Generally Speaking

A United States Tax Court once defined fraud as “the intentional commission of an act or acts for the specific purpose of evading a tax believed to be owing. Fraud implies bad faith, intentional wrongdoing, and a sinister motive.”¹ As a general rule, all corporations operating in the United States are required to pay federal income taxes on gross income earnings. Section 61 of the Internal Revenue Code defines gross income as all income from whatever source derived.

Tax Minimization

No one likes to pay taxes, and accordingly, a desire to minimize the amount one must pay in taxes is perfectly acceptable. As once said by the late, eminent Judge Learned Hand: “Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; here is not even a patriotic duty to increase one’s taxes.”²

Corporate taxpayers have traditionally been successful at minimizing paying taxes:

“Corporations have been helped in their quest by a tax code that has become ridiculously complex, a result of the annual welter of revisions from Congress and dogged work by an army of lobbyists. But in the late 1990s, the hunt for tax breaks became a much bigger business. For one thing, a new class of professionals — Wall Street investment bankers — joined the legions of lawyers and accountants hawking tax-management services. “Squadrons of lawyers, accountants, and Wall Street structured-finance experts have made an art form of minimizing the U.S. multinational’s effective tax rate within this maze of the U.S. tax code, tax treaties, and global tax systems,” says Selva Ozelli, international tax editor for RIA, a New York provider of tax information and software..According to a recent Harvard University study, U.S. companies avoided paying tax on nearly $300 billion in income in 1998.”³

The conclusion is that in recent years, more and more corporations operating in the United States have come to rely on tax dodging rather than the actual sale of products and services in order to achieve healthy profits.

“Tyco and Enron may have been the masters, but it’s not just corporate rogues that have taken tax games to new extremes. After all, Enron Corp. modeled its massive tax department on that of General Electric Co. (GE ) and a host of other big companies, according to a recent Senate committee report. Tech companies like Microsoft (MSFT ), Cisco Systems (CSCO ), and Compaq Computer (HPQ ) proved adroit at shrinking their tax bills in the ’90s through many means. Claiming unfair competition from lower-taxed overseas competitors, manufacturers have taken steps, too. Cooper Industries Ltd. (RD ) reincorporated in Bermuda last May. Stanley Works dropped plans to move domiciles to Bermuda last summer after a backlash from lawmakers.

That kind of corporate maneuvering, combined with a long-term trend in Congress of shifting more of the tax burden to individuals, has driven corporate taxes down dramatically over the past four decades.”⁴

What Specific Types of Activities Are Considered Tax Fraud?

“Tax fraud” is a term we often hear but rarely understand. The first thing to understand about tax fraud is that it can consist of both actions and omissions. An action, obviously, could be defined as an activity deliberately undertaken in order to accomplish some objective. An omission, on the other hand, is a failure to take action in a particular matter. For example, where a corporation deceives the IRS about the amount of gross income received, an action is done with the objective of misleading the government.

Tax fraud is a general term that can be applied to a wide range of actions and omissions. The list boiled down to the basics, includes but is not limited to:

• Deliberately underreporting or omitting income
• Overstating the amount of deductions
• Claiming false deductions
• Hiding or transferring assets or income ⁶

By no means is the above list complete. Whether it’s hiding income, misreporting income, or trying to claim more deductions than those to which the person or corporation is entitled, the tax defrauder’s behavior has one ultimate goal: the intent to deceive the government. Tax fraud includes tax evasion, defined as the existence of a tax deficiency, coupled with an affirmative act constituting evasion or attempted evasion and a degree of willfulness.

Corporate Tax Fraud

A Closer Look

Corporate tax fraud is undeniably a steadily growing problem in the United States:

“Tax evasion by wealthy individuals and large companies has become a recurring election-year political issue. According to the Treasury Department, in 2003 corporate tax receipts as a share of the overall economy, or gross domestic product (GDP), fell to the lowest level since 1937, with the exception of 1983.

The General Accounting Office (GAO), Congress’ investigative arm, found that more than 60 percent of U.S. firms and about 70 percent of foreign-owned companies operating in the United States did not pay any U.S. federal taxes between 1996 and 2000. The report released April 2, 2004 also said that those foreign firms that pay some U.S. taxes report a much smaller average tax liability on their U.S. earnings in relation to their gross receipts — than do U.S. firms.

