ࡱ> HJG` 0bjbj .@(2$BL@BBBBBB$wh`f&&&f{&"@&@6 VH|0?^??,x ffz &&&& d 46.  INCLUDEPICTURE "cid:image001.gif@01C5CEBA.366CB520" \* MERGEFORMATINET   INCLUDEPICTURE "cid:image002.gif@01C5CEBA.366CB520" \* MERGEFORMATINET   INCLUDEPICTURE "cid:image001.gif@01C5CEBA.366CB520" \* MERGEFORMATINET   INCLUDEPICTURE "cid:image003.gif@01C5CEBA.366CB520" \* MERGEFORMATINET  A Very Strange Indictment By ROBERT WEISBERG and DAVID MILLS Wall Street Journal October 12, 2005;PageA16 The recent indictment of some KPMG partners makes for very interesting reading. In the months leading up to it (and the now-rumored indictment of other tax advisors on similar grounds), numerous news stories suggested the KPMG accountants had somehow knowingly participated in tax fraud by creating fake losses for wealthy clients. Whether or not this proves true, the indictment makes no such allegation. While the accountants and their clients may have done some bad things, the notion that their behavior is criminal, and even sufficiently criminal to threaten the very existence of this major firm and its thousands of jobs, casts doubt on the fairness and judgment with which the federal prosecutors have exercised their discretion. Why did they do so in this case? Probably for the simple reason that they are -- quite properly -- offended by the proliferation of newfangled and economically questionable tax shelters, yet at the same time exasperated that Congress shows no interest in legislating these shelters out of existence or enacting a clear "business purpose" requirement, in spite of repeated requests from the Internal Revenue Service. The prosecutors seem to be venting their frustration over this failure to act by fashioning felony charges out of ethereal legal material. * * * The KPMG indictment has more verbiage than clarity, but at its core is an alleged violation of the business purpose doctrine. This doctrine was invented by the IRS and the courts as a way to combat certain tax-motivated transactions. It holds that the courts should deny a taxpayer the tax benefits of a transaction that otherwise qualifies under the words of the Internal Revenue Code if the expectation of gain that motivated the transaction derived primarily from the tax savings, not from some gain inherent in the transaction itself. But just how much prospective "real" gain, as compared to tax benefits, will the IRS say is necessary to establish a business purpose? This is uncertain and often varies with the nature of the transaction and the tax result sought. The business purpose doctrine is very much the moral equivalent of that much-loved definition of pornography -- the IRS knows it when it sees it. Since the business purpose doctrine has no explicit statutory support and is applied to disallow tax results which are otherwise consistent with the technical provisions of the tax law, the tax return itself never mentions it. Nor does the return require any representation that the taxpayer's transactions have complied with the business purpose doctrine as it is understood by the IRS. The only things reported on the tax return are the transactions undertaken by the taxpayer and the claimed tax result. If the IRS decides to examine the tax return and notices a transaction giving rise to a loss that might be subject to challenge, it then conducts an audit. If, after reviewing information then elicited from the taxpayer, it determines that there was not a sufficient business purpose, the agency will negate the tax benefits of the transaction and adjust upwardly the taxes due. And then, in a next stage, if the audit also concludes that when the taxpayer filed the return he did not reasonably believe that there was "substantial authority" that the transaction would satisfy the business purpose doctrine, the IRS may also impose civil penalties. So what does the government think really happened in the KPMG case? The firm gave an opinion about the propriety of deducting losses on real securities transactions. The taxpayers needed the opinions to protect themselves against civil penalties the IRS might later try to impose. They did not need the opinions to file their tax returns claiming the losses. The indictment contends that the accountants knowingly based their opinion on false representations from the clients about the business purpose of the transaction. And out of this opinion the government has produced a conspiracy charge alleging two crimes which the accountants supposedly conspired to commit: tax evasion and tax perjury. Now the first of these, tax evasion, is a very serious crime, but it should not be confused with simply failing to pay taxes due. Rather, felony tax evasion requires a so-called "affirmative act of evasion," such as keeping false accounting books or literally hiding money so that the IRS cannot find it. In the KPMG case, each taxpayer claimed losses on its tax returns -- in accordance with a literal application of the tax law. Then, as often happens, the IRS challenged the claims. This is not the stuff of felony tax evasion. The opinion given by the KPMG accountants had no relevance to the propriety of filing a tax return consistent with the literal application of the tax law; the opinion