Category Archives: Uncategorized
May 9, 2018 Andrew Hayashi
Gladriel Shobe,
Private Benefits in Public Offerings: Tax Receivable Agreements in IPOs, Vand. L. Rev. (forthcoming 2018), available at
SSRN.
In Private Benefits in Public Offerings, Prof. Shobe describes the emergence and evolution of a fascinating term in initial public offerings: tax receivable agreements (TRAs). These agreements reserve for the pre-IPO owners of the business the economic value of certain tax attributes that are either created in the course of the IPO or which were created over a course of years before the IPO. TRAs are contracts between the post-IPO corporation and the pre-IPO owners, pursuant to which the corporation makes distributions to those pre-IPO owners as tax assets are used. In one variation, pre-IPO owners receive the economic benefit of basis step ups that arise in certain “turbocharged” IPOs, and in other variations the pre-IPO owners receive the economic benefit of net operating losses and historical basis in the corporation’s assets.
Shobe then goes on to evaluate the fairness of these agreements. One view that motivates her discussion is that tax assets are underpriced in IPOs, and that TRAs are one way of ensuring that the pre-IPO owners receive a “fair price” for these assets. The opposing view is that the tax assets are properly valued in IPOs already, so that the TRAs allow pre-IPO owners to extract a greater purchase price from new investors than they otherwise would, and perhaps should.
One important contribution of the paper is to describe how these agreements work, and to document how they have both proliferated and mutated into different forms. Shobe teaches the reader a great deal about this feature of IPOs and make some important observations about how they operate. Her work raises the question of why certain variants of the TRA were adopted in some IPOs and other variants were adopted in others, and why TRAs that convey the benefits of net operating losses and historical basis have become increasingly popular over time. Exploring the relationship between the form of the TRA and other characteristics of the IPO might help explain what function they serve.
The paper’s normative discussion focuses almost exclusively on the question of whether such agreements are fair, because the pre-IPO owners are being compensated for a valuable tax asset, or unfair because new investors are unaware of the liability that the corporation is assuming when they set the purchase price. One might also think more broadly about why such an agreement might exist, beyond simply extracting value from unwitting purchasers. Thinking carefully about how tax assets differ from other assets points in some interesting directions.
For example, the value of net operating losses (NOLs) depends on the IPO corporation’s taxable income. Pre-IPO owners that reserve for themselves payments contingent on the use of those NOLs are sending a signal to potential investors about their expectations about the profitability of the company. Those same pre-IPO owners might be thought to have better information about the corporation’s prospects, so that the signal allows them to extract a higher price in the IPO. The same rationale would not apply with the same force to TRAs in which the pre-IPO owners reserve for themselves the benefits of historical basis in non-depreciable assets, since the benefits of the basis are contingent on the future value of those assets (and whether they are ever sold) and do not depend only on the income of the corporation generally. This suggests that empirical testing of the signaling hypothesis might be of value. Shobe notes that private deals often require purchasers to pay sellers for the value of tax assets but also require sellers to pay buyers for undisclosed tax liabilities. She suggests that the fact that TRAs in public deals only incorporate one half of this bargain might be unfair. Perhaps. But there might be are other differences between public and private deals they could justify the use of TRAs to resolve information asymmetries in expected future income, but not to address tax liabilities, which arose in the past and are subject to due diligence.
More generally, there is a fascinating puzzle about what work TRAs are doing. Shobe lays the descriptive groundwork and takes a first step in assessing the merits, and I hope that this paper also sparks additional work by contract law and corporate law scholars exploring the reasons for these provisions.
Apr 10, 2018 Kim Brooks
Some of my favourite tax scholarship steps outside technical detail and speaks to how tax systems promote or are informed by higher-order values. So, I welcome Shirley Tillotson’s magnificent and richly researched new book on the era between the enactment of Canada’s federal income tax law in 1917 and its heady 1960s reform period, which saw taxpayer-citizens actively debating the contours of democracy through the vehicle of tax reform. At its heart, the book is about what we can learn about democracy from our engagement with taxation and how our democracy can be enhanced when we find ourselves talking about taxes over coffee.
