Comments on Codification of the Economic Substance Doctrine



March 26, 2007

The Honorable Charles B. Rangel The Honorable Max Baucus

Chairman Chairman

House Committee on Ways and Means Senate Finance Committee

1102 Longworth House Office Building 219 Dirksen Senate Office Building

Washington, DC 20515 Washington, DC 20510

The Honorable Jim McCrery The Honorable Charles E. Grassley

Ranking Member Ranking Member

House Committee on Ways and Means Senate Finance Committee

1106 Longworth House Office Building 219 Dirksen Senate Office Building

Washington, DC 20515 Washington, DC 20510

Re: Codification of Economic Substance

Dear Chairmen and Ranking Members:

The American Institute of Certified Public Accountants (AICPA) is providing its thoughts on the possible introduction of legislation to clarify or codify the economic substance doctrine. The AICPA has a clear position on abusive tax transactions – they should be eradicated. They insult the large majority of honest taxpayers and their CPA advisers who strive every day to obey increasingly complex tax laws.

However, it is extremely difficult, if not impossible, to craft workable statutory language that adequately delineates economic substance. We believe such proposals are counterproductive and we strongly oppose them. We firmly believe that codifying the economic substance doctrine would have a long-term, negative effect on both taxpayers and the government, and would not produce the intended results. Just last week we testified before the House Select Revenue Measures Subcommittee about the unintended effects of the AMT. The evolution of the AMT has been slow; codification could rapidly miss its mark. In addition to introducing statutory complexity and traps for small businesses and a broad cross section of taxpayers, codifying economic substance would deprive the tax system of the flexibility needed to keep pace with the changing economic environment. As past experience with abusive tax shelters shows, fixed rules are often easy to avoid and can lead to new abuses. Past efforts to codify economic substance have also drawn extensive critical comment not only from the AICPA, but from other professional organizations, and the IRS and Treasury.

In our view, deterrence and the eventual eradication of abusive transactions are best accomplished through targeted disclosure; reasonably high non-disclosure penalties; clearer standards for opinion letters and reasonable cause penalty relief; aggressive enforcement; and continued evolution of appropriate solutions by an informed judiciary.

From a revenue estimating perspective, we understand the practical appeal of legislative codification efforts; in the past, the Joint Committee has scored the legislative proposals on economic substance as raising significant revenues. However, introduction in the new Congress will require updated scoring and, we believe, the environment has changed in a way that should significantly reduce the revenue estimated. Examples of the environmental change include: (1) three recent and significant court decisions (Coltec; Black and Decker; and Castle Harbor) have reaffirmed the principle; (2) the IRS revision of and making better use of corporate disclosures in Schedule M-3, Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More; (3) the issuance in July 2006 of Financial Accounting Standards Board Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, which interprets FASB Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes which many commentators believe provides a disincentive to entering into purely tax motivated transactions by providing specific disclosure rules; and (4) the impact of regulations under Internal Revenue Code sections 6011, 6111 and 6112 relating to the disclosure of reportable transactions (potentially abusive transactions).

The AICPA is the national, professional association of CPAs, with approximately 330,000 members, including CPAs in business and industry, public practice, government, and education; student affiliates; and international associates. Our members advise clients on federal, state, and international tax matters and prepare income and other tax returns for millions of taxpayers. They provide services to individuals, not-for-profit organizations, small and medium-sized businesses, as well as America’s largest businesses. It is from this broad perspective that we offer our thoughts today.

We would be pleased to discuss our thoughts with you or others at any time. If you have any questions, please contact me at (212) 773-2858 or jeffrey.hoops@; or Edward S. Karl, AICPA Director, at (202) 434-9228, or ekarl@, if we can assist you in any way.

Sincerely,

Jeffrey R. Hoops

Chair, Tax Executive Committee

cc: Janice Mays, Chief Counsel, House Committee on Ways and Means

John Traub, Minority Chief Counsel, House Committee on Ways and Means

Patrick Heck, Chief Counsel, Senate Finance Committee

Mark Prater, Minority Chief Counsel, Senate Finance Committee

Thomas Barthold, Acting Chief of Staff, Joint Committee on Taxation

Eric Solomon, Assistant Secretary (Tax Policy), Treasury

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