More Taxation through Eroded Tax Avoidance

It all makes sense now.

The US government expects to generate increased corporate tax revenue this year. Much more.

How is this possible without a tax hike?

Well, it could be possible through an increase in corporate revenues. Business growth leads to the collection of more taxes. Maybe in 1999 – but the world is different now.

Instead, the source of this new revenue is a bit more subtle. Needless to say, the Treasury Department has four holiday cards to mail this year: Deloitte, E&Y, KPMG, and PwC.

Increased audit requirements, under the Sarbanes-Oxley Act of 2002, have resulted in increased audit fees and a decline in auditor tolerance for aggressive tax avoidance programs. The loss of tax advisory fees by the Big Four is only part of the story. More profound is the fact that fewer tax avoidance schemes result in higher corporate taxes.

This makes the Treasury Department quite happy.

It’s all really straightforward.

Auditors have become less tolerant of aggressive approaches to tax and accounting practices since SOX was passed. Tax reduction programs are only effective if they push the envelope. They involve risk. Auditors were once willing to let companies accept the risk necessary to implement meaningful tax avoidance programs.

Not any more.

There are two reasons for the auditors’ newfound aversion to this risk. Obviously, auditors are sensitive to anything that looks or smells like impropriety in the wake of this decade’s major corporate governance scandals. They are gun shy. Exacerbating this timidity is the recent pursuit of KPMG by the Justice Department for its sale of allegedly abusive tax shelters.
This is a pretty nice trick. Implicitly, the government has implemented a subtle tax hike through SOX. Auditors, unwilling to approve bold tax avoidance schemes, appear to have been deputized by the IRS.

Hung Jury Does Not Mean Acquitted

Five executives from Enron’s internet business have learned that an indecisive jury does not mean freedom. Of the 170 counts on which these defendants were tried, the vast majority led neither to an acquittal nor a guilty verdict.

The US government has decided to try again for a conviction. So far, these five defendants have eluded a guilty verdict.

This latest round of battles between Enron’s internet business employees and the US government is likely to provide momentum to the winner in the prosecution of Enron’s senior executives (such as Ken Lay) – expected to begin in early 2006.

In this second attempt at a guilty verdict – targeting Joseph Hirko, Rex Shelby, Kevin Howard, Michael Krantz, and Scott Yeager – the government has narrowed its focus to thirty-one charges.

Former Enron investors are watching these criminal cases closely, as they may improve their chances of victory in civil suits.

Congratulations to Kollabra!

I’d like to take the opportunity to congratulate Kollabra on its recent win. Kollabra, which is a freelance client of mine, made the Deloitte Technology Fast 500 list for 2005. This is a substantial success for a rapidly growing company.

Kollabra develops custom engineering solutions for a wide variety of companies across North America. With a mix of full-time and contract employees that is 25 strong, Kollabra has a federated team structure that enables fast, flexible solution delivery.

The Deloitte Technology Fast 500 is a great benchmark for success. Companies named to the Fast 500 have to develop innovative technology solutions – they can’t repurpose existing technology in an “innovative” manner. These contenders have to bring a five-year operating history to the table. Revenue for the first year must exceed US$50,000, and revenue for the fifth year must exceed US$1 million.

Don't Just Focus on SOX!

I was a bit disturbed, though not surprised, by an article that I read in the financial Times last week. Public companies have become obsessed with bringing their IT departments into SOX compliance that they are overlooking a variety of other IT security risks. According to a recent security study by E&Y, most public y traded companies are focusing almost singularly on SOX, overlooking general IT security concerns.

This bit of news definitely bothered me. Public companies are spending so much time focusing on mechanically meeting the SOX standards proscribed by their auditors that they are not paying any attention to other critical business needs. What we are seeing, consequently, is the artificial compliance environment overshadow the market-defined business operating environment. Businesses have to eschew the needs determined by the market to focus on those imposed by the environment.

The result of this mess is a significant risk of fraud - which is what SOX set out to prevent! We are losing the war as we struggle to win the Sarbanes-Oxley battle.

Government-imposed priorities do not work in what is generally a free market economy. I will concede that what we have in the US is a hybrid economy, characterized fundamentally by free market characteristics. This makes sense. A truly free market is open to manipulation and fraud. Some artificial safeguards are of course necessary.

The corporate governance disasters of the past few years really do illustrate this point. Left to their own devices, companies will bend, break, or even maul the rules for the sake of financial gain. Enron, WorldCom, and Tyco demonstrate this fact. Auditors, of course, have become complicit in these efforts. Enron relied on Andersen's guidance, and a plethora of high net worth individuals accepted KPMG's help in dodging their tax obligations.

Some government oversight is necessary.

The goal should be to find a model in which oversight can be introduced without impeding the ability of companies to operate and respond to the market. As with everything, we need balance.