A parade of big companies is under investigation for inflating their earnings during the stock-market boom of the 1990s. Now some of them see an unusual silver lining: They want back the taxes they overpaid along the way.
In the latest wrinkle in the unfolding series of corporate scandals, MCI and Enron Corp. are in the process of collecting or filing for tax refunds or credits from the Internal Revenue Service because of tax payments on billions of dollars they falsely claimed to have earned. Qwest Communications International Inc., which plans to restate $2.2 billion in revenue, also is likely to seek a refund. Embattled HealthSouth Corp., accused of overstating its earnings by more than $2 billion, said that it hasn't made a final decision to file for a refund but is considering it.
Fraud or not, the current tax code makes no distinctions. It is a basic tenet of tax law -- both for individuals and corporations -- that those who overpay are entitled to a refund.
With the number of corporate scandals and expected financial restatements at a historic high, no one knows just yet how much the federal government could have to forfeit on the refunds and credits. Even if such credits are ultimately lowered as part of settlements, observers believe that the federal government will probably be out hundreds of millions of dollars.
Investigations into fraud at MCI, which recently changed its name from WorldCom Inc., have uncovered accounting irregularities that are now expected to reach $11 billion. The fraud masked two years of losses at the country's second-largest long-distance company during the height of the telecommunications and technology boom of the late 1990s.
Already, as MCI prepares to emerge from bankruptcy in September, a person close to the situation says it has collected tax refunds of nearly $300 million on those now-discredited profits.
Richard Lipton, a tax attorney for the Chicago-based law firm Baker & McKenzie, said corporate fraud should have no effect on the ability of companies to recoup tax overpayments. "It's not the government's money, it's the shareholders' money," Mr. Lipton said, adding that corporate penalties for making a false tax return are capped at $500,000.
The overpayments are one more thing for shareholders to be upset about, since companies were deprived of the use of that cash. "You are really in a sense shortchanging shareholders," says Henry Hu, a corporate and securities-law professor at the University of Texas Law School. "It is a perverse set of circumstances. You are basically making gifts to the government in order to make yourself not look bad."
In a recent study of 27 companies charged with fraud, a University of Chicago accounting professor, Merle Erickson, found that top management apparently was willing to sacrifice tax payments made in cash in order to publicly report sham earnings and revenue gains. His study found that, on average, companies "sacrificed" 11 extra cents in taxes for each dollar of fraudulent earnings.
As it turns out, companies committing fraud were more afraid of the IRS than of their own auditors. Also, tax payments in the late 1990s weren't too much of an impediment to earnings as companies touted the measure known as Ebitda, or earnings before interest, taxes, depreciation and amortization as a more accurate gauge of their results and growth potential.
Even Enron, which paid just $63 million in taxes between 1996 and 2001, is seeking tax credits, say people familiar with the matter. That may be tough to collect, however, since the IRS has claims of its own, one person familiar with the company said. Enron spokesman Mark Palmer said that the company is "in settlement discussions with the IRS."
As Richard Lipton and Henry Hu point out above, it really is the shareholders' money that was stolen and given as a gift to the government to prop up the appearance of respectability. The IRS acted as an unwitting toll booth on the way to legitimizing the imaginary profits. These companies couldn't have achieved have the results they did simply by doing business, so they created a house of mirrors that included paying hundreds of millions of dollars in actual taxes that protected the illusion from further scrutiny. For a while, anyway.
Getting the money back from the IRS, out of the hands of the Bush administration (which helped to create this haze of corporate irresponsibility), and into the deserving hands of the shareholders who were swindled is therefore, in the words of an embattled Martha Stewart, still a good thing.