(CNN) -- Mitt Romney's refusal to release tax
returns in the critical years of his income accumulation has done little
to dispel the legitimate concern that arises from hints buried in his
scant disclosure to date: Did he augment his wealth through highly
aggressive tax stratagems of questionable validity?
One relevant line of
inquiry, largely ignored so far, is to examine what exists in the public
record regarding his attitude toward tax compliance and tax avoidance.
While this examination is hampered because his dealings through his
private equity company, Bain Capital, are kept shrouded, there are other
indicators.
A key troubling public
manifestation of Romney's apparent insensitivity to tax obligations is
his role in Marriott International's abusive tax shelter activity, as
previously
reported by Jesse Drucker in Bloomberg.
Romney has had a close,
long-standing, personal and business connection with Marriott
International and its founders. He served as a member of the Marriott
board of directors for many years. From 1993 to 1998, Romney was the
head of the audit committee of the Marriott board.
During that period,
Marriott engaged in a series of complex and high-profile maneuvers,
including "Son of Boss," a notoriously abusive prepackaged tax shelter
that investment banks and accounting firms marketed to corporations such
as Marriott. In this respect, Marriott was in the vanguard of a
then-emerging corporate tax shelter bubble that substantially undermined
the entire corporate tax system.
Son of Boss and its
related shelters represented perhaps the largest tax avoidance scheme in
history, costing the U.S. many billions in lost corporate tax revenues.
In response, the government initiated legal challenges that resulted in
complete disallowance of the losses claimed by Marriott and other
corporations.
In addition, the Son of
Boss transaction was listed by the Internal Revenue Service as an
abusive transaction, requiring specific disclosure and subject to heavy
penalties. Statutory penalties were also made more stringent to deter
future tax shelter activity. Finally, the government brought successful
criminal prosecutions against a number of individuals involved in Son of
Boss and related transactions not associated with Marriott, including
principals at major law and accounting firms.
In his key role as
chairman of the Marriott board's audit committee, Romney approved the
firm's reporting of fictional tax losses exceeding $70 million generated
by its Son of Boss transaction. His endorsement of this stratagem
provides insight into Romney's professional ethics and attitude toward
tax compliance obligations.
Like other prepackaged
corporate tax shelters of that era, Marriott's Son of Boss transaction
was an entirely artificial transaction, bearing no relationship to its
business. Its sole purpose was to create a gigantic tax loss out of thin
air without any economic risk, cost or loss -- other than the fee
Marriott paid the promoter.
The Son of Boss transaction was vulnerable to attack on at least two grounds.
First, the transaction's
promoters and consumers relied on a strained technical statutory
analysis. Second, the Son of Boss deal violated the fundamental tax
principle that the tax law ignores transactions unless they have a
motivating business purpose and a substantial nontax economic effect.
In the Marriott case, the IRS raised both arguments and won on the first interpretive issue.
The Court of Claims
(affirmed by the Court of Appeals) rejected Marriott's technical
analysis, finding no reliable argument or authority to support it. The
court therefore did not need to reach the issue of business purpose and
economic substance. In subsequent decisions, involving similar
transactions but other parties, the courts have sustained the second
line of attack as well, finding the claimed losses to be fictitious.
The complete judicial
rejection of the Son of Boss tax scheme was entirely predictable. In
mid-1994, for example, roughly contemporaneously with Marriott's
execution of its Son of Boss trade and well before Marriott filed its
return claiming the artificial loss, the highly respected Tax Section of
the New York Bar Association filed a public comment with the U.S.
Treasury and IRS urging rejection of the technical claims made by
promoters of such schemes.
In his key position as
head of the board's audit committee, Romney was required under the
securities laws and his fiduciary duties to review the transaction. In
fact, it has been publicly reported that Romney was the Marriott Board
member most acquainted with the transaction and to whom the other board
members turned for advice. This makes sense because aggressive
tax-driven financial engineering was a large part of what Romney (and
Bain) did for a living. For these reasons, it is fair to hold him
accountable for Marriott's spurious tax reporting.
Romney's campaign staff
has attempted to deflect responsibility, arguing that he relied on
Marriott's tax department and advisers.
This claim is
disingenuous. In a transaction of this magnitude, sensitivity and
questionableness, the prudent step would be to secure advice to the
audit committee and the board from experienced and independent tax
counsel, who would certainly have cautioned that the Marriott position
was risky and not supported by precedent or proper statutory
interpretation.
Moreover, on the key
issue of the business purpose and economic substance, Romney was, or
should have been, aware of the facts that the transaction had its
genesis solely in tax avoidance and was a "marketed" tax shelter.
He had an insider's
perspective on the motivation and lack of substance in the transaction,
as well as the financial sophistication to understand the tax avoidance
involved. Romney failed in his duties to Marriott and its shareholders
and acted to undermine the fairness of the tax system.
No one could accuse
Romney of lacking the intelligence and analytical skills to have dealt
with this transaction appropriately. Indeed, his strengths in this
regard were the reason the other board members relied on him.
What emerges from this
window into corporate tax compliance behavior is the picture of an
executive who was willing to go to the edge, if not beyond, to bend the
rules to seek an unfair advantage, and then hide behind the advice of
so-called experts to deflect criticism when a scheme backfires.
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The opinions expressed in this commentary are solely those of Peter C. Canellos and Edward D. Kleinbard.
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