The Secret Way the Rich Escape

...In a system that relies on citizen honesty (since it is the taxpayer, not the government, who makes the initial calculation of taxes owed), it is important that the system meet taxpayer needs where it legitimately can...

...John was aware of the disadvantages of having his profit on the deal taxed all in one lump in the year of the sale (which would push him into a much higher tax bracket) and thought he had carefully worked things out so that the transaction would be treated as an “installment sale”-that is, so that he could, in calculating the tax, spread the profit out over a five-year period...

...Thus was the shifting of a $175million burden to the other United States taxpayers assured...

...That is, not only would the general public have to bear the burden of any overcharges on the monopolistically-priced electrical equipment, but under the ruling, the public was also required to bear about half the cost of the companies’ damage payments to aggrieved parties...

...0 1973 Philip M. Stern...

...This contrast could well give rise to the following two situations: For John and Esther Hale, the letter from Internal Revenue seemed not far removed from disaster...

...Boiled down to its simplest terms, Continental Oil wanted to borrow $460 million to buy up one of its major energy-source competitors, Consolidation Coal, the largest coal company in the United States...

...This list amply demonstrates [IRS’] lack of adherence to the formal commitment to Congress to publish [ precedent-setting] rulings,” said the attorneys...

...The answers offered to those objections are many...

...Maiestv of the Law Accordingly, the highly prestigious New York law firm of Simpson, Thacher & Bartlett was engaged to present the facts of the ABC transaction to IRS with a request for a binding in-advance-of-the-fact ruling...

...Haste Makes Waste Surprised and puzzled, John telephoned Internal Revenue...

...That need not be the case if all rulings were to be made public on a tentative basis, to take formal effect in, say, 30 or 60 days unless a hearing were requested by a given number of individual taxpayers, the number to be set high enough to discourage frivolous or harassing requests while still providing for public comment...

...What should be done to improve the rulings procedures...

...Doing so would make IRS more careful in issuing rulings that will have to stand the light of day...

...Without IRS approval, Continental would have to make just about twice as many dollars of profits to repay the mammoth $460-million loan...

...If the ruling goes the other way-that is, if it favors the requesting company, shifts a major tax burden onto the rest of the taxpayers-they have no corresponding right to challenge the ruling in court, no matter how unjustified IRS action might be found there...

...Moreover, the expenses involved in bringing and sustaining a court action usually dampen the ardor of those whose motives are purely frivolous...

...g., mergers) where publication of the facts would (or might) blow up the entire negotiation...

...On the contrary, and even more serious, is the one-sidedness of the process after the issuance of the ruling letter...

...and Occidental Petroleum bought up Island Creek Coal Company via an ABC transaction...

...Private Justice The various ruling letters mentioned above were just fine for the companies that requested and received them, for they assured tens and even hundreds of millions of dollars of tax savings for General Electric, Westinghouse, U. s. Steel, Anaconda Copper, and others...

...Yet, in the first six years that law was in effect, not more than 100 court suits were brought...

...If IRS declines the requested ruling, it risks a court challenge...

...Moreover, to the extent these in-advance rulings avoid time-consuming and expensive court contests, they can benefit the government as well as the taxpayer...

...if it grants the request, all will be tranquil...

...In that same year, Congress decreed that where criminal anti-trust violations are involved, two thirds of the damage payments are no longer deductible...

...Moreover, all rulings dealing with charitable foundations are made public without apparent public harm...

...That letter ruling was but one of the roughly 30,000 issued every year...

...By contrast, rulings are well known toand hence are mainly used by-businesses, especially major companies advised by experienced and handsomelypaid tax attorneys...

...As of 1971, it was estimated that this one ruling had cost the American taxpayers $400 million, the electronic companies alone saving about $250 million...

...For example, the Freedom of Information Act conferred broad rights upon citizens to bring legal actions in order to extract information from the government...

...The above is perhaps an oversimplified, ye t surprisingly precise parallel to the manner in which the Internal Revenue Service hears and decides the tens of thousands of tax law questions put to it each year...

...Thus was the way paved for the buy-up of the nation’s largest coal company by what was then the nation’s 10th largest oil company...

...Thus was the $175-million tax saving assured the Continental Oil Company...

...On one occasion, when the Treasury Department issued a tentative regulation that offended the china clay industry, a private attorney who had long represented the industry fished out of his files a contrary, unpublished ruling IRS had given one clay company 15 years earlier-a letter of which not even Treasury was aware...