A historian could learn a lot about tax history from reading iterative drafts of legislation, department of finance notes, house of commons debates, and parliamentary committee reports: indeed, some have. Tillotson doesn’t take those as her starting place. Instead, she is interested in how “real people” engage with the tax system and its reform. For her book, she culled through thousands of letters between taxpayers and tax authorities. The letters were mined from the records of the Department of Finance and the Department of National Revenue, in the papers of prime ministers, finance ministers, opposition leaders, and tax officials.
She displaces the myth that tax rage or revolt are new phenomenon. Her work documents a range of complaints about the tax system and proposed reforms over 50 years; yet, there was change in that period. No one could contest that what started as a perhaps more modest (and elite-focused) project had become a mass tax. Perhaps her work offers us hope that in the face of resistance and complaint there is the potential for dialogue, adjustment, compromise, and ultimately, transformation.
Tillotson is a beautiful writer, and often funny, a pleasant surprise. And so, her work is worth reading in its entirety for pleasure alone. Nevertheless, as a teaser for a largely American Jotwell readership, she also draws out some of the American tax story. For example, before the Second World War, Canada relied more heavily on regressive taxes than the United States, and was appealing to wealthy Americans seeking to reduce their government contributions. Although Americans adopted a marital income splitting approach to tax unit, Canada resisted (despite some strong advocacy to follow suit). Canada has lacked the constitutional-style tax resisters often found in the US, although Tillotson’s book certainly documents the stroppiness of the Canadian public when it comes to tax policy and tax reform. Hence the unruly title of this Jot.
Let me end with a brief aside. One of the things I appreciate in the work of others is their willingness to engage with scholarly colleagues and to acknowledge the contributions of others. Tillotson has worked closely over the years with a Canadian colleague, Elsbeth Heaman. (Heaman also published a tax history book in 2017 – Tax, Order, and Good Government: A New Political History of Canada, 1867 – 1917 (2017). Tillotson gracefully and regularly acknowledges — both in this work, but also in her interviews and media work on it — the joy and value of having had a thoughtful collaborator in the pursuit of Canadian tax history.
Tillotson’s book is a fine contribution to tax and social history. If you are an American wondering how tax dialogue works in the big piece of land to the North, it’s well worth your time.
Mar 1, 2018 Kathleen DeLaney Thomas
For those interested in understanding taxpayer compliance—including what motivates taxpayers to report honestly and how to reduce tax evasion – there is a robust body of empirical and legal literature. A number of economists and lawyers have examined the effect of traditional deterrence mechanisms like audits and penalties, as well as non-economic factors like social norms, guilt, taxpayer attitudes about how their tax money is spent, and other psychological factors. While this growing body of literature provides a rich description of the myriad of factors that influence tax compliance decisions, our understanding of taxpayer behavior is far from complete, and further study continues to be necessary. In expanding our understanding of taxpayer motivations, one revealing but possibly overlooked resource is the IRS Taxpayer Advocate Service (“TAS”), which each year publishes a number of empirical studies and other reports relevant to tax compliance. The authors of TAS studies are uniquely situated in that they have access to IRS tax return data, which should provide the best evidence of how taxpayers make decisions in the real world.
As part of the Taxpayer Advocate’s most recent Annual Report to Congress, the TAS published Audits, Identity Theft Investigations, and Taxpayer Attitudes: Evidence from a National Survey (the “Report”). The Report surveyed 2,729 Schedule C filers, that is, taxpayers reporting income from self-employment. Of this group, roughly half (1,363) had been previously audited and half (1,366) had not. One of the primary goals of the Report was to examine how audits influence taxpayer attitudes and behavior. While several of the findings are predictable and consistent with other research on audits, three of the Report’s findings are quite surprising.
The first and most surprising finding is that nearly 40 percent of the audited taxpayers surveyed did not know they had been audited. You read that right. When audited taxpayers were asked if they had been audited in the past, a significant number of them (38.7 percent) did not appear to realize they had been. Why? The answer is at least partly in the details. Taxpayers who experienced a “correspondence audit” (in the form of letters from the IRS) were far more likely to not realize they were being audited compared to those who experienced an in-person audit. It’s plausible that taxpayers envision audits as involving an IRS agent digging through their files, and that they simply do not perceive an exchange of letters as an audit. But since more than 70 percent of audits are done through correspondence, perhaps audits don’t have as strong of a deterrent effect as we might assume.
