Question

Part I

You are working on the valuation of accounts receivable, and bad debt reserves for the current year's annual report. The CFO stops by and asks you to reduce the reserve by enough to increase the current year's EPS by 2 cents a share. The company's policy has always been to use the previous year's actual bad debt percentage adjusted for a specific economic index. The CFO's suggested change would still be within acceptable GAAP. However, later, you learn that with the increased EPS, the CFO would qualify for a significant bonus. Does this violate any tax laws? If so which ones? What would be the appropriate way to handle this for tax purposes?

Part II.

Consider the following: Accounting firm KPMG created tax shelters called BLIPS, FLIP, OPIS, and SOS that were based largely in the Cayman Islands and allowed wealthy clients (there were 186) to create $5 billion in losses, which were then deducted from their income for IRS tax purposes. BLIPS (Bond Linked Issue Premium Structures) had clients borrow from an offshore bank for purposes of purchasing currency. The client would then sell the currency back to the lender for a loss. However, the IRS contends the losses were phony and that there was never any risk to the client in the deals. The IRS has indicted eight former KPMG partners and an outside lawyer alleging that the transactions were shams, illegal methods for avoiding taxes. KPMG has agreed to pay a $456 million fine, no longer to do tax shelters, and to cooperate with the government in its prosecution of the nine individuals involved in the tax shelter scheme. Many argue that the courts have not always held that such tax avoidance schemes show criminal intent because the tax laws permit individuals to minimize taxes. However, the IRS argues that these shelters evidence intent because of the lack of risk.

In this case, the IRS contends that the losses generated by the tax shelters were phony and that the clients never incurred any risk. Do tax avoidance schemes indicate criminal intent if the tax laws permit individuals to minimize taxes? Justify your answer.

Answer 1

Answer :-

Part 1

Even though the suggested changes by the CFO lie within GAAP, the proposed changes will unfairly increase the EPS of the company, misleading the common investors and other users. It is evident that the CFO is doing it for his or her personal gain rather than for the transparency of financial reporting. Thus, manipulating the reserve in this case comes under the heading of unethical behavior. Taking a stand in such a situation is a difficult and challenging test for an employee who reports to the CFO.

Part 2

The tax laws permit individuals to minimize taxes by means that are within the law like using tax deductions, changing one's tax status through incorporation, or setting up a charitable trust or foundation. In the given case the losses reported were phony and the whole scheme was fabricated to illegally benefit certain individuals; hence there appears to be a criminal intent in the scheme. Although there is no reason to pay more tax than necessary, the lack of risk in these types of shelters makes participation in such schemes of questionable ethics, at the best.