...Under these conditions, the only party checking up on the IRS is the company requesting the ruling, since it alone is in a position to lodge an effective protest...

...How many readers of these words know about them...

...IRS’ exclusive possession of that card index gives government attorneys a one-sided weapon that they can use effectively against private taxpayers whose lawyers are in the dark about unpublished rulings...

...Second, provide opportunity for public comment before major rulings formally take effect...

...From the companies’ point of view, the effect of the IRS decision was no different than if Congress had changed the basic anti-monopoly laws...

...It’s a shame,” he said, “that you didn’t come to us with your contract beforehand...

...The ruling in the Continental case also paved the way for other businesses to take over coal companies, using the lucrative ABC device: Kennecott Copper later ABC’d the Peabody Coal Company, the nation’s second largest...

...Third, in the case of mergers or acquisitions involving publicly-held companies, the details of the transactions are ultimately given to the shareholders (and hence made public) anyway...

...r Publish or Perish ~~ Confidentiality is not supposed to be a problem, for in 1952, at the urging of a congressional investigating committee, IRS issued instructions that all rulings “of general interest” were to be made public, a commitment reaffirmed in 1960...

...On December 29, 1966-just two days before a New Year’s Eve deadline, an IRS ruling letter saved the United States Steel Corporation the discomfort of having some $60 million of “excess foreign tax credits” expire, unused...

...With a law as complex as the Internal Revenue Code there is ample room for doubt about its meaning, and there are bound to be cases where companies would be paralyzed without advance knowledge of how IRS will treat a given transaction...

...By 1972, five of the top 10 had been gobbled up by oil companies, leaving only two major independent coal companies in the U. S. After seeing how great an impact the ABC and treble-damage rulings had, Congress concluded that Internal Revenue had been wrong and passed laws reversing the rulings...

...That task falls to the judge, who is thus thrust into the awkward role of being both advocate This article is adapted from Philip Stern’s The Rape of the Taxpayer, to be published in March by Random House...

...It dealt with their tax return of two years earlier and, in particular, with the sale of their house (for considerably more than they had originally paid...

...We could have told you that it wouldn’t qualify for the installment sale, and could probably have told you how to change it to make it fit the regulations...

...Having heard but one side of the case, the judge declares the trial ended and retires to deliberate the matter...

...At this writing, that action is pending in the courts...

...In theory-that is, technically speaking-rulings are available to any taxpayer who knows about them and submits a request...

...As mentioned, Consolidation Coal was one of Continental’s major competitors in the field of selling energy, and so the merger of the two reduced competition...

...But the importance of IRS rulings often goes beyond the dollar tax savings assured the various companies, for while the rulings supposedly revolve around highly technical interpretations of the tax law, they can also decide very large policy questions...

...In 1972, were able to list some 30 major rulings that had been of sufficient “general interest” to have rated mention in legal periodicals, yet had never been formally published by Internal Revenue...

...yet common sense and experience say they are remote, rather than imminent, possibilities...

...The above portrayal of the revenue ruling process is, admittedly, a partial one that highlights what seems to me its defects and may suggest that the process is wholly without merit or utility...

...On January 10, 1972, an IRS ruling permitted the Anaconda and Kennecott Copper Companies, plus a few others, a tax break on the losses they sustained when the Chilean government expropriated their assets, saving the companies between $75 and $175 million...

...Third, broaden the right of citizens to challenge particular rulings in court...

...The exclusive distribution of the unpublished rulings can some times work against the government...

...But IRS found an ingenious means of circumventing that requirement: it merely obliterated the word “Precedent” from all rulings thus categorized in its files and reclassified them as “Reference”a term not mentioned in the Freedom of Information Act...

...thus, before any banks would put up the money, they insisted on knowing whether IRS would give its blessing to the ABC deal...

...Some tax experts acknowledge that the law on the question was close, but feel that IRS did some stretching of past law and precedents in arriving at the ruling...

...Yet, out of roughly 30,000 rulings issued each year during the sixties, an average of only 480-about 1.5 per cent-were formally published by IRS...

...If IRS’ decision is unfavorable to the requesting company, it can proceed with its intended course of action, refuse to pay the tax, and contest the IRS position in a court of law...

...To put it another way, the IRS ruling effectively amended the anti-trust laws and cut the damage payments in half...

