Ethical Obligations and Decision Making in Accounting, 4/e 1
Case 8-4 KPMG Tax Shelter Scandal
In Chapter 4 we discussed the artificial tax shelter arrangements developed by KPMG LLP for
wealthy clients that led to the settlement of a legal action with the Department of Treasury and
the Internal Revenue Service. On August 29, 2005, KPMG admitted to criminal wrongdoing and
agreed to pay $456 million in fines, restitution, and penalties as part of an agreement to defer
prosecution of the firm. In addition, nine members of the firm were criminally indicted for their
The facts of the tax shelter arrangement are complicated so we have condensed them for
purposes of this case and present them in Exhibit 1.
KPMG developed tax shelters to generate losses of $11.2 billion dollars for 601 wealthy clients
that enabled them to avoid paying $2.5 billion in income taxes. KPMG mainly used four
methods to help the wealthy clients avoid their tax liabilities or tax charges on capital gains. The
shelters implemented were the Foreign Leveraged Investment Program (FLIP), Offshore
Portfolio Investment Strategy (OPIS), Bond Linked Issue Premium Structure (BLIPS), and Short
Option Strategy (SOS/SC 2). These shelters were designed to artificially create substantial phony
In the implementation of FLIP and OPIS, KPMG issued misleading opinion letters with
assistance from its co-conspirators. The opinion letters were misleading because KPMG knew
that the tax positions taken were more likely than not to prevail against the IRS, and the opinion
letters and other documents used to implement FLIP and OPIS were false and fraudulent in a
number of ways: For instance, the opinion letters began by falsely stating that the client
requested KPMG’s opinion regarding the U.S. federal income tax consequences of certain
investment portfolio transactions, while the real fact is that the conspirators targeted wealthy
the investor with the opportunity for capital appreciation, when in fact the strategy was based on
the expected tax benefits promised by certain conspirators in the tax frauds.
EXHIBIT 1
SUMMARY OF TAX SHELTER TRANSACTIONS DEVELOPED BY KPMG1
Back in Chapter 4 we discussed the “realistic possibility of success” standard in taking tax
positions under the Statements on Standards for Tax Services of the AICPA. This is a high
standard to meet. Generally, there would need to be a 70–80 percent of prevailing if a tax
position were challenged by the IRS. The “more likely than not” standard appears in Treasury
under Section 6694 and reportable transactions.
EXHIBIT 2
CIRCULAR 230 TAX POSITIONS AND COMPLIANCE STANDARDS
Reasonable basis: Reasonable basis is the minimum standard for all tax advice and for
preparation of all tax returns and other required tax documents to avoid a penalty under Section
6694 for the underpayment of taxes. If a return position is reasonably based on at least one
relevant and persuasive tax authority cited, the return position will generally satisfy this standard.
Substantial authority: Substantial authority for the tax treatment of an item exists only if the
KPMG admitted that its personnel took specific deliberate steps to conceal the existence of the
shelters from the IRS by, among other things, failing to register the shelters with the IRS as
required by law; fraudulently concealing the shelter losses and income on tax returns; and
attempting to hide the shelters using sham attorney-client privilege claims.
The information and indictment alleged that top leadership at KPMG made the decision to
approve and participate in shelters and issue KPMG opinion letters despite significant warnings
from KPMG tax experts and others throughout the development of the shelters and at critical
Ethical Obligations and Decision Making in Accounting, 4/e 3
As we noted in Chapter 4, an unusual aspect to the case is the culture that apparently existed in
KPMG’s tax practice during the time the shelters were sold, which was to aggressively market
tax shelter arrangements targeting wealthy clients by approaching them with the deals rather than
the clients coming to KPMG. Back in the late 1990s, the stock market was booming and the firm
sought to take advantage of the increasing number of wealthy clients by accelerating its tax
services business. The head of KPMG’s tax department at the time, Jeffrey M. Stein, and its
CFO, Richard Rosenthal, created an environment that treated those who didn’t support the
KPMG had for years stoutly denied any impropriety, calling its tax advice legal. But Flynn took
a gamble and met with Justice Department officials and acknowledged that KPMG had engaged
in wrongdoing. He got no promises in return, and the admission could have sunk the firm.
Instead, it provided flexibility to the prosecutors, who were aware that the collapse of one of only
four remaining accounting giants could harm the financial markets. Two months later, the
government gave KPMG a deferred-prosecution deal, holding off indicting if KPMG paid a $456
million penalty and met other conditions.
Questions
1. What are the ethical obligations of tax practitioners under the AICPA Code? What are
their obligations with respect to taking tax positions?
Tax practitioners muse adhere to the ethics rules of the AICPA including to maintain objectivity,
although serving in an advocacy position is well-established as an exception in tax practice.
Also, due care should be followed in performing professional tax services and the SSTS should
be followed.
Ethical Obligations and Decision Making in Accounting, 4/e 4
Statement on Standards for Tax Services No. 1 (SSTS) provides excellent material to review tax
ethics standards with students. The following summarizes that statement.
The statement sets forth the applicable standards for members (CPAs) when recommending tax
return positions, or preparing or signing tax returns (including amended returns, claims for refund,
and information returns) filed with any taxing authority
.
For purposes of these standards
When recommending a tax return position, a member has both the right and the responsibility to be
an advocate for the taxpayer with respect to any position satisfying the aforementioned standard
.. Any
position recommended must have a “realistic possibility of success” if challenged by a taxing authority.
To meet the realistic possibility standard, a member should have a good-faith belief that the position
is warranted by existing law or can be supported by a good-faith argument for an extension,
modification, or reversal of the existing law through the administrative or judicial process. Such a
In determining whether a realistic possibility exists, a member should do all of the following:
•
Establish relevant background facts
•
Distill the appropriate questions from those facts
2. Evaluate the characteristics of ethical leadership with respect to the actions taken by
KPMG as described in the case. Link your discussion to the tax standards discussed in
your response to question 1.
The leadership in the tax department at KPMG was aggressive in that selling tax shelter products
to wealthy clients was more important than whether the tax shelter product was requested by the
client. The firm sought out wealthy clients rather than them approaching KPMG for help in
minimizing taxes. Beyond that, KPMG compromised its objectivity and was driven by a culture
that selling tax products was more important than anything else.
In the implementation of two tax shelters — FLIP and OPIS —, KPMG issued misleading opinion
letters with assistance from its co-conspirators. The opinion letters were misleading because
KPMG knew that the tax positions taken were more likely than not to prevail against the IRS,
and the opinion letters and other documents used to implement FLIP and OPIS were false and
fraudulent in a number of ways: For instance, the opinion letters began by falsely stating that the
Ethical Obligations and Decision Making in Accounting, 4/e 6
3. Given that KPMG completely lost sight of its public interest obligations in the tax
shelter case, and its actions cost American taxpayers at least $2.5 billion in evaded
taxes, do you believe some kind of inspection process for tax advisory/consulting
engagements should be established, similar to the one of the PCAOB for audits of
public companies? Explain.
Inspecting tax advisory/consulting services by a PCAOB-like entity might help to sharpen the
ethics of tax practitioners who are attempted to push the envelope especially where the opinion
letters are concerned. The realistic possibility of success standard is subjective and application of
this standard to a particular tax client may be influenced by pressures resulting from existing