Friday, July 29, 2022
Weekly SSRN Tax Article Review And Roundup: Speck Reviews Klein’s The Corporate Tax Paradox
This week, Sloan Speck (Colorado; Google Scholar) reviews a new work by Israel Klein (Ariel University; Google Scholar), The Corporate Tax Paradox, 42 Va. Tax Rev. __ (2022).
In The Corporate Tax Paradox, Israel Klein presents (and offers a resolution to) a puzzle: After the IRS began requiring certain corporate taxpayers to report uncertain tax positions in 2010, the net dollar value of these positions increased annually for large public companies, growing from $162 billion in 2013 to $241 billion in 2020. If the IRS has quantitative and qualitative information on these uncertain tax positions, why doesn’t it audit each and every one of them to conclusion? Alternatively, why do large public companies continue to report these uncertain (and, in Klein’s terminology, unsustainable) positions, if they’re required to be disclosed to both shareholders and the IRS?
Klein posits a jurisdictional resolution. Since 2007, FIN 48, an accounting standard, has required public companies to identify—and make reserves on their financial statements for—tax positions that fail to reach a “more likely than not” level of certainty. This requirement applies to positions taken under any country’s tax law. For perhaps obvious reasons, the IRS collects information on, audits, and resolves positions taken on U.S. federal tax returns. Klein hypothesizes that at least some of the growth in uncertain tax positions stems from rising tax shenanigans in non-U.S. jurisdictions. Klein supports this hypothesis through regression analyses of several models using Compustat data on large U.S. public companies. Klein concludes that the IRS should—and perhaps is obligated to—share any information on uncertain tax positions with the taxing authorities of treaty partners, so that those treaty partners can better enforce their own tax laws.
Klein’s excellent analysis raises important questions about why regulators might require disclosure of uncertain tax positions, as well as how companies might respond to such requirements. From the IRS’s perspective, universal audit of disclosed positions may yield suboptimal results. By their very nature, uncertain tax positions are probabilistic, and there is no guarantee of IRS success, especially in light of historical resource constraints on the government side. In addition, adverse outcomes in individual cases may bloom into systemic defects, at least in the IRS’s view. One dyspeptic judge can pull the plug on years of careful regulatory and enforcement work. Of course, circumspection on audit doesn’t mean that disclosure has no teeth. The IRS might use information on uncertain tax positions to guide prospective action. This type of long game is hard to test, however, without narrative work using insider knowledge.
For taxpayers and their advisors, reporting requirements may not deter taking—and disclosing—uncertain tax positions. Distilling legal arguments into numeric probabilities is something of a metaphysical task, and determinations under FIN 48 are arcane and often opaque to clients. These problems compound when positions involve anything other than binary, all-or-nothing outcomes, or when legal and accounting advisors disagree on the merits or process. Even the most sophisticated taxpayer can be forgiven for taking on faith that the “best” tax position triggers an unavoidable FIN 48 reserve. Although FIN 48 reserves certainly capture aggressive tax planning, they also reflect sticky situations in which taxpayers really are trying to get things right. Furthermore, reporting requirements may themselves shape norms about acceptable tax behavior, in a sort of creeping erosion of taboo. In a full-disclosure world, the revelation is not just that the emperor has no clothes; it’s that no one else is wearing any, either. For this reason, companies may report higher FIN 48 reserves because it’s perceived as “normal” to do so. The relationship between disclosure, compliance, and enforcement is nuanced.
Similarly, Klein alludes to the fact that his causal claim—that tax positions in non-U.S. jurisdictions have driven increases in the total dollar amount of FIN 48 reporting—represents only one facet of the current challenges to tax compliance in a global economy. Many have noted that enterprises with non-U.S. income have a propensity to engage in tax avoidance and evasion. Although some of this tax gaming likely occurs entirely in non-U.S. jurisdictions (and may not be disclosed to the IRS), some gaming also leverages the multinational character of these businesses in cross-border schemes. Klein’s article emphasizes that information sharing may help with the former type of gaming as well as the latter. More broadly, Klein’s proposals about information sharing evoke a certain postwar ethos about the United States’ obligation—morally or legally—to support other (democratic) countries’ systems of government, including their fiscal capacities. This ethos, of course, has fallen strongly out of favor among significant segments of the U.S. population. There’s a lot of current flux in United States’ role in the global fiscal system, and Klein’s data and arguments provide a strong counterpoint to “go-it-alone” sentiments.
Overall, Klein’s article continues his admirable work at the intersection of accounting compliance and tax enforcement. Klein provides compelling analysis of how disclosure has affected uncertain tax positions over the long term, and his work should be valuable to scholars in law and accounting, as well as policymakers and regulators worldwide.
Here’s the rest of this week’s SSRN Tax Roundup:
- David R. Agrawal (Kentucky, James W. Martin Sch. Pub. Pol’y & Admin.) & Jan K. Brueckner (UC Irvine, Dept. Econ.), Taxes and Telework: The Incidence of State Income Taxes in a Work-from-Home Economy (Jul. 14, 2022)
- Samuel D. Brunson (Loyola Chicago), Decentralized Autonomous Organizations and Futureproofed Tax Status (Jul. 20, 2022)
- Florian Buhlmann, Michael Hebsaker, Tobias Kreuz, Jakob Schmidhaeuser, Sebastian Siegloch &
- Holger Stichnoth (Leibniz Centre for Eur. Econ. Res.), ZEW-EviSTA: A Microsimulation Model of the German Tax and Transfer System, ZEW—Centre for Eur. Econ. Res. Discussion Paper No. 22-026 (2022)
- Wanyi Chen (Shanghai U., SILC Bus. Sch.) & Liguang Zhang (Sichuan Agric. U., Sch. Mgmt.), Does Tax Uncertainty Affect Corporate Innovation? Evidence from China (Jul. 18, 2022)
- Wei Cui (U. Brit. Colum.), Strategic Incentives for Pillar Two Adoption (Jul. 13, 2022)
- Jeffery M. Kadet (Washington), Joint Strategic Emerging Issues Team—Submission of Comments Re Profit Shifting (Jun. 28, 2022)
- Alexander P. Kontoghiorghes (Bank Eng.), Do Personal Taxes Affect Investment Decisions and Stock Returns?, Bank Eng. Working Paper No. 988 (Jul. 1, 2022)
- Rebecca M. Kysar (Fordham), Interpreting by the Rules, 99 Tex. L. Rev. 1115 (2021)
- Simona Gabriela Masca (Babes-Bolyai U., Faculty Econ. & Bus. Admin.) & Andrada Iulia Botca (Babes-Bolyai U.), Tax Evasion—Measures and Empirical Evidence (Jun. 23, 2022)
- Simona Gabriela Masca (Babes-Bolyai U., Faculty Econ. & Bus. Admin.) & Carla Pitea (Babes-Bolyai U.), Tax Evasion Within European Union—Trends and Determinants (Jun. 23, 2022)
- Simona Gabriela Masca (Babes-Bolyai U., Faculty Econ. & Bus. Admin.) & Andra Iulia Pop (Babes-Bolyai U.), VAT Fraud in Europe—A Case Study (Jun. 17, 2022)