The second surprising finding is that audited taxpayers have more favorable views about justice in the tax system than non-audited taxpayers. Specifically, audited taxpayers perceive higher levels of procedural justice, informational justice, interpersonal justice, and distributive justice as compared to unaudited taxpayers, perhaps indicating that their experience with the IRS was “transparent, respectful, and appropriate” according to the Report. On the one hand, this may indicate that the IRS gets a bad rap: we might assume an audit will be an invasive and stressful experience when, in actuality, perhaps it’s not so bad. On the other hand, less than half of taxpayers surveyed owed the IRS money after their audit, and nearly 19 percent were owed a refund. This happy and perhaps unexpected outcome likely influenced the attitudes of some survey respondents.
The third surprising finding is that taxpayers who receive a refund after an audit have less favorable views about the tax system than those who receive no adjustment after an audit. In fact, taxpayers with no change after an audit reported the highest perceived levels of distributive justice in the tax system and most positive attitudes overall as compared to taxpayers who owed money and those who were owed a refund. Interestingly, this indicates that post-audit refunds don’t necessarily promote positive attitudes towards the IRS and the tax system. Perhaps the explanation here is that an audit with no adjustment indicates that everything was working correctly: the taxpayer got it right on her return and IRS inquiry did not change the result. On the other hand, it is somewhat surprising that taxpayers who got their returns right the first time aren’t more resentful that they were audited at all, especially as compared to those who receive a surprise refund.
Other aspects of the Report were not surprising. Self-employed taxpayers tend to consider cheating more than employed taxpayers, which makes sense because the former group has significantly more opportunity to cheat. It is also unsurprising that taxpayers who owed money after an audit report more negative attitudes about the tax system compared to those who weren’t audited, including lower levels trust in the IRS and higher levels of anger.
Overall, there are a number of possible takeaways from the Report. Audits appear to have a deterrent effect, but we may overestimate their power given the number of taxpayers who don’t realize they have been audited. At the very least, we can’t necessarily analyze the impact of audits collectively, as the type of audit (correspondence versus in-person) matters a great deal. Furthermore, the IRS’s bad reputation—at least when it comes to audits—might be undeserved, given the positive attitudes reported by many audited taxpayers. More generally, the Report highlights the fact that taxpayer attitudes about the tax system are heterogeneous and complex, underscoring the importance of continued study. Finally, the Report illustrates the wealth of information on tax compliance that is available thanks to TAS.
Cite as: Kathleen DeLaney Thomas,
What Do Audits Teach Us About Tax Compliance?, JOTWELL
(March 1, 2018) (reviewing Taxpayer Advocate Service Research Report,
Audits, Identity Theft Investigations, and Taxpayer Attitudes: Evidence from a National Survey (2017)),
https://tax.jotwell.com/audits-teach-us-tax-compliance/.
Jan 25, 2018 Omri Marian
Over the past several years, a series of leaks related to offshore tax avoidance and evasion (SwissLeaks, LuxLeaks, the Panama Papers, Bahama Leaks, and Paradise Papers, to name a few) has fueled calls for tax transparency. To date, most discussion of the leaks has been policy-oriented (leaks: good or bad?) and largely anecdotal (based on some truly outrageous revelations). It was not until very recently, however, that a small group of researches started delving into the data exposed by these leaks to make statistically significant empirical findings. Alstadsæter, Johannesen & Zucman’s (AJZ) paper is an excellent example of such paper, which combines methodological sophistication, public data, and leaked data, to make important new contributions to the voluminous literature on the offshore tax world.
Matching leaked data with data from random audits in Scandinavian countries, public wealth records in those countries, and data from voluntary disclosure programs, AJZ find that offshore tax evasion (meaning, the act concealing income from tax authorities in offshore accounts), is not evenly distributed across wealth groups. Rather, they demonstrate that “the probability to hide assets offshore rises sharply with wealth, including within the very top groups of the wealth.”
