This case illustrates such rather controversial accounting issue as restructuring of EVC (Economic Value to the Customers), the purposes of this operation, and its implications. In order to gain a better understanding of this question, we need to summarize the key facts: such organization as United Parcel Service (UPS) filed a lawsuit against the Commissioner of Internal Revenue claiming that the respondent falsely detected deficiencies in their income statement; furthermore the petitioner argued that the company was eligible to tax deductions because it had to incur some additional expenses. It should be pointed out that UPS transferred assets to several legal entities such as Oversees Partners Ltd (OPL), and National Union Fire Insurance or (NUF).
Officially, they were not UPSs subsidiaries or subdivisions, however, at that moment they were predominantly owned by the shareholders of United Parcel Service. In other words, all these companies belonged to the same persons, and this fact significantly influenced the decision of the court. According to the allegations of UPS, the firm was entitled to a tax deduction because it had to pay certain amounts of money to these firms. But the court found that these demands were not valid (Wallace, 2003).
At this point, it is of crucial importance for us to understand whether these allegations were grounded, and more importantly whether these operations were consistent with generally accepted accounting principles.
In this case, we can single out two applicable GAAPs, namely the principles of full disclosure and non-compensation. In accordance with them, any legal entity is required to reveal all the data, which may throw light upon the financial situation within the organization. In this regard, we should say that UPS did not fully follow them, because the management of this company excluded some amount from their gross income, which certainly violates the very definition of this concept.
Such a notion as full disclosure does not validate any concealment of revenue sources. Yet, this argument cannot be fully substantiated unless we analyze the major reasons why UPS transferred their excess value activities to affiliated organizations. On the whole, it can be done for several purposes, and one of them is tax evasion, but this is just a preliminary hypothesis.
Naturally, we cannot presume that restructuring of EVC is always an attempt to evade taxes but in the overwhelming majority of cases, this is the true motive. It is necessary to understand whether Oversees Partners and National Union Fire Insurance were actually owned by UPC. In addition to that, we should the relationships, existing among these three organizations. As it has been noted before, these NUF and OPL were not branches or subdivisions of United Parcel Service at least officially, but the shares belonged to the same persons. As a rule, such kind of connection is called a “fronting agreement”, which means one legal entity purchases the right to use the name of an insurer.
Occasionally, such a contract is concluded because a certain enterprise is not experienced in this particular field, and so they need qualified services of the insurer which has established its reputation. Secondly, such an agreement can be reached provided that a firm is not licensed to write insurance (Wollan, 2002). Nonetheless, this is not the major reason in this case; because United Parcel Service had every capacity to ensure its clients, thus there is no proof indicating that there was a real necessity to transfer the assets to NUF and OPL. It should be taken into consideration that the management of UPS referred to the so-called “fronting fees”, given to NUF.
However, these fees were paid practically to the same people. But the management tried to prove that these were real disbursements. From a legal standpoint, this is a sham or fictional transaction. The money was given to these companies always remained in the possession of UPS. As a consequence, this diminished the gross income of the company, but only officially and this is the main reason why the Commissioner of Internal Revenue detected deficiencies in their statement. He noticed that NUF and OPL were daughter enterprises of United Parcel Service the company was not entitled to any tax deductions.
Therefore, we can conclude that the operations, conducted by United Parcel Service were contradictory to generally accepted accounting principles because they were pursuing neither economic nor business purposes.
The restructuring of excess value activities was done in order to diminish the state gross income, which subsequently implies tax evasion. The management of UPS alleged that they had to pay certain amounts of money to these companies while in fact, it was just a fronting agreement or just a fictional contract. Consequently, UPS was not eligible for a tax deduction and the decision of the court was quite grounded. This case is important to the extent that it shows us how various schemes can be devised in order to reduce gross income and avoid paying taxes.
Bibliography
Eugene Wollan (2002). “Handbook of Reinsurance Law”. Aspen Publishers Online.
Lawrence Witner (2001). “Sham Transactions”. Journal of Accountancy. (192), 4 pp 104-108.
Wanda A. Wallace (2003). “Mastery of the Financial Accounting Researcg System (FARS) through cases”. Wiley.