Slowly but surely, corporate taxpayers are resigning themselves to a new era in tax compliance, where aggressive tax planning is giving way to a more measured, transparent approach.
In another step on its path to cut-to-the-chase tax administration, the Internal Revenue Service recently made its Compliance Assurance Process permanent. The program allows large corporate taxpayers to have their tax returns essentially audited before they are filed. The IRS first introduced the CAP system in 2005 as a pilot program, but now plans to expand it to more companies.
Tax experts expect companies to start queuing up. “The pendulum is slowly swinging toward cooperation,” says Bob Gordon, a partner at tax advisory firm True Partners Consulting.
The expansion of the CAP program follows on the heels of Schedule UTP, where companies are required to disclose shaky positions on their tax return, and Schedule M3, where companies must reconcile financial statement income with tax return income. “All of these initiatives at the IRS are designed to encourage taxpayers not to fight,” says Gordon. “There are still taxpayers who will say ‘I'm right, by gosh, and I'm going to fight to the death,' but there are a lot of taxpayers now who are going to do a very reasoned cost benefit analysis.”
Through CAP, large corporate filers can work with the IRS as they prepare their returns to identify and resolve any significant issues before the return is filed. That cuts the risk of bloody audits and reduces the reserves companies must set aside to settle unresolved tax issues. It also cuts any interest expense companies might accrue to settle old tax disputes where penalties and interest might apply. When the IRS introduced the program in 2005, it admitted only 17 companies. Now there are 140 corporate taxpayers participating.
The IRS also has developed a “pre-CAP” system to process companies that still have open tax years to be examined and settled before they can enter the CAP system. And for companies that have been in the CAP program for a while, the IRS also hopes to convert some to a “compliance maintenance” process, where low-risk, well-behaved corporate taxpayers will get an even faster pass through the pre-filing process.
“The IRS has taken incremental steps in getting there, but there's no question they are trying to get resolution earlier and earlier in the process,” says George Hani, vice chair of the tax department at law firm Miller & Chevalier. “And it's not just their idea. Some of this is driven by corporate taxpayers who want to have certainty sooner.” That's especially true after companies were required by accounting rules to put more information in financial statements about unresolved tax issues, and then by tax rules to put more information on uncertain tax positions in their tax returns on Schedule UTP.
For corporate taxpayers facing such filing requirements, the CAP program looks appealing, says Kevin Brown, U.S. leader of tax controversy and dispute resolution for PwC. “There is a lot of pent-up demand for CAP,” he says. “The rationale is if I'm going to have to fill out this UTP and provide a high level of transparency, maybe I can get something in return, which would be certainty sooner. If you're going to go through that level of disclosure with the IRS anyway, wouldn't it be great to know you're not going to be audited?”
“There's a price to pay for certainty. If you go through the CAP program, it's likely you'll be leaving some money on the table. For tax directors, that's a balancing act.”
—Bob Gordon,
Partner,
True Partners Consulting
Recent academic research suggests CAP has produced some measurable benefits for participants. A study out of the University of Illinois says CAP participants generally sign up for the program because they want to reduce uncertainty so they can lower the amount they must reserve under financial accounting rules. The study also concludes that CAP participants are successful in that respect. On average, they reduce their reserves by more than $14.5 million compared with non-CAP participants.
Other cost benefits are tougher to pin down. For example, companies are more likely to reduce penalties and interest if they resolve issues quickly instead of allowing them to linger, says Gordon. However, given the inherent complexity of tax law, if companies agree to settle tax issues too fast, they probably pay more tax overall. “There's a price to pay for certainty,” he says. “If you go through the CAP program, it's likely you'll be leaving some money on the table. For tax directors, that's a balancing act.”
Doing Less With More
Tax experts also differ on the extent to which a faster, more straightforward audit process requires more tax staffing resources. David Auclair, national managing principal with the Washington national tax office of Grant Thornton, says transparency carries a price tag. “Transparency brings with it a burden of providing more information,” he says. “That puts a lot more pressure on the normal burden of your tax function.”
CAP PERMANCY IN A NUTSHELL
Below is a summary of the Compliance Assurance Process from the IRS:
I. Pre-CAP
A. Pre-CAP Description
Takes place in a traditional post-file environment and is conducted by a Team Coordinator, not an Account Coordinator.
The purpose is to close all transition years except for one open and one unfiled year and to assist the Taxpayer to qualify for CAP.
Taxpayer must meet the CAP eligibility criteria (see IRM).
Taxpayer can apply for Pre-CAP at any time.
Taxpayer and the Service will develop an action plan to eliminate transition years within an agreed amount of time.
B. Pre-CAP Requirements
Taxpayer will work with the exam team to develop an action plan for preparing the Taxpayer to enter the CAP.
Taxpayer will sign a Pre-CAP MOU.
Taxpayer and Team will work in a CAP environment.
Taxpayer will exhibit the transparency and cooperation needed to progress to the CAP.
Taxpayer will agree to identify issues within transactions and provide information in a timely manner to resolve the issues.
For a Taxpayer to be eligible for the CAP after 2011, all transition years must be closed except for one open, filed year and one unfiled year.
II. CAP
A. CAP Description
Taxpayer will proactively provide the Service with pertinent facts in order to develop material issues.
Transparency and cooperation will reduce the Taxpayer's and the Service's use of resource needs.
The Service will conduct due diligence review as appropriate
B. CAP Requirements
Taxpayer will sign a CAP MOU.
Taxpayer will exhibit transparency and cooperation with the Service.
Taxpayer will identify issues within completed business transactions.
Taxpayer must meet the CAP eligibility criteria (see IRM).
Source: Internal Revenue Service.
Companies likely would face a burden at first in working with the IRS to get exams and audits caught up to the current year, says Brown. “You've got to answer their questions quickly, so there would be more labor required to get into the rhythm of this,” he says. After that, companies likely would face less demand on resources to comply through CAP, he believes, especially considering how certainty in the federal return would trickle down to greater certainty in an untold number of state returns and a faster running statute of limitations on many issues.
Gordon, however, isn't sure companies would see the demand on resources trail off after getting situated into CAP, “unless you agree to every position the IRS takes, and unless you assume the IRS is never wrong.” Companies will still have to devote time to carefully articulating and defending their tax positions, he says. “You're still going to need to look at the issue and argue with the IRS,” he says. “You're just doing it now instead of three years from now.”
At the international level, companies are bracing for greater transparency initiatives as well, according to recent research by KPMG. The firm asked 100 tax executives at a global conference for their views about the biggest challenges facing their tax departments, and the majority cited an increasing volume of tax examinations from many countries, not just the United States.
Rodney Lawrence, tax principal for KPMG, said a number of European countries have become more aggressive in that respect, as well as “supernational” groups like the Organization for Economic Cooperation and Development, which is developing a method for countries to cooperate in global tax audits. Where companies are struggling with international tax compliance, it's often driven by a dearth of implementation guidance, he says. Tax executives are hopeful in the face of increasing transparency requirements globally that tax authorities will not only ask for more information but also offer more guidance so companies can comply confidently.
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