadvertently failed to disclose to Ms. Smith stock options ($16 million fair market value) that a court would consider marital assets. According to the terms of the agreement, Ms. Smith had not waived her marital interest in the stock options. Pursuant to a settlement (or an amendment to the original agreement), Mr. Smith paid Ms. Smith $6 million in 2011 in settlement of the claim that she had made regarding her interest in this property.

In considering this issue, Mr. Smith expressed concern that the transfer to Ms. Smith would exhaust his unified transfer tax credit and create a taxable gift transfer. However, because Mr. Smith made the payment pursuant to a written agreement relative to their marital and property rights, and Mr. and Ms. Smith divorced within the three-year period beginning one year prior to the signing of the agreement, under Sec. 2516, Mr. Smith was not subject to gift tax on the transfer and did not have to use his unified transfer tax credit.

The blog post will continue in Part III.

by Ray A. Knight, CPA, J.D. and Lee G. Knight, Ph.D. (April 2013)

Edited and posted by Harold Goedde CPA, CMA, Ph.D. (taxation and accounting)

Written by | Posted in Estate Planning Tax • Federal • Individual • North America • Real Estate
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