Book-Tax Conformity and the Corporate Tax Shelter Debate: Assessing the Proposed Section 475 Mark-to-Market Safe Harbor

176 Pages Posted: 8 Feb 2005  

Linda M. Beale

Wayne State University Law School

Abstract

Recent accounting scandals in which large corporations such as Enron and Freddie Mac have used complex financial products and transactions to puff or hide income, sometimes with the assistance of major financial institutions, have brought renewed attention to the relationship between financial and tax accounting. In an earlier article, I examined the ways that heightened disclosure and penalty requirements for aggressive tax transactions, coupled with cooperation between the SEC and the IRS and disclosure of certain tax information in SEC filings, could improve corporate governance and simultaneously discourage abusive tax transactions. This Article continues my examination of the relationship between financial accounting and tax issues in two ways. First, it examines the history of book-tax conformity proposals to determine the concerns most relevant to an assessment of conformity proposals. Second, it evaluates Treasury's conformity proposal for mark-to-market accounting of securities dealers' notional principal contracts in light of those concerns.

In assessing particular conformity proposals, the Article concludes that the most important concerns are whether conformity enhances or reduces structural coherence and whether it supports the self-assessment principle underlying our voluntary compliance scheme. Especially problematic are conformity proposals in areas of rapid financial and tax innovation that significantly increase the potential for "self-help" manipulation of income determinations.

Treasury's proposed safe harbor for marking securities to market falls short of the normative standards for conforming tax to financial accounting. The case for conformity in this context rests almost entirely on lessening dealers' compliance burdens by eliminating the need for separate tax valuations; yet, given the availability of commercial valuation programs and electronic data storage to these sophisticated financial intermediaries who must provide various kinds of information on their portfolio to different regulators, these potential burdens do not appear to merit significant weight. This is especially true where, as here, the financial accounting rules for marking to market do not provide the required assurance of consistency with income tax and anti-manipulation values. Furthermore, because a regulation project will be necessary even if the proposed mark-to-market safe harbor is adopted, the Article recommends that Treasury instead develop tailored regulatory guidance that establishes guidelines for permissible valuation methodologies. The Article concludes with some preliminary suggestions for areas that the regulations should cover and ways that the difficult issues such as credit risk adjustments might be addressed.

Suggested Citation

Beale, Linda M., Book-Tax Conformity and the Corporate Tax Shelter Debate: Assessing the Proposed Section 475 Mark-to-Market Safe Harbor. Virginia Tax Review, Vol. 24, Fall 2004. Available at SSRN: https://ssrn.com/abstract=664023

Linda M. Beale (Contact Author)

Wayne State University Law School ( email )

471 Palmer
Detroit, MI 48202
United States

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