The Office of the Chief Counsel of the IRS released an Advice Memorandum on May 6 that said a disgorgement payment to the SEC in a corporate FCPA enforcement action wasn’t tax deductible.
Section 162(f) of the Tax Code says deductions aren’t allowed “for any fine or similar penalty paid to a government for the violation of any law.”
In this case, the taxpayer — a U.S. company — entered into a consent agreement with the SEC that required disgorgement, “representing profits gained as a result of the conduct alleged in the complaint.”
While penalties usually aren’t deductible, compensatory payments are. In the Advice Memorandum, the IRS said the taxpayer couldn’t establish that the disgorgement was intended to compensate the SEC or the United States for actual losses.
The IRS said,
Here, there simply is nothing indicating that the purpose of the disgorgement payment was to compensate the United States Government or some non-governmental party for its specific losses caused by Taxpayer’s violations of the FCPA. Consequently, we think the disgorgement payment is not deductible pursuant to section 162(f) because the payment was primarily punitive. Similarly, a deduction for a loss under section 165 is prohibited. See generally Rev. Rul. 77-126, 1977-1 C.B. 47; Stephens v. Commissioner, 905 F.2d 667 (2d Cir. 1990).
Clarke predicted the IRS may try to analogize disgorgement to a criminal forfeiture of assets as a basis to argue that disgorgement is non-deductible.
That’s just what the the Office of the Chief Counsel did in the Advice Memorandum:
Additionally, we think some cases that impose disgorgement as a discretionary equitable remedy can have similarities to some cases that impose forfeiture as required by statute. Cf. United States v. Contorinis, 692 F.3d 136, 146 (2d Cir. 2012); United States v. Dobruna, 2015 U.S. Dist. LEXIS 160476 (E.D.N.Y. 2015). We note that forfeiture is not deductible even when it is used by the government to compensate victims. See Bailey, 756 F.2d at 47. Forfeiture and restitution to a victim serve different purposes, and a criminal defendant can be required to pay restitution and also forfeit an equal amount. United States v. Newman, 659 F.3d 1235, 1239-1242 (9th Cir. 2011).
In 2010, however, Clarke said “the purpose of criminal forfeiture is, in the main, different and more akin to a fine or similar penalty than is disgorgement worked by a settlement agreement in these situations.”
But as the IRS Advice Memorandum noted, “there simply is nothing indicating that the purpose of the disgorgement payment was to compensate the United States Government or some non-governmental party for its specific losses caused by Taxpayer’s violations of the FCPA.”
This question will come up again. Disgorgement is now part of most SEC enforcement actions under the FCPA, and it’s a big deal. There have been six FCPA cases with disgorgement of more than $100 million, according to our list of the ten biggest disgorgements in FCPA cases.
Meanwhile, courts aren’t bound by the IRS Advice Memorandum and it’s not legal precedent.
So the lesson today as in 2010 is that taxpayers can argue that FCPA-related disgorgements are deductible. The success of the argument will depend chiefly on what the SEC intends and how the agreement describing the disgorgement is written to reflect that intent.
The Office of the Chief Counsel of the Internal Revenue Service Advice Memorandum Number 201619008 (January 29, 2016) released May 6, 2016 is here (pdf).
Richard L. Cassin is the publisher and editor of the FCPA Blog. He’ll be the keynote speaker at the FCPA Blog NYC Conference 2016.