was given for an entirely different purpose -- to protect against civil penalties which might be imposed after the return is filed and audited. Therefore, any false representations reflected in the opinion letter are irrelevant to the crime of tax evasion. * * * The second crime is so-called tax perjury, which involves a demonstrable lie uttered in a tax return or some other document required to be submitted to the IRS under penalty of perjury. But in what way did the accountants here conspire to commit such perjury? The most we see is that when, during the audit, the taxpayer said it had a business purpose sufficient to meet the IRS standard for avoiding civil penalties and it produced the KPMG opinion (not given under penalty of perjury), the taxpayer was being disingenuous. But that hardly renders perjurious a tax return that was factually correct. At most the client misstated (with the accountant's conspiratorial encouragement) its subjective belief about the legality of a transaction in order to combat the potential application of penalties. That may have been less than forthright, but it is very hard to square with a perjury prosecution, for which a misleading intent is far from sufficient. Since the government sought the indictment, it must have developed -- and perhaps will ultimately argue for -- a creative theory by which this alleged wink-wink arrangement is worthy of criminal prosecution. It might argue that penalties are included within the definition of taxes, so that any attempt to avoid penalties would be tantamount to tax evasion. But it would take great creativity, and also pose substantial theoretical and practical difficulties, for the government to introduce an entirely new crime -- "tax penalty tax evasion." There is one other hint of a legal theory in this strange indictment. At one point it seems to allege that the accountants engaged in a conspiracy to defraud the United States. Federal law does permit a charge of conspiracy to defraud the U.S. without requiring a charge of an intent to violate a specific criminal statute. But the courts have been loath to permit the government to bring this sort of charge in a case where it is also citing specific criminal laws as objects of the conspiracy. And there has never been a prosecution under the general "defraud" clause in a tax case where the alleged conspiratorial objective is reducing one's taxes without substantial legal basis for doing so. Even if the government can convince the courts of one of these creative theories, there is still another problem. Under well-established Supreme Court precedent, tax fraud, be it the more serious crime of evasion or the less serious crime of tax perjury, is one of the very few areas of criminal law where ignorance of the law is an excuse. In fact, it is the core area of criminal law where this is true -- people are guilty only if they fully understood that their actions violated a criminal prohibition. So the very idea of punishing the accountants in a kind of test case of this theory of the criminal tax law is self-refuting. That is, even if the accountants knew the transaction would be deemed to lack a business purpose, they had no reason whatsoever to think that under these circumstances they could face anything worse than the usual civil penalties. And without that knowledge, they cannot be guilty of tax fraud. * * * Finally, the indictment suggests that the accountants were involved in obstruction of justice, but, strangely enough, it does not actually charge obstruction. One can only speculate that the IRS and the Department of Justice were dissatisfied with the amount of jail time for obstruction offenses under the sentencing guidelines and decided, without unambiguous legal justification, to seek more jail time to send a harsh message. They may have feared that offering the jury the lesser crime of obstruction as an additional charge would have led the jury to view it as the proper alternative charge. KPMG has already been forced to publicly acknowledge wrongdoing as a price of staying in existence, and has been further forced to cut all financial ties to these defendants -- all this without the government even having to prove that the claimed tax losses were improperly taken. The government may be quite right that the claimed losses in this matter must be rejected and that stern civil financial penalties must be imposed. And Congress may well want to declare certain shelters illegal and even devise a criminal law to prohibit the kind of activity alleged in this indictment. Still, that does not justify the KPMG indictment. As a study in how one branch of government responds to what it perceives as the failure of another, this is a very interesting historical episode. But as a legal matter, unless and until we see a superseding indictment charging clearly criminal behavior, the KPMG matter should be left to the civil system. Mr. Weisberg is Edwin E. Huddleson, Jr. Professor of Law and director of the Criminal Justice Center at Stanford University. Mr. Mills is senior lecturer at Stanford Law School. Together, they teach a course on white-collar crime at Stanford Law School. 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