“Too many corporations are finagling [finding devious] ways to dodge paying Uncle Sam, despite the benefits they receive from this country,” said Senator Carl Levin, Democrat from Michigan. Levin requested the study along with Senator Byron Dorgan, a Democrat from North Dakota.”⁷

The IRS definition of corporate tax fraud is activity that:

encompasses violations of the Internal Revenue Code (IRC) and related statutes committed by large, publicly traded (or private) corporations, and/or by their senior executives. These schemes are characterized by their scope, complexity, and the magnitude of the negative economic consequences for communities, employees, lenders, investors, and financial markets.⁸

If corporate tax avoidance is big business, corporate tax fraud is a far larger concern. As with avoidance, tax evasion through fraud has a significant impact upon individual taxpayers in the United States. And despite promises of reform, the government’s focus has until quite recently been on individual taxpayers who aren’t protected by “squadrons of attorneys” and therefore make easier targets.

One would think that following the financial scandal surrounding the collapse of Enron, corporate tax fraud would have seen a steady decrease. Yet this may not be the case.

Enron’s aggressive strategy of minimising its asset base and avoiding taxes on a global basis made it the darling of international investors, and it was only after the house of cards collapsed that its accounting and legal advisors sought to distance themselves from what was delinquent corporate behaviour from the outset. Importantly, however, many of the practices adopted by Enron remain in use, particularly in the field of tax abuse. Studies conducted in the United States show that a large number of top companies, including famous brands such as Accenture, ExxonMobil, Hewlett-Packard, Intel, Halliburton, 3M, and Bank of America, have paid armies of accounting, banking, and legal practitioners to concoct schemes devised solely to launder profits without paying their fair share of taxes.

Recent estimates suggest that the US federal authorities lose some US$170 billion (Euro 143 bn) annually to corporate tax avoidance, and this is in addition to the US$85 billion (Euro 71 bn) lost to the Treasury as a result of tax shelter abuse by wealthy individuals. ⁹

As time passes and the wake of Enron and other scandals diminishes, corporate tax fraud is a game that many companies are still willing to play.

The Other Consequences: Secondary Costs of Corporate Tax Fraud

The price of corporate tax fraud extends to more than just the individual American taxpayer. Tax fraud and its eventual exposure wreaks havoc in the marketplace and among stockholders.

Employees, stockholders and pension plans saw hundreds of billions of dollars of stock value evaporate after business scandals and charges of corporate malfeasance rocked Wall Street and the country in recent months.

Public Citizen’s examination of 20 companies under investigation by the Securities and Exchange Commission and/or the Department of Justice found that the total shareholder value of these corporations has been eroded by nearly $236 billion since government investigations were announced or when a company admitted financial mismanagement (see attached analysis).

While all $236 billion in stockholder losses is not solely due to corporate fraud (some portion is due to the overall decline in the stock market), our analysis suggests that a substantial portion is due to corporate malfeasance - either because many of these companies saw large losses shortly after it became public that they were under investigation by the federal government or restated their earnings and because some of the problems of some of these companies helped fuel the overall decline in stock values, particularly in their industrial sector (see discussion in the methodology section in the attached analysis).

The corporate crime blotter includes businesses under government investigation for many reasons: accounting inconsistencies, overstating profits (and understating losses), booking sales that never materialized and incomplete disclosure of shareholder risk concerning mergers.

Shareholder value in 14 of these companies was diminished by more than $1 billion, and at least $25 billion in shareholder value was lost in four different companies. The share prices of five companies fell by more than 90 percent - and the value of 13 company stocks has been cut by half - since the public learned about investigations into fraud and abuse. The median stock value lost by the 20 companies is 52 percent.

The biggest losses came to stockholders in Tyco ($84.2 billion), Lucent ($55.5 billion), WorldCom ($26.9 billion), Enron ($25 billion), Xerox ($9.8 billion) and Qwest ($9.8 billion). The $211 billion in shareholder value lost by these six corporations represents about 90 percent of the total losses in the 20 companies that Public Citizen examined.”¹⁰

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