updated 2/20/2004 11:02:14 AM ET 2004-02-20T16:02:14

The U.S. Justice department launched a criminal probe into tax shelters KPMG offered to individuals and companies, intensifying its effort to stop tax avoidance schemes it regards as tantamount to evasion. 

KPMG said on Thursday it had been informed that the U.S. attorney's office in the Southern District of New York began an investigation into tax shelters it sold to customers. The probe will add to the firm's legal headaches, as it is already trying to reach a rapid settlement with the Internal Revenue Service over its past sales and marketing of tax shelters.   

"It is our understanding that the investigation is related to tax strategies that are not longer offered by the firm," KPMG said. "We have assured the U.S. attorney's office that we intend to cooperate fully in this matter." 

KPMG is the latest of the Big Four auditing firms including PricewaterhouseCoopers, Ernst & Young and Deloitte to face government criticism over its tax work in recent months. The issue has damaged the profession's reputation and raised questions over auditor independence and whether such firms use tax advice relationships to secure more lucrative work. 

The IRS's investigation into how accounting firms sold tax shelters over the past two years is part of the government's broader aggressive crackdown on tax shelter schemes it believes are illegal. 

The agency has spent a year trying to force more than 90 accounting and law firms, insurance companies, brokerages and banks to disclose the names of customers for such products. It has filed lawsuits against several large accounting firms, including KPMG and BDO Seidman, which have refused to turn over details about the customers of their tax shelters.   

Ernst & Young became the second of the Big Four firms to settle with the IRS by agreeing to pay a $15 million fine and supply the agency with full information about clients. It follows a similar accord with PwC, which agreed to pay an undisclosed fine to cover tax shelter abuses dating back to 1995.  

KPMG's problems began last November when U.S. lawmakers released details of how it aggressively marketed tax products to minimise liabilities. 

In January it attempted to draw a line under the affair with several changes to its senior personnel. It announced the retirement of one partner and reassignment of two others linked to its aggressive sales of tax products. 

Jeff Stein, deputy chairman of KPMG's U.S. business and previously vice chair of tax services, is to retire on January 31. Jeff Eischeid, the tax partner leading the personal financial planning section, has been placed on "administrative leave". Richard Smith, vice-chair of tax services for the past two years, is to get new responsibilities. 

The firm came under renewed criticism in January over its tax advice work, as it was revealed that WorldCom avoided paying hundreds of millions of dollars in state taxes under a scheme it drew up. 

The latest report into the collapse of the scandal-hit U.S. telecommunications group, now called MCI, attacks KPMG for "flawed tax advice" and says its behaviour in failing to warn of the risks of its strategies "may constitute negligence". 

The report by Richard Thornburgh, the court-appointed examiner in the WorldCom case, said the company avoided state taxes by charging subsidiaries more than $20 billion in royalties over four years. The royalties were payments for intangible assets, including one that KPMG defined as the "foresight of top management". The report said such "foresight" should not have qualified for treatment as an intangible asset. 

KPMG defended its work at WorldCom, saying the strategy was still in effect at the company: "[It] is commonly used by companies with subsidiaries in many jurisdictions to simplify their state tax structure." 

The report suggests the company has grounds for suing KPMG but MCI decided not to pursue the firm after its board and lawyers reviewed the scheme.

© The Financial Times Ltd 2010. "FT" and "Financial Times" are trademarks of the Financial Times.


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