Friday, May 25, 2007

Risky Bets on Winning Tax Fights

Published: May 25, 2007

Death may still be certain, but taxes are something else entirely.

Disclosures are now appearing in quarterly reports from American public companies, showing that companies are betting billions on tax breaks that may not work out.

The disclosures also show that some companies keep fighting over taxes for decades. While most companies say they have cleaned up tax disputes from the 1990s and even up to 2002 or 2003, others are far slower. Some are still fighting over audits that began in the 1980s — leaving the companies at risk of paying billions in taxes and penalties.

Exxon Mobil may be the slowest of the settlers. It reports that it is still facing audits from the Internal Revenue Service for tax years back to 1989, and in Malaysia all the way back to 1983. All told, the company reports that $3.7 billion is being held in reserve to cover tax benefits the company claimed on its returns but deemed doubtful enough that it did not include them in profit reports to shareholders.

The new rule from the Financial Accounting Standards Board is supposed to make all companies account for taxes in the same way, something that has not happened in the past, when accounting rules were vague and practices seem to have varied greatly.

Getting into compliance now has caused some companies to cut their book values by hundreds of millions of dollars, and others to raise their values by similar amounts.

The part of the rule that was perhaps most anticipated by investors and tax authorities was a requirement that companies warn shareholders of expected changes in tax reserves within the next year.

The prospect of that warning scared a lot of companies, which worried that a statement that a company expected $100 million of reserves to be freed up when an audit was completed could spur the I.R.S. to get tougher in the audit. The companies begged the standards board to delay the effective date of the rule, but in vain.

There have been some disclosures. Altria, the tobacco company, says “it is reasonably possible that within the next 12 months certain U.S. state and foreign examinations will be resolved,” providing $105 million in profits for the company. Those profits would come if the taxing authorities allowed tax benefits that the company claimed but did not report to investors, presumably because it thought there was a risk they would not be approved.

But many companies found ways to talk without saying anything. “The disclosures have been handed over to the lawyers,” said Harvey L. Pitt, a former chairman of the Securities and Exchange Commission (and a nonpracticing lawyer), “and the lawyers are obfuscating.” He spoke this week at a conference on the rule sponsored by Siegel & Associates, a consulting firm.

Consider a couple of disclosures. Here’s one from JPMorgan Chase: “It is difficult to project how unrecognized tax benefits will change over the next twelve months, but it is reasonably possible that they could change significantly.”

Here’s another from Occidental Petroleum: “It is reasonably possible that Occidental’s existing liabilities for uncertain tax benefits may increase or decrease within the next twelve months primarily due to the progression of audits in process or the expiration of statutes of limitation. Occidental cannot reasonably estimate a range of potential changes in such benefits due to the unresolved nature of the various audits.”

Under the rule, companies are supposed to report in their profits any tax benefit claimed on tax returns if there is at least a 51 percent chance that the tax authorities will agree.

That standard — called “more likely than not” in tax jargon — is a pretty generous one. Some companies previously posted tax benefits they thought would probably be approved, a higher standard. Book values for those companies actually increased under the new standard. But over all, more companies cut book values than raised them, said Sampriti Ganguli, managing director of the Tax Director Roundtable, a group of corporate executives.

The leader in claiming tax benefits that it fears may not be accepted appears to be Merck, at $7.4 billion, according to a survey by David Zion, an analyst at Credit Suisse. General Electric and AT&T also reported figures over $6 billion If those tax positions are ultimately upheld, reported profits will rise by those amounts. If they are rejected, profits will not suffer unless the tax authorities reject benefits that the companies expected to be approved and reported as profit. But cash flows will be hurt.

A big question now for many companies is whether the I.R.S. will change its policies and ask to see more internal corporate documents on how the numbers were calculated, and then use the figures in audits. The I.R.S. has said it is thinking about changing its policy, Saul M. Rosen, Citigroup’s tax director, said at the Siegel conference. “Is it fair,” he asked, “for an agent to know what level of reserves a company has set up for a particular issue, or where a taxpayer thinks his position may have a weak point?”

If the I.R.S. finds itself embarrassed by companies reporting billions in profits after audits are settled in their favor, Mr. Rosen’s question may become the next big battleground in tax policy.