Tax shelter regulations

The IRS recently promulgated the final version of the triumvirate of provisions commonly referred to as the “tax shelter regulations.” These regulations were prompted by changes to Section 6111, which, after a decade of near-hibernation, was amended in 1997 to require the registration of certain “confidential arrangements.”

When the February 2000 temporary and proposed regulations were published under this section, the package included two companion regulations which were intended primarily to backstop Section 6111. Treas. Reg. 1.6011-4T was promulgated under Treasury’s Section 6011(a) power, which grants Treasury the authority to require certain statement filings, and required corporate taxpayers to disclose their participation in “reportable transactions” (generally, listed transactions and other confidential or marketed tax shelters).

Section 6112 was similarly dusted off, and Treas. Reg. 301.6112-1T was amended to require certain promoters of corporate tax shelters to maintain lists of their investors.

By June 2002, however, Treasury was aware that the tax shelter regulations’ net had not snared the number of transactions and taxpayers it had hoped. Treasury attributed this shortfall to two causes. One of these causes was, in the opinion of Treasury, the “overly narrow manner” in which taxpayers were interpreting the regulations’ disclosure and registration requirements.

The other was that many (if not most, at least in number) of the targeted transactions were not entered into by corporations but rather by individuals and partnerships. In the final regulations, promulgated in March of this year, Treasury certainly has widened its net.

In these final regulations, Treasury explicitly has moved the spine of the tax shelter regulations from Treas. Reg. 301.6111-2 to Treas. Reg. 1.6011-4. Section 6111(d), the initial impetus for the tax shelter regulations, has become Treasury’s greatest limitation, because it is the only of the three relevant Code provisions which is limited on its face to corporate transactions. (As mentioned above, section 6011(a) is an extremely broad grant of administrative power, and Section 6112(b)(2) permits Treasury to apply the list maintenance requirement to arrangements having potential for tax avoidance or evasion beyond Section 6111 tax shelters.)

The final regulations perform the following functions:

* Completely overhaul and simplify the disclosure requirements, which now apply to all taxpayers that participate in any one of six types of reportable transactions;

* Simplify the list maintenance requirements, which now apply to essentially any party that receives a fee in connection with a reportable or registered transaction; and

* Make only conforming changes to the Section 6111 regulations, announcing instead that Treasury will await the enactment of legislation requiring the registration of Section 6011 reportable transactions before making substantive changes.

Thus, Treasury makes clear that the concepts and principles set forth in the final version of Treas. Reg. 1.6011-4’s disclosure provisions may serve as the exclusive driving mechanism for the registration and list maintenance requirements in the future. The specifics of this mechanism are discussed below.

Treas. Reg. 1.6011-4: The disclosure requirement

The most important of the three regulations, Treas. Reg. 1.6011-4, requires every taxpayer that has indirectly participated in a “reportable transaction” to attach a disclosure statement on Form 8886 to its return for the relevant taxable years. There are six categories of transactions which qualify as reportable transactions. If any one of these is met, regardless of how “unshelterlike” the transaction may be, disclosure is required.

Listed transactions

A listed transaction is any transaction that is the same or substantially similar to a transaction that the IRS has identified in published guidance as a tax-avoidance transaction.

Confidential transactions

A confidential transaction is defined vaguely as “a transaction that is offered to a taxpayer under conditions of confidentiality.” A transaction is considered a confidential transaction if the taxpayer’s ability to disclose the tax structure of the transaction is limited by an agreement with “any person who provides a statement to the taxpayer as to the potential tax consequences that may result from the transaction.”

At first glance, this category may seem inapplicable to most standard corporate transactions; we rarely consider those on the other side of the table “persons providing a statement as to the potential tax consequences” of the transaction. However, given that there are tax statements — no matter how insubstantial — between parties to almost every deal, the term “confidential transaction” seems to include virtually any transaction where the parties have agreed to keep the transaction confidential.

Fortunately, the regulations provide two exceptions to the general rule. First, limitations on disclosure of the tax structure are permitted if necessary to comply with securities laws and disclosure is not otherwise limited. Second, in the case of most taxable or tax-free M&A deals, confidentiality is permitted until the earlier of the date of public announcement of discussions relating to the acquisition, the date of public announcement of the acquisition, or the date of the execution of a sale or merger agreement.

Another way to avoid having a confidential transaction is to authorize disclosure of the transaction’s tax aspects. With certain limitations, the regulations state that a transaction is not considered a confidential transaction if every person who makes a statement to the taxpayer as to the potential tax consequences that may result from the transaction provides the taxpayer with express written authorization to disclose the tax structure to any and all persons.

Transactions with contractual protection

These transactions are those for which the taxpayer has the right to a full or partial refund of fees if all or part of the intended tax consequences from the transaction are not sustained, and those for which fees are contingent on the taxpayer’s realization of tax benefits from the transaction.

Loss transactions

The loss transaction category represents the most significant change to Treas. Reg. 1.6011-4 from prior versions. This is a transaction that results in a taxpayer claiming a loss for federal income tax purposes of at least $10 million in any single taxable year or $20 million in any combination of taxable years for corporations, and, in general, $2 million in any single taxable year or $4 million in any combination of taxable years for all other taxpayers.

The IRS has excepted some innocuous loss transactions (e.g., loss on the sale of property that was purchased with cash) by means of an “angel list” published in a Revenue Procedure.

Transactions with a significant book-tax difference

This category casts a large net in a small pond. It applies only to (i) 1934 Act reporting companies and their related companies and (ii) business entities that have $250 million or more in assets (aggregating the assets of all related business entities). The transactions covered are those in which the treatment of any item or items from the transaction for federal income tax purposes differs, or is reasonably expected to differ, by more than $10 million from the treatment of the item for book purposes in any taxable year.

Special rules are provided for consolidated returns, foreign taxpayers, disregarded entities, partners and shareholders of certain foreign corporations.

The breadth of this category can be measured by its “angel list” of exceptions, also found in a separate Revenue Procedure. This list provides certain transactions which, presumably, Treasury believes fall within the definition of a transaction with a book-tax difference, but will not be required to be disclosed. These transactions include cancellation of indebtedness income; federal, state, local and foreign taxes; compensation of employees; charitable contributions; and tax exempt interest.

Transactions involving a brief asset holding period

This is a narrow category, requiring only the disclosure of any transaction resulting in a tax credit (including any foreign tax credit) exceeding $250,000 if the underlying asset giving rise to the tax credit is held by the taxpayer for less than 45 days. This category presumably targets transactions similar to those in two cases lost by the IRS (Compaq, IES Industries).

Notwithstanding that these regulations are now in “final” form, it is widely expected that further revisions will follow, most likely within the next year. The confidential transactions category is the most likely to be amended, either through a narrowing of scope or the promulgation of another “angel list.”

These regulations, and several related provisions in pending legislation, should remain a hot topic for the foreseeable future.

Donald R. Bly ([email protected]) is a tax associate with King & Spaulding LLP. Reach him at (404) 572-2787.