...The IRS agent, while firm that John would have to pay the deficiency, was sympathetic, since, he said, a minor change in the transaction could have saved the Hales the extra tax...

...The ruling process has its usefulness...

...It was, to be precise, a $175-miIlion tax problem...

...The Secret Way the Rich Escape by Philip, M. Stern Imagine and appraise for yourself the fairness of a courtroom trial that proceeds as follows: The judge enters...

...And it thrusts the IRS into the dual role of both advocate and judge...

...In that sense, Internal Revenue is, in effect, the Supreme Court...

...But taxpayers and their attorneys cannot so easily discover the precedents for IRS rulings since the vast majority are known only to three parties: the IRS, the requesting company, and its attorney...

...Thus was the precedent set, and the path made easier for other oil companies to buy up other coal companiesas in fact subsequently happened...

...But were they equally fine for the general public, for the rest of the U. S. taxpayers who must suffer the consequences of what amounts to changes in the anti-monopoly laws...

...The enactment of the Freedom of Information Act in 1966 was supposed to have a salutary effect, for on its face that law requires agencies such as the IRS to make public all actions of “precedential” value...

...And so it stands, as final as a Supreme Court decision (until and unless the Congress of the United States sees fit to change it...

...Coddling Criminals For example, in ruling that trebledamage payments by anti-trust violators were “ordinary and necessary” business expenses, and therefore tax deductible, IRS in effect made it just half as expensive to be caught violating the anti-monopoly laws...

...But the IRS ruling came in 1964 without congressional assent...

...In 1972, a legal action was filed to compel IRS to make public not only the unpublished rulings but IRS’ confidential card index of rulings and related correspondence covering the notorious oil-depletion allowances...

...These questions come mostly from business concerns, often seeking an in-advance-of-the-fact ruling about how IRS would apply the tax law to an upcoming transaction...

...A lawyer for just one of the opposing factions, whom we will call Lawyer A, rises and argues his case...

...In due course, on August 18, 1966, a piece of paper assuring Continental its $175-million tax saving went forward from IRS-a “letter ruling” approving the ABC transaction...

...promote more even treatment among various taxpayers...

...Cleaning It Up But perhaps the most serious aspect is the one-sidedness of the process after the ruling is issued (with an adverse ruling being appealable to the courts by its requester while a favorable ruling cannot be appealed...

...As if the $60-million tax saving weren’t enough, U. S. Steel also asked for-and Internal Revenue generously granted-permission to similarly whipsaw the U. S. Treasury for further losses in future years...

...IRS’ facilitating Continental Oil’s ABC buy-up of Consolidation Coal also involved important anti-trust policy considerations...

...If IRS throws in the legal towel, the matter is settled until and unless Congress enacts a corrective law which is unlikely to happen with any promptness...

...Thus, attorneys for both sides have equal access to past court interpretations and they are equally able to use old decisions to support their arguments...

...That was all very nice, but it didn’t suggest to John Hale how he was going to come up with $4,000 before the end of the year...

...Open it up and let in some fresh air (and even a little public argument and debate), and it can become a more balanced process, fairer not just to the one taxpayer requesting the ruling, but to all of those nameless (and, heretofore, voiceless) rest of the taxpayers as well...

...Unhappily, in both cases, Congress did not act until the major horses had already fled the barn...

...Before him there is only one lawyer’s table instead of the usual two...

...There is no Lawyer B to develop and argue the other side...

...It provides for only one-sided advocacy (by the requester of the ruling), and, because there is no public notice that the deliberation is even taking place, it offers no opportunity for comment by disinterested parties...

...As the judge ponders the questions before him, Lawyer A makes repeated private visits to his chambers, pressing him with further arguments, rebutting any doubts he seems to have...

...No press or members of the public are permitted...

...As to the second proposal, many pro test that requiring (or even expanding the opportunity for) public hearings would overtax IRS and Treasury personnel and would so bog down the ruling process as to render it useless...

...In normal legal procedures, lawyers who want to know what previous court decisions have held on any given question have comparatively little difficulty finding out...

...The upshot was that the Hales had toepay a “deficiency” of a little more than $4,000, and if they didn’t pay it before the end of the year, the government would start charging six-p er cen t interest...

...In 1969, Congress unmasked the legal intricacies of the ABC transactions and passed a law taxing ABC’s for what they are: pure mortgage loans which must be repaid with after-tax dollars...

...If Continental Oil could employ such an arrangement to buy Consolidation Coal, it would save about $175 million in taxes...