AJZ findings stand in sharp contrast to what is known (or at least assumed) about tax evasion from stratified random audits, which—per AJZ— is “the key source used so far in rich countries” to study tax evasion. AJZ argue that random audits miss large part of tax evasion, “because it assumes that detected and undetected forms of tax evasion are similarly distributed across the income spectrum”. They suggest, however, that “sophisticated forms of evasion involving legal and financial intermediaries—that are only accessible to wealthy taxpayers—are unlikely to be uncovered in random audits.”
AJZ find, however, that “[Scandinavian] households who own around $10-12 million in net wealth are twice more likely to conceal assets abroad than households with around $5-6 million; households with more than $45 million are four times more likely.” Consider another example: random audits suggest that the average evasion rate in Scandinavian countries is 3% (meaning, about 3% of all individual taxes are evaded in Scandinavia). AJZ find, however, that the top 0.01% of Scandinavian households (in terms of net wealth) evade about 25% of their income through offshore accounts. This stands in sharp contrast to the average 3% benchmark.
These findings are profound in many important ways. It means, for example, that models for assessing the tax gap (meaning, the amount of uncollected taxes) probably understate the tax gap, if such models usually assume even distribution of detected and undetected tax evasion among income groups. If undetected evaded income is concentrated at the top, it also means it should have been taxed at higher rates than previously assumed for purposes of calculating the gap. The findings also mean that standard measures of inequality severely understate the level of inequality, because such models rely on reported data, which by definition does not include unreported income, which—we now know—is concentrated within top-earning households.
In their paper, AJZ address the effects of their findings on inequality and the tax gap at length. But several other important themes—some more implicit—emerge. First, consider the fact that in Scandinavian countries tax compliance is a cultural trait. What might be the outcomes in economies where tax avoidance (and evasion) have a more favorable public view, such as the United States? AJZ indeed note that because other economies “own much more wealth offshore than Norway, the results found in Scandinavia are likely to be lower bounds for these countries.” Second, another important theme relates to the data on which we rely in tax policy making. Proposed legislation, enforcement actions, and administrative guidance all rely on modeling, which in turn rely on reported tax data. The AJZ paper at least raises a plausible argument that the entire tax-policy making process relies on severely faulty (if not incorrect) data. Finally, the AJZ paper emphasizes how leaks may affect our tax system, and point to the role of civil protest in tax. For years, policy makers and taxpayers invested significant effort in protecting taxpayers’ privacy, sometime legitimizing the offshore system as a protector of legitimate privacy concerns. These arguments make some sense in theory. But when 95% of the accounts identified in the leaks are not reported to tax authorities (as AJZ find when trying to match the leaked accounts with required reports on offshore accounts), the legitimacy of the privacy argument is diminished. It really seems that, for the most part, intermediaries in secrecy jurisdictions main function is to facilitate tax evasion and other illicit activities.
In a utopian world, we would not need to rely on leaks to provide the information needed to prescribe successful tax policies. But in this world, the AJZ paper suggests that leaks may play a helpful role in pushing us towards better tax policy. It is the leaks (and the data exposed in papers such as AJZ’s paper) that have driven recent changes in international tax law (such as the adoption of the common reporting standards and the automatic exchange of information by multiple countries). It is difficult to understate how profound has been the effect of leaks, and the following public outcry, on real tax policy. It is truly a bottom-up legal change.
There is a lot more to like in the paper, and I cannot hope to discuss it all in the confined space of this review. I will just note one of my favorite aspects: AJZ develop a model showing that after disclosing tax evasion in an amnesty program, tax evaders do not then find legal ways to avoid taxes. This suggests that discovered tax evasion is not substituted by “legal” tax avoidance, which means that anti-evasion enforcement action are efficient.
To summarize, AJZ’s paper is an early one among several others that use recent leaked data to try to empirically assess what we didn’t know we didn’t know about offshore tax evasion. The implications are profound and should guide data-driven tax policy making for the foreseeable future.
Dec 5, 2017 Charlotte Crane
The Dwindling Taxable Share Of U.S. Corporate Stock, written by Steven M. Rosenthal and Lydia S. Austin, analyzes the available data regarding the ownership of corporate stock in the United States. Over the history of the income tax, most business capital has been invested in corporations, so an assumption that the income taxation of business meant income taxation of corporations was a reasonable assumption. Similarly, most owners of domestic capital were assumed to be taxable individuals.
