TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, September 26, 2005

Johnson: Hurray for the KPMG Indictments

Johnsonsg_2Hurray for the KPMG Indictments, by Calvin H. Johnson (Texas):

On the KPMG Shelter I know best, the FLIP or OPIS shelter, the law was fine, it was KPMG that was evil. KPMG sold $100 million tax deductions that did not exist. It was extraordinary how extraordinarily easy and profitable it was to do.

FLIP was a basis shift or defective redemption shelter. A Cayman Island entity borrowed $100 million from Swiss Bank, bought bank stock, sold the stock back to the bank a couple of weeks later and repaid the loan. KPMG claimed that the shell could not use the $100 basis (not that it mattered for any reason) and that the $100 thereby shifted to a related American taxpayer, who was made related so he could use the $100 million loss. KPMG was wrong. The Cayman Island redemption was in fact a sale or exchange, rather than essentially equivalent to a dividend under section 302(b)(1), notwithstanding the KPMG claim. Redemptions are sometimes dividends because the retained stock recaptures most of what was given up, when the remaining shares grow to equal 100% of outstanding shares. Even at $100 mil. the retained shares were less than 1/2% of outstanding stock, so that only 1/2% of the redeemed shares were recaptured. The rest or 99.5% of the redeemed stock was sold.

There are maybe eight substance over form doctrines by which the tax law defends itself against nonsense interpretations: losses have to have substance not just form; transactions must have pretax sense, both a business purpose and profit even to a church; accounting must clearly reflect income; steps are collapsed; shams are ignored. All are part of the law. A tax system needs to defend itself from vicious attacks. But KPMG FLIP failed technically before even getting to that.

Some shelters are like Al Qaeda's conceptual break-through on airplanes. Al Qaeda thought about airplanes in a completely new way by flying them into the World Trade Center. Some are like AIDS virus attacking healthy T-cells so as to kill people, in ways that humans had not seen in their million years. FLIP/OPIS was not even that. It did not even work.

Why did KPMG do it? For the same reason Willie Sutton robbed banks. That is where the money was. They were selling on their reputation, which was once a very valuable asset to sell. They correctly guessed that the IRS was a paper tiger, stretched too thin with too little talent to catch the masters of the universe. Indeed KPMG was caught not by IRS audit, but by leaks from inside to the Times. Only jail time changes that calculus.

Do not forget it was our Eagle that KPMG was eviscerating, that is, Uncle Sam, the United States, US and us.

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Tracked on Sep 27, 2005 6:23:09 AM