Corporate Tax Shelter Disclosure

Corporate tax shelter disclosure

December 01, 2002 | By Keith Martin in Washington, DC

The US government identified six broad categories of transactions in October that it wants corporations to report to the Internal Revenue Service as potential tax shelters.

Reporting is already required for corporate tax shelters, but the government recast the net more widely after deciding that too few transactions were being disclosed under the existing rules.

The IRS plans to study deals that are disclosed and rush out guidance in the future in cases where it believes tax results are unwarranted. However, the first reports using the new broader definition of corporate tax shelter will not be received by the IRS until 2004. The new broader reporting requirements apply to transactions entered into on or after January 1, 2003. A company must report any tax shelter in which it participates by attaching a form to its tax return. Since most large corporations will not file their 2003 returns until September 2004, there will be a significant time lag before the new rules begin to have an effect (unless corporations are deterred in the meantime from entering into deals that will eventually have to be reported).

This is the third time that the IRS has tried to define what it considers a potential corporate tax shelter. Reporting of a narrower set of transactions has been required since March 2000.


Any corporation that participates “directly or indirectly” in a “reportable transaction” must attach a form with the details of the transaction to its tax return for each year the transaction affects its US tax position. A copy of the form must also be sent the first year to a special office the IRS has set up in Washington to monitor aggressive tax schemes.

A transaction is a “reportable transaction” under the latest IRS regulations released in October if it fits in any of the following six categories.

  • It is on a list of transactions the government considers abusive — so-called “listed transactions” — or it is “substantially similar.” The IRS published an initial list of listed transactions in February 2000, but has updated it several times since then. The list now has on it 21 items. They include LILOs, or lease-leaseback transactions where a foreign entity or US municipality leases a power plant, gas pipeline, railcars or other equipment to a US institutional equity participant and subleases it back, certain tax plays involving foreign tax credits that are described in IRS Notice 98-5, “lease strips” and ACM Partnership-type transactions.
  • The corporation participated in the transaction “under conditions of confidentiality.” A transaction fits in this category if the taxpayer’s “disclosure of the structure or tax aspects ... is limited in any way by an express or implied understanding,” regardless of whether the understanding is legally binding. An example of an implied understanding is where the broker offering the deal describes it as “proprietary” or “exclusive.” The IRS suggested  — perhaps facetiously — that it will accept that an offering is not confidential if “every person who makes or provides a statement, oral or written ... as to the potential tax consequences” signs a written authorization permitting the company investing in the deal and all its employees, representatives and agents to disclose the deal structure and tax analyses to “any and all persons, without limitation of any kind.” The authorization must extend to disclosure of any “opinions or other tax analyses” the company was given.
  • The corporation has contractual protection against the possibility that some of the tax benefits will be disallowed. Examples of contractual protection are an unwind clause, a right to partial refund of fees, fees that are contingent in the first instance on the tax benefits from the transaction, insurance against loss of tax benefits, or a tax indemnity. However, a tax indemnity from another participant in the transaction who had no role in promoting it — such as the tax indemnities that lessees typically give lessors in big-ticket lease transactions — is not a problem.
  • The transaction is expected to allow the corporation to claim a tax loss of at least $10 million in any single year or $20 million in a combination of years either under section 165 of the US tax code or by virtue of a “sale or other disposition” of an asset, like a partnership interest. Operating losses and tax depreciation are not the types of losses the IRS has in mind. The thresholds to trigger reporting by partnerships and S corporations are half these figures.
  • The expected tax treatment of the transaction for tax purposes is expected to differ from its book treatment by more than $10 million in a single tax year. Reporting under this trigger only applies to public companies that are required to report financial information to the US Securities and Exchange Commission under the Exchange Act of 1934 and other companies with $100 million or more in gross assets. The IRS has already made 13 exceptions where book-tax differences do not bother it, including disparities caused by differences in how assets are depreciated for book and tax purposes. Such disparities can be ignored. Jeffrey Paravano, a senior Treasury official, said in November that the government is considering making as many as another 40 to 50 exceptions.
  • The transaction is expected to generate tax credits of at least $250,000 for holding assets generating the credits for fewer than 45 days. This trigger is aimed mainly at foreign tax credit plays.

Partnerships will be required to disclose transactions in which they participated, even though the partners must also report them.

The reporting will be on a new IRS Form 8886 that the agency is still in the process of developing.

Companies are barred from disposing of any documents “that are material to an understanding of the facts of the transactions, the expected tax treatment of the transaction, or the taxpayer’s decision to participate” in it. Such materials must be retained until the statute of limitations expires for the last tax year affected by the transaction. The new disclosure regulations are “temporary and proposed” and may undergo some further revision before they are reissued in final form. They are effective as written in the meantime.


Existing IRS regulations require promoters of corporate tax shelters to register them with the Internal Revenue Service before the shelters are offered to corporations. These regulations have not changed. “Tax shelter” is defined more broadly under them than under the new rules for taxpayer disclosure.

Promoters must register with the IRS in advance any deals about which the following three things are true.

First, the transaction must have “avoidance or evasion” of federal income taxes as a “significant purpose.” So-called listed transactions fall into this category automatically. Other transactions where federal income tax benefits are “an important part of the intended results” do also, but only where the promoter expects to offer the transaction to more than one potential participant. Thus, unless the transaction is a one-off deal that will never be repeated, it will trip this “avoidance or evasion” test.

Second, the transaction must be offered “under conditions of confidentiality.” This condition is not easy to avoid. There is implied confidentiality where the accountant, investment banker or other promoter pitching the idea leads the company to believe the idea is proprietary. The IRS has effectively issued a challenge to promoters: a transaction is not offered under conditions of confidentiality if the promoter signs a written agreement with everyone with whom he discusses possible participation “expressly authoriz[ing] such persons to disclose every aspect of the transaction with any and all persons, without limitation of any kind.”

Finally, the promoter must be expected to receive more than $100,000 in total fees. Fees from all “substantially similar” deals the promoter does must be aggregated. Thus, if he expects to repeat the deal several times with other companies, the fees add up to a much larger number.

Advance registration applies to tax shelters offered after February 28, 2000. If a shelter was offered before, registration will be triggered the first time it is offered again after February 28. Registration must occur before interests in the transaction are “offered for sale.”

Deals are registered with the IRS by filing a Form 8264.

Tax maneuvers engaged in by some foreign companies also must be registered. These will be viewed as involving indirect participation by a US company — and, therefore, as potentially involving the “avoidance or evasion” of US taxes — if a US company owns at least 10% of the shares by vote or value of the foreign company that is the direct participant in the scheme. If the foreign company is a partnership for US tax purposes, ownership by the US company of at least a 10% capital or profits interest, or expected receipt of at least 10% of loss allocations, will be enough to require US registration.

Material Advisers

Existing IRS regulations require promoters also to keep a list for seven years of companies they persuade to invest in corporate tax shelters in case the IRS wants to see it.

However, the IRS broadened these rules in October. After this year, every “material adviser” will have to keep not only a list of participants, but also be available to supply information about the structure of the transaction and the tax analysis to the IRS if so requested. The information must be retained for 10 years.

A “material adviser” is anyone who “makes or provides any statement, oral or written, to any person as to the potential tax consequences of the transaction.” However, he or she must receive a fee of at $50,000. The figure increases to $250,000 if all participants in the transaction were C corporations. Some communications between lawyers and their clients may be protected from disclosure to the IRS by the attorney-client privilege.

by Keith Martin, in Washington