...That is a specter traditionally raised by those who dislike public spats, and it usually is not as terrifying in actual practice as had been anticipated...

...Harassing legal actions are not inconceivable...

...In 1966, the Continental Oil Company had a tax problem of considerably greater magnitude than that of John and Esther Hale...

...Why not apply the same rule across the board...

...Second, those who request rulings are asking for what, in a court of law, would be a declaratory judgment, which legally would require public disclosure of all the facts involved...

...For example: .On July 24, 1964, General Electric, Westinghouse, and the other major electronic companies-whose 1960 conviction for price-fixing in criminal violation of the anti-trust laws subjected them to treble-damage claims by customers who had been overchargedwere granted IRS approval to treat their treble-damage payments as tax-deductible “ordinary and necessary” business expenses...

...But if it is favorable to A, no one else, no matter how aggrieved, may appeal...

...But while the ABC device had been successfully used in buying oil properties, it was unclear that IRS would approve such an arrangement for the purchase of “hard” minerals like coal...

...Students of the problem have widely varying views, but many believe that the following changes would make the process far more open and balanced: mFirst, require that all IRS rulings be made public...

...There is no provision for public hearings on these rulings-even when matters of such high policy are involved...

...But, apparently only the government’s attorneys were privy to those private rulings...

...While most do not involve such prodigious sums (about 14,000 of them merely grant approval to changes in accounting methods), they often involve subs tan tial amoun ts-occasionally far more than was at stake in Continental’s case...

...First, as Columbia law professor George Cooper has observed, where large public policy questions and/or large dollar amounts are involved, these ruling decisions are “not a ‘private’ matter in any but the most technical sense...

...But because Continental was counseled by influential and experienced tax lawyers, the company knew it could go to IRS to seek advance approval of its plan...

...The government also contends that the rulings offer helpful information on troublesome questions of interpretation and enforcement...

...Many of the requests for rulings are routine...

...For example, in a court suit entailing more than $3.4 million of taxes supposedly owed by Allstate Insurance Company, the opinion noted, that “the government placed in evidence a number of privateletter rulings of the Internal Revenue Service over a 12-year period” to bolster its position...

...Allstate’s lawyers “disputed the existence” of the unpublished rulings...

...But, as you will see, others involve tens, if not hundreds, of millions of dollars...

...And does that danger outweigh the disadvantages of the present one-sided nature of the post-ruling legal challenge...

...not only are court opinions made public, they are meticulously indexed...

...But apparently he had run afoul of some technicality in the law, and Internal Revenue was taxing the whole profit in the year of the sale...

...and put all taxpayers on an equal footing, both with each other and with government attorneys, in having full knowledge of the precedents on which they can rely...

...Yet, while useful, the procedures for issuing rulings do suffer major defects: the process takes place in excessive privacy, thus inviting unseen and potentially improper pressures...

...Alas-and this is the crucial defect in the process-there is no opportunity for advocates for those “rest of the U. S. taxpayers,” to argue their side of the case, either before or after the rulings are issued...

...If the decision is unfavorable to Lawyer A, he can appeal it to a higher court...

...That intricate triangular transaction had an enormous advantage: it enabled the companies to pay back the borrowed money with untaxed dollars, rather than having to use after-tax dollars, as most taxpayers do when they repay loans...

...Of course, that is not the case...

...For some years, oil companies wishing to borrow in order to buy additional oil properties had been using an ingenious three-party device known as an “ABC” transaction, which involves, basically, using one company as a front for buying another...

...and judge...

...As to making all rulings public, it has been objected that such a step would result in disclosure of legitimate business secrets and would render the rulings process useless in the very cases where an in-advance ruling is most needed, namely, those involving delicate and confidential business negotiations (e...

...When he ultimately reaches and issues his decision, it, like the trial itself, is not open to the public, but is kept confidential, known only to the judge, Lawyer A, and the client...

...The bulk of the electric company treble damages had already been deducted and the important “hard mineral” ABC takeovers had already been consummated...

...The earlier version, favorable to the china clay companies, prevailed...

...If the Suit Fits Finally, as to broadening the right of citizens to bring court challenges against particular IRS rulings, it will doubtless be objected that this would open the floodgates to frivolous, harassing suits...

...After computing tax savings, the companies paid not 300 percent damages, but only 150 per cent...

...However, most average taxpayers are not even aware they can ask for an in-advance-of-thefact ruling...