One could, therefore, use as a starting point for any reform proposal, the idea that a corporation would be taxed at the stated corporate rates and would make distributions of earnings to individuals who would be taxed at the stated individual rates. Rationalization of business taxation has often aimed at eliminating the incentive to engage in business investment other than through corporate entities. This rationalization (or “integration”) using these standard assumptions about the nature of corporate holdings, involves pushing the corporate tax out to shareholders (by effectively reducing rates when corporate income is distributed), or pushing the individual tax into corporations (by effectively reducing the rate on dividends received).
As many involved in the realpolitik of tax reform in the last decade appreciate, this easy starting point is no longer available. Although corporations continue to be registered in increasing numbers, and start-up enterprises continue to use them, free-standing corporations are now far less likely to either be the direct holders of productive assets or to be directly held by taxable individuals. Corporations are now much more likely to be minority shareholders in noncorporate entities, are more likely to be held by ownership chains that no long involve 80% control (the prerequisite to aggregation of entities into single entities for tax purposes) and, as Rosenthal and Austin demonstrate, more likely to have shareholders that are not taxable individuals.
The authors have set out to unpack the actual nature of the shareholder side of corporate taxation. Although it has been acknowledged for many years that not all shareholders are subject to tax on their corporate holdings, the prevailing assumption has been that most shareholders are, and thus that the earnings on capital invested through US corporations are, absent some sort of sophisticated tax planning, subject to two levels of tax. Reform has meant designing taxes such that the combination of the tax on corporations and the tax on shareholders is no more than the tax on investment made without the use of the corporate form.
Rosenthal and Austin review the work of others and the statistical reports in the Financial Accounts reported by the Federal Reserve. They conclude that a relatively low proportion of corporate holdings are subject to such double taxation. Their conclusion is that something just less than 25% of corporate entities are owned by taxable individuals. The biggest difference in the approach of Rosenthal and Austin involves disaggregating the Federal Reserve classification of “households” into nontaxable and taxable holders. Much of the nontaxable holdings are in pension plans and other preferred tax savings vehicles.
Rosenthal and Austin’s work complicates the task of rationalizing the corporate income tax. The challenge of the tax reformer becomes not simply developing a scheme that equates the taxation of returns to corporate equity with the returns made through other legal entities, but also determining which of the varied patterns of shareholder taxation should be preserved. This, in turn, requires determining whether the inducements intended when these patterns were created should be preserved, even if it means there may be no US tax imposed on some returns.
Rosenthal and Austin presented their work primarily to address the integration debate. Their work provides support for those who would push shareholder taxes in (even if this means eliminated some shareholder preferences) rather than pushing corporate taxation out, and relying on shareholder taxation. But their work has done something equally important, in showing how little we actually know about the taxation of business income. They did not attempt to unpack the corporate side of the historical assumptions. But it prompts a series of questions including the extent of investment made entirely outside of corporate entities, and the amount of investment made nominally through corporate entities but which is in fact under the control of entities in partnership with such corporations. These corporate-side questions present equivalent challenges to old assumptions about the nature of business taxation.
Rosenthal and Austin have made the work of those analyzing the taxation of business income in the US much harder. But that is a good thing, if it results in a disruption of the old approaches to integration and corporate reform more generally.
Nov 7, 2017 Diane Ring
Michael Hatfield,
Cybersecurity and Tax Reform, 93
Ind. L.J. (forthcoming Spring 2018) available at
SSRN.
The international tax arena is awash with calls for tax transparency, and a variety of reforms are underway at the national, regional and global level to bring such transparency to fruition. See, e.g., Joshua Blank’s recent article The Timing of Tax Transparency, reviewed by Omri Marian earlier this year. Of course, with great caches of information comes great potential for security breaches of all types. Michael Hatfield, in his forthcoming article, Cybersecurity and Tax Reform, draws attention to the immensely important cybersecurity risks and challenges of a tax system founded on government collection and use of significant quantities of information. Quoting a former FBI Assistant Director, Hatfield describes IRS taxpayer information as “the gold standard” for being a “treasure trove of information” from the perspective of cyber criminals—large quantities of very valuable data housed in one agency. Is the IRS ready? Maybe not.
Hatfield’s solution to these cyber risks (given the operational demands of running a tax system and the constraints faced by the IRS) is substantive law reform and not merely more security. To be clear, security is a great idea, but at some point, reality must step in and when it does, Hatfield argues that it points to a remedy grounded in tax design and not just cybersecurity. His bold proposal—to have the tax system collect less data—relies on the marriage of substantive law changes and a rethinking of the sources of data security.
To make his case, Hatfield begins by painting a somewhat discouraging picture of technology at the IRS. The IRS was an early adopter of computer technology in the 1960s, but it did not stay on the cutting edge. Hatfield offers a nuanced and rich understanding of why the IRS has had difficulty keeping pace with new technology and increasing demands on computerization in the ensuing decades. He points to a mix of factors including: (1) inadequate funding for the scale of the task (given the complex nature of IRS work, the volume of data, and the need to interface with the public); (2) inability to recruit and retain cybersecurity experts (with competition from not only the private sector but also from other government agencies such as NSA, the Pentagon, and the White House, which as Hatfield suggests, may have more “mission” appeal than the IRS); (3) too many users (including both IRS employees as well as taxpayers, third party information reporters, and tax professionals); and (4) the inherent challenges of cybersecurity.
What is interesting in light of its less-than-stellar cybersecurity/technology is that the IRS has not suffered a catastrophic cyberattack or breach to date. In an odd twist, Hatfield contends that the outdated technology at the IRS has served as a partial barrier to cybersecurity attacks. However, the pressure for the IRS to modernize remains strong. Technological innovation is viewed as the path by which the IRS can improve collection of taxes owed. There is also pressure to turn the tax compliance process into the online experience demanded by members of Congress and the public. These constituents have come to expect full online access and service based on their private sector experiences with ordering goods and services, managing bank accounts, and paying and processing credit cards online. In the face of pressure to modernize, Hatfield remains less than sanguine about IRS success on the technical battleground of cybersecurity.
Instead, Hatfield suggests that Congress seriously embrace a goal of collecting less information. He draws on a number of contemporary tax reform proposals to demonstrate ways in which some of them could systematically reduce the quantity and variety of information required and the number of individuals interacting with the tax system. One example he highlights is Pay-As-You Earn (PAYE)—a system of withholding through the year that would adjust withholding to ensure that the net amount withheld matches the taxpayer’s overall tax liability. The result would be no refund and possibly no tax return—at least assuming certain other simplifying tax law changes accompany PAYE, such as a reduction in the number of credits and deductions, fewer tax rates, and a diminished role of family status in individual taxation.
Hatfield offers this and other examples to illustrate his broader argument that Congress can and should tackle the challenge of cybersecurity in the tax system through a new approach to tax legislation. Specifically, he urges Congress to add cybersecurity impact to the usual list of criteria according to which tax legislation is judged (revenue, efficiency, equity, administrability, and political viability). Thus, Congress would consider whether proposed tax legislation would reduce the quantity and types of data collected and would consider such a reduction a point in favor of a particular rule. Hatfield makes a compelling case for the need to minimize the collection problem by having less data in the first place, rather than relying on raw technology and security to protect tax information. But he appreciates the tradeoffs that such an approach would entail in terms of accuracy, precision, equity, and the tax system’s ability to meet non-revenue goals (e.g., redistribution, business incentives, etc.).
There may be another reason that limited-information tax regimes may be difficult for the IRS to implement: cybersecurity risks from the private sector and from foreign governments. Across the globe, tax leaks (including leaks of data gathered in hacks of financial institution customer data) have highlighted notable gaps in tax laws, tax enforcement and tax compliance. The public and legislatures are now regularly confronted with information suggesting ways in which social, political and economic elites have engaged in tax evasion or tax avoidance. In response, international pressure has mounted for increased tax transparency and disclosures to governments. The goal is to have governments directly collect the useful information that tax leaks have been providing. It is possible that we may find ourselves trapped in a cycle in which cybersecurity risks emanating from the private sector and foreign governments create pressure on the IRS to obtain more information, which then generates cybersecurity risks associated with growing government data repositories. It is unclear whether Congress would be willing to affirmatively reduce information collection to break the cycle. But, as Hatfield argues effectively, it is an option Congress needs